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SIRI > SEC Filings for SIRI > Form 10-Q on 25-Apr-2014All Recent SEC Filings

Show all filings for SIRIUS XM HOLDINGS INC.

Form 10-Q for SIRIUS XM HOLDINGS INC.


25-Apr-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(All dollar amounts referenced in this Item 2 are in thousands, unless otherwise stated)

The terms "we," "us," "our," and "our company" as used herein and unless otherwise stated or indicated by context, refer to Sirius XM Radio Inc. and its subsidiaries prior to our corporate reorganization and to Sirius XM Holdings Inc. and its subsidiaries after our corporate reorganization.

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 Quarterly Report on Form 10-Q 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 Quarterly Report on Form 10-Q and in other reports and documents published by us from time to time, particularly the risk factors described under "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013 and "Management's Discussion and Analysis of Financial Condition and Results or Operations" herein and in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2013.

Among the significant factors that could cause our actual results to differ materially from those expressed in the forward-looking statements are:

we face substantial competition and that competition is likely to increase over time;

our ability to attract and retain subscribers in the future is uncertain;

our business depends in large part upon the auto industry;

general economic conditions can affect our business;

failure of our satellites would significantly damage our business;

interruption or failure of our information technology and communications systems could negatively impact our results and our brand;

if we fail to protect the security of personal information about our customers, we could be subject to costly government enforcement actions and private litigation and our reputation could suffer;

royalties for music rights have increased and there can be no assurance they will not continue to increase in the future;

the unfavorable outcome of pending or future litigation could have a material adverse effect;

we may not realize the benefits of acquisitions or other strategic initiatives, including the acquisition of Agero's connected vehicle business;

rapid technological and industry changes could adversely impact our services;

failure of third parties to perform could adversely affect our business;

changes in consumer protection laws and their enforcement could damage our business;

failure to comply with FCC requirements could damage our business;

other existing or future government laws and regulations could harm our business;

we may from time to time modify our business plan, and these changes could adversely affect us and our financial condition;

our indebtedness could adversely affect our operations and could limit our ability to react to changes in the economy or our industry;

our broadcast studios, terrestrial repeater networks, satellite uplink facilities or other ground facilities could be damaged by natural catastrophes or terrorist activities;

Holdings' principal stockholder has significant influence over our management and over actions requiring general stockholder approval and its interests may differ from the interests of other holders of Holdings' common stock;

Holdings is a "controlled company" within the meaning of the NASDAQ listing rules and, as a result, qualifies for, and relies on, exemptions from certain corporate governance requirements; and

our business may be impaired by third-party intellectual property rights.

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


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on which the statement is made, to reflect the occurrence of unanticipated events or otherwise, except as required by law. 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.

Executive Summary

We broadcast music, sports, entertainment, comedy, talk, news, traffic and weather channels, as well as infotainment services, in the United States on a subscription fee basis through our two proprietary satellite radio systems. Subscribers can also receive music and other channels, plus features such as SiriusXM On Demand and MySXM, over the Internet, including through applications for mobile devices. We are also a leader in providing connected vehicle applications and services. Our connected vehicle services are designed to enhance the safety, security and driving experience for vehicle owners while providing marketing and operational benefits to automakers and their dealers. Subscribers to our connected vehicle services are not included in our subscriber count.

We have agreements with every major automaker ("OEMs") to offer satellite radios in their vehicles from which we acquire a majority of our subscribers. We also acquire subscribers through marketing to owners of factory-installed satellite radios that are not currently subscribing to our services. Additionally, we distribute our satellite radios through retail locations nationwide and through our website. Satellite radio services are also offered to customers of certain daily rental car companies.

As of March 31, 2014, we had 25,826,109 subscribers of which 21,255,297 were self-pay subscribers and 4,570,812 were paid promotional subscribers. Our subscriber totals include subscribers under our regular pricing plans; discounted pricing plans; subscribers that have prepaid, including payments either made or due from automakers for subscriptions included in the sale or lease price of a vehicle; subscribers to our Internet services who do not also have satellite radio subscriptions; and certain subscribers to our weather, traffic, data and Backseat TV 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 longer term subscription plans as well as discounts for multiple subscriptions. We also derive revenue from activation and other fees, the sale of advertising on select non-music channels, the direct sale of satellite radios and accessories, and other ancillary services, such as our weather, traffic, data and Backseat TV services.

In certain cases, automakers and dealers include a subscription to our radio services in the sale or lease price of new vehicles or previously owned vehicles. The length of these trial subscriptions varies but is typically three to twelve months. We receive subscription payments for these trials from certain automakers. We also reimburse various automakers for certain costs associated with satellite radios installed in new vehicles.

Liberty Media Corporation beneficially owns, directly and indirectly, over 50% of the outstanding shares of our common stock. Liberty Media owns interests in a broad range of media, communications and entertainment businesses, including its subsidiaries, Atlanta National League Baseball Club, Inc. and TruePosition, Inc., its interests in Charter Communications, Live Nation Entertainment and minority equity investments in Time Warner Inc., Time Warner Cable and Viacom.

On January 3, 2014, Holdings' Board of Directors received a non-binding letter from Liberty Media proposing a transaction pursuant to which all outstanding shares of common stock of Holdings not owned by Liberty Media would be converted into the right to receive 0.0760 of a new share of Liberty Series C common stock, which would have no voting rights. On March 13, 2014, Liberty Media announced that its proposal was no longer applicable.

We also have a 37% equity interest in Sirius XM Canada which offers satellite radio services in Canada. Subscribers to the Sirius XM Canada service are not included in our subscriber count.


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Results of Operations

Set forth below are our results of operations for the three months ended
March 31, 2014 compared with the three months ended March 31, 2013.
                                                          Unaudited
                                                 For the Three Months Ended
                                                          March 31,                2014 vs 2013 Change
(in thousands)                                      2014             2013           Amount          %
Revenue:
Subscriber revenue                              $  851,436       $  783,342     $     68,094         9  %
Advertising revenue                                 22,214           20,211            2,003        10  %
Equipment revenue                                   23,978           18,156            5,822        32  %
Other revenue                                      100,083           75,689           24,394        32  %
Total revenue                                      997,711          897,398          100,313        11  %
Operating expenses:
Cost of services:
Revenue share and royalties                        195,411          148,531           46,880        32  %
Programming and content                             74,870           74,610              260         -  %
Customer service and billing                        91,069           80,394           10,675        13  %
Satellite and transmission                          21,380           19,695            1,685         9  %
Cost of equipment                                    7,804            7,027              777        11  %
Subscriber acquisition costs                       123,022          116,111            6,911         6  %
Sales and marketing                                 76,327           65,899           10,428        16  %
Engineering, design and development                 15,911           14,842            1,069         7  %
General and administrative                          76,243           56,340           19,903        35  %
Depreciation and amortization                       68,267           67,018            1,249         2  %
Total operating expenses                           750,304          650,467           99,837        15  %
Income from operations                             247,407          246,931              476         -  %
Other income (expense):
Interest expense, net of amounts capitalized       (54,092 )        (46,174 )         (7,918 )     (17 )%
Interest and investment income                       4,349            1,638            2,711       166  %
Loss on change in value of derivatives             (27,023 )              -          (27,023 )    (100 )%
Other income                                            95              247             (152 )     (62 )%
Total other expense                                (76,671 )        (44,289 )        (32,382 )     (73 )%
Income before income taxes                         170,736          202,642          (31,906 )     (16 )%
Income tax expense                                 (76,748 )        (79,040 )          2,292         3  %
Net income                                      $   93,988       $  123,602     $    (29,614 )     (24 )%


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Our results of operations discussed below include Sirius XM Connected Vehicle Services Inc. activity in 2014, as well as the impact of purchase price accounting adjustments associated with the July 2008 merger between our wholly owned subsidiary, Vernon Merger Corporation, and XM Satellite Radio Holdings Inc. (the "Merger"). The purchase price accounting adjustments related to the Merger, include the: (i) elimination of deferred revenue associated with the investment in XM Canada, (ii) recognition of deferred subscriber revenues not recognized in purchase price accounting, and (iii) elimination of the benefit of deferred credits on executory contracts, which are primarily attributable to third party arrangements with an OEM and programming providers. The deferred credits on executory contracts attributable to third party arrangements with an OEM included in revenue share and royalties, subscriber acquisition costs, and sales and marketing concluded with the expiration of the acquired contract during 2013. The impact of these purchase price accounting adjustments is detailed in our Adjusted Revenues and Operating Expenses tables on pages 44 through 45 of our glossary.

Total Revenue

Subscriber Revenue includes subscription, activation and other fees.

For the three months ended March 31, 2014 and 2013, subscriber revenue was $851,436 and $783,342, respectively, an increase of 9%, or $68,094. The increase was primarily attributable to a 7% increase in the daily weighted average number of subscribers, the inclusion of subscription revenue generated by our connected vehicle business and the increase in certain of our subscription rates beginning in January 2014. These increases were partially offset by growth in subscription discounts offered through customer acquisition and retention programs, an increasing number of lifetime subscription plans that have reached full revenue recognition and a change in an agreement with an automaker.

We expect subscriber revenues to increase based on the growth of our subscriber base, including connected vehicle subscribers, the effects of an increase in certain of our subscription rates in January 2014 and the sale of additional subscription services to subscribers.

Advertising Revenue includes the sale of advertising on certain non-music channels, net of agency fees. Agency fees are based on a contractual percentage of the gross advertising revenue.

For the three months ended March 31, 2014 and 2013, advertising revenue was $22,214 and $20,211, respectively, an increase of 10%, or $2,003. The increase was primarily due to a greater number of advertising spots sold and broadcast.

We expect our advertising revenue to grow as more advertisers are attracted to our national platform and growing subscriber base and as we launch additional non-music channels.

Equipment Revenue includes revenue and royalties from the sale of satellite radios, components and accessories.

For the three months ended March 31, 2014 and 2013, equipment revenue was $23,978 and $18,156, respectively, an increase of 32%, or $5,822. The increase was driven by royalties from higher OEM production and sales to distributors, partially offset by lower per unit revenue on direct to consumer sales.

We expect equipment revenue to increase based on OEM production for which we receive royalty payments for our technology and, to a lesser extent, on the volume and mix of equipment sales in our aftermarket and direct to consumer business.

Other Revenue includes amounts earned from subscribers for the U.S. Music Royalty Fee, revenue from our Canadian affiliate and ancillary revenues.

For the three months ended March 31, 2014 and 2013, other revenue was $100,083 and $75,689, respectively, an increase of 32%, or $24,394. The increase was driven by revenues from the U.S. Music Royalty Fee as the number of subscribers on the 12.5% rate increased along with an increase in subscribers, and higher royalty revenue from Sirius XM Canada.

We expect other revenue to increase as our subscriber base drives higher U.S. Music Royalty Fees and as the revenue of our Canadian affiliate grows.


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Operating Expenses

Revenue Share and Royalties include distribution and content provider revenue share, advertising revenue share, and broadcast and web streaming royalties. Advertising revenue share is recognized in revenue share and royalties in the period in which the advertising is broadcast.

For the three months ended March 31, 2014 and 2013, revenue share and royalties were $195,411 and $148,531, respectively, an increase of 32%, or $46,880, and increased as a percentage of total revenue. The increase was due, in part, to greater revenues subject to royalty and revenue sharing arrangements and a 5.6% increase in the statutory royalty rate for the performance of sound recordings; partially offset by improved OEM revenue share rates due to a change in a contract with an automaker. Revenue share and royalties was also negatively impacted by the absence of a benefit to earnings from the amortization of deferred credits on executory contracts initially recognized in purchase price accounting associated with the Merger. For the three months ended March 31, 2013, revenue share and royalties was positively impacted by a $39,761 benefit to earnings from the amortization of these deferred credits on executory contracts.

We expect our revenue share and royalty costs to increase as our revenues grow, our royalty rates increase and as a result of the discontinued deferred credits on executory contracts associated with the Merger.

Programming and Content includes costs to acquire, create, promote and produce content. We have entered into various agreements with third parties for music and non-music programming that require us to pay license fees and other amounts.

For the three months ended March 31, 2014 and 2013, programming and content expenses were $74,870 and $74,610, respectively, an increase of less than 1%, or $260, but decreased as a percentage of total revenue. The increase was primarily due to a $1,533 reduction in the benefit to earnings from the purchase price accounting adjustments associated with the Merger attributable to the amortization of the deferred credit on acquired programming executory contracts and increased personnel costs. The increase was partially offset by the renewal of certain agreements at more cost effective terms.

We expect our programming and content expenses to fluctuate as we offer additional programming, and renew or replace expiring agreements.

Customer Service and Billing includes costs associated with the operation and management of internal and third party customer service centers, and our subscriber management systems as well as billing and collection costs, transaction fees and bad debt expense.

For the three months ended March 31, 2014 and 2013, customer service and billing expenses were $91,069 and $80,394, respectively, an increase of 13%, or $10,675, but remained flat as a percentage of total revenue. The increase was primarily due to the inclusion of costs associated with our connected vehicle services business for the first quarter of 2014 and higher subscriber volume driving increased subscriber contacts.

We expect our customer service and billing expenses to increase as our subscriber base grows and as we attempt to improve the customer service experience for our subscribers.

Satellite and Transmission consists of costs associated with the operation and maintenance of our satellites; satellite telemetry, tracking and control systems; terrestrial repeater networks; satellite uplink facilities; broadcast studios; and delivery of our Internet streaming service.

For the three months ended March 31, 2014 and 2013, satellite and transmission expenses were $21,380 and $19,695, respectively, an increase of 9%, or $1,685, but remained flat as a percentage of total revenue. The increase was primarily due to increased satellite insurance expense and costs associated with our Internet streaming operations.

We expect overall satellite and transmission expenses to increase as we enhance our Internet-based service and add functionality, and expand our terrestrial repeater network.


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Cost of Equipment includes costs from the sale of satellite radios, components and accessories and provisions for inventory allowance attributable to products purchased for resale in our direct to consumer distribution channels.

For the three months ended March 31, 2014 and 2013, cost of equipment was $7,804 and $7,027, respectively, an increase of 11%, or $777, and decreased as a percentage of equipment revenue. The increase was primarily due to higher sales to distributors, partially offset by lower costs per unit on direct to consumer sales.

We expect cost of equipment to increase with changes in sales, supply chain management and inventory valuations.

Subscriber Acquisition Costs include hardware subsidies paid to radio manufacturers, distributors and automakers; subsidies paid for chip sets and certain other components used in manufacturing radios; device royalties for certain radios and chip sets; commissions paid to automakers and retailers; product warranty obligations; freight; and provisions for inventory allowances attributable to inventory consumed in our OEM and retail distribution channels. The majority of subscriber acquisition costs are incurred and expensed in advance of, or concurrent with, acquiring a subscriber. Subscriber acquisition costs do not include advertising, marketing, loyalty payments to distributors and dealers of satellite radios or revenue share payments to automakers and retailers of satellite radios.

For the three months ended March 31, 2014 and 2013, subscriber acquisition costs were $123,022 and $116,111, respectively, an increase of 6%, or $6,911, but decreased as a percentage of total revenue. The increase was primarily due to eliminating the benefit to earnings in 2014 from the amortization of deferred credits on executory contracts initially recognized in purchase price accounting associated with the Merger and an increase in satellite radio installations in new vehicles, partially offset by improved OEM subsidy rates per vehicle and a change in a contract with an automaker. For the three months ended March 31, 2013, the benefit to earnings from amortization of deferred credits was $22,005.

We expect subscriber acquisition costs to fluctuate with OEM installations and aftermarket volume; however, OEM subsidy rates and the cost of subsidized radio components are expected to decline. We intend to continue to offer subsidies, commissions and other incentives to acquire subscribers.

Sales and Marketing includes costs for advertising, media and production, including promotional events and sponsorships; cooperative marketing; customer acquisition and retention, and personnel. Cooperative marketing costs include fixed and variable payments to reimburse retailers and automakers for the cost of advertising and other product awareness activities performed on our behalf. Customer acquisition and retention costs include expenses related to direct mail, outbound telemarketing and email communications.

For the three months ended March 31, 2014 and 2013, sales and marketing expenses were $76,327 and $65,899, respectively, an increase of 16%, or $10,428, and increased as a percentage of total revenue. The increase was primarily due to additional subscriber communications and retention programs associated with a greater number of subscribers and promotional trials, costs associated with our connected vehicle services business, and not receiving the benefit to earnings in 2014 from the amortization of the deferred credit for acquired executory contracts recognized in purchase price accounting associated with the Merger.

We anticipate that sales and marketing expenses will increase as changes in certain contractual marketing agreements become effective and as we expand programs to retain our existing subscribers, win back former subscribers, and attract new subscribers. We expect the increase in sales and marketing costs to be partially offset by the impact of the expiration of the acquired executory contracts.

Engineering, Design and Development includes costs to develop chip sets and new products and services, research and development for broadcast information systems and costs associated with the incorporation of our radios into new vehicles manufactured by automakers.

For the three months ended March 31, 2014 and 2013, engineering, design and development expenses were $15,911 and $14,842, respectively, an increase of 7%, or $1,069, but remained flat as a percentage of total revenue. The increase was driven primarily by costs associated with our connected vehicle services business, higher product development costs, and expenses related to enhanced subscriber features and functionality for our service.

We expect engineering, design and development expenses to increase in future periods as we continue to develop our products and services.


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General and Administrative includes executive management, rent and occupancy, finance, legal, human resources, information technology, and insurance costs.

For the three months ended March 31, 2014 and 2013, general and administrative expenses were $76,243 and $56,340, respectively, an increase of 35% or $19,903, and increased as a percentage of total revenue. The increase was primarily driven by personnel costs associated with our connected vehicle services business for the first quarter of 2014, legal fees and costs, particularly legal and investment banking expenses, related to the Liberty Media proposal.

We expect our general and administrative expenses to increase in future periods as a result of, among other things, enhanced information technology, on-going legal costs and personnel costs to support the growth of our business.

Depreciation and Amortization represents the recognition in earnings of the acquisition cost of assets used in operations, including our satellite constellations, property, equipment and intangible assets, over their estimated service lives.

For the three months ended March 31, 2014 and 2013, depreciation and amortization expense was $68,267 and $67,018, respectively, an increase of 2%, or $1,249, and decreased as a percentage of total revenue. The increase was driven by the inclusion of costs associated with our connected vehicle services business, and additional assets placed in-service, including our FM-6 satellite, offset by a reduction of amortization associated with the stepped-up basis in assets acquired in the Merger (including intangible assets, satellites, property and equipment) through the end of their estimated service lives and certain satellites reaching the end of their estimated service lives.

We expect depreciation expense to decrease in future periods due to reduced amortization associated with the stepped-up basis in assets acquired in the . . .

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