Future subscriber revenue will be dependent upon, among other things, the growth of our subscriber base, promotions, mail-in rebates offered to subscribers and corresponding take-rates, plan mix, subscription prices and the identification of additional revenue streams from subscribers.
For the three months ended March 31, 2007 and 2006, net advertising revenue was $6,721 and $7,338, respectively, a decrease of $617.
We expect advertising revenue to grow as our subscribers increase, as we continue to improve brand awareness and content, and as we increase the size and effectiveness of our advertising sales force. Advertising revenue is also subject to fluctuation based on the overall radio advertising environment, as well as the mix of businesses advertising their goods and services.
For the three months ended March 31, 2007 and 2006, equipment revenue was $4,671 and $3,692, respectively, an increase of $979. The increase was the result of higher sales through our direct to consumer distribution channel, offset by the effects of promotional discounts.
We expect equipment revenue to increase as we continue to introduce new products and as sales grow through our direct to consumer distribution channel.
For the three months ended March 31, 2007 and 2006, satellite and transmission expenses were $7,986 and $8,203, respectively, a decrease of $217. Excluding stock-based compensation of $656 and $902 for the three months ended March 31, 2007 and 2006, respectively, satellite and transmission expenses increased $29 from $7,301 to $7,330. As of March 31, 2007 and 2006, we had 127 and 139 terrestrial repeaters, respectively, in operation.
Future increases in satellite and transmission expenses will primarily be attributable to the launch of new satellites, the addition of new terrestrial repeaters and maintenance costs of existing terrestrial repeaters. We expect to deploy additional terrestrial repeaters in 2007 and 2008 subject to obtaining necessary regulatory approvals. Such expenses may also increase in future periods if we decide to reinstate our in-orbit satellite insurance.
For the three months ended March 31, 2007 and 2006, programming and content expenses were $59,998 and $299,734, respectively, a decrease of $239,736. Excluding stock-based compensation of $2,935 and $249,800 for the three months ended March 31, 2007 and 2006, respectively, programming and content expenses increased $7,129 from $49,934, to $57,063. This increase of $7,129 was primarily attributable to license fees associated with new programming and compensation related costs for additions to headcount. Stock-based compensation decreased $246,865 primarily due to expense associated with shares of our common stock delivered to Howard Stern and his agent in January 2006 upon the satisfaction of performance targets in 2006.
Our programming and content expenses, excluding stock-based compensation expense, will increase as we continue to develop and enhance our channels. We regularly evaluate programming opportunities and may choose to acquire and develop new content or renew current programming agreements in the future at substantial costs.
Future expense associated with stock-based compensation is contingent upon a number of factors, including the number of stock-based awards granted, the price of our common stock, assumptions used in estimating the fair value of stock-based awards, estimates for forfeitures, vesting provisions and the timing as to when certain performance criteria are met, and could materially change.
Revenue Share and Royalties. Revenue share and royalties include distribution and content partner revenue share, residuals and broadcast and webstreaming royalties. Residuals are monthly fees paid based upon the number of subscribers using a SIRIUS radio purchased from a retailer.
For the three months ended March 31, 2007 and 2006, revenue share and royalties were $27,134 and $13,527, respectively, an increase of $13,607. This increase was primarily attributable to increased revenue share as a result of increased revenue from OEM subscriptions and broadcast royalties as a result of higher total revenues.
We expect revenue share to increase as we continue to experience revenue growth and expand our distribution of SIRIUS radios through automakers. In addition, we expect broadcast and webstreaming royalties, which are typically variable in nature, to increase as our subscriber base grows. We are currently a party to a proceeding before the Copyright Royalty Board of the Library of Congress to establish the royalty rate and terms for the sound recordings we use on our satellite radio service for the period 2007 through 2012.
Customer Service and Billing. Customer service and billing expenses include costs associated with the operation of our customer service centers and subscriber management system as well as bad debt expense.
For the three months ended March 31, 2007 and 2006, customer service and billing expenses were $21,853 and $17,862, respectively, an increase of $3,991. Excluding stock-based compensation of $199 and $244 for the three months ended March 31, 2007 and 2006, respectively, customer service and billing expenses increased $4,036 from $17,618 to $21,654. This increase of $4,036 was primarily due to increased call center operating costs necessary to accommodate our subscriber base and transaction fees due to the addition of new subscribers. Customer service and billing expenses, excluding stock-based compensation, increased 23% compared with an increase in subscribers of 61% year over year.
We expect our customer care and billing expenses, excluding stock-based compensation expense, to increase as our subscriber base grows due to increased call center operating costs, transaction fees necessary to serve a larger subscriber base and bad debt expense.
Cost of Equipment. Cost of equipment includes costs for SIRIUS radios and accessories sold through our direct to consumer distribution channel.
For the three months ended March 31, 2007 and 2006, cost of equipment was $9,292 and $3,465, respectively, an increase of $5,827. The increase was primarily attributable to higher sales volume, offset by a decline in per unit costs. In addition, we recorded $2,782 for the three months ended March 31, 2007 to the inventory allowance primarily as a result of lower of cost or market adjustments and reserves for slow moving inventory.
We expect cost of equipment to increase in the future as we introduce new products and as sales through our direct to consumer distribution channel grow.
Sales and Marketing. Sales and marketing expenses include costs for advertising, media and production, including promotional events and sponsorships; cooperative marketing; customer retention and compensation. Cooperative marketing costs include fixed and variable payments to reimburse retailers and automakers for the cost of advertising and other product awareness activities.
For the three months ended March 31, 2007 and 2006, sales and marketing expenses were $38,162 and $34,481, respectively, an increase of $3,681. Excluding stock-based compensation of $5,644 and $2,202 for the three months ended March 31, 2007 and 2006, respectively, sales and marketing expenses increased $239 from $32,279 to $32,518. Sales and marketing expenses were relatively consistent for the first quarter of 2007 as compared to the first quarter of 2006, despite a 61% increase in total revenue.
We expect sales and marketing expenses, excluding stock-based compensation expense, to increase as we continue to build brand awareness through national advertising and promotional activities and expand our subscriber retention efforts.
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Future expense associated with stock-based compensation is contingent upon a number of factors, including the number of stock-based awards granted, the price of our common stock, assumptions used in estimating the fair value of stock-based awards, estimates for forfeitures, vesting provisions and the timing as to when certain performance criteria are met, and could materially change.
Subscriber Acquisition Costs. Subscriber acquisition costs include hardware subsidies paid to radio manufacturers, distributors and automakers, including subsidies paid to automakers who include a SIRIUS radio and a prepaid subscription to our service in the sale or lease price of a new vehicle; subsidies paid for chip sets and certain other components used in manufacturing radios; commissions paid to retailers and automakers as incentives to purchase, install and activate SIRIUS radios; product warranty obligations; provisions for inventory allowance; and compensation costs associated with stock-based awards granted in connection with certain distribution agreements. The majority of subscriber acquisition costs are incurred and expensed in advance of acquiring a subscriber. Subscriber acquisition costs do not include advertising, loyalty payments to distributors and dealers of SIRIUS radios and revenue share payments to automakers and retailers of SIRIUS radios. Subscriber acquisition costs also do not include amounts capitalized in connection with our agreement with Hertz, as we retain ownership of certain SIRIUS radios used by Hertz.
For the three months ended March 31, 2007 and 2006, subscriber acquisition costs were $100,117 and $119,043, respectively, a decrease of 16% or $18,926. Excluding stock-based compensation of $1,880 and $9,899 for the three months ended March 31, 2007 and 2006, respectively, subscriber acquisition costs decreased 10%, or $10,907, from $109,144 to $98,237. This decrease of $10,907 was primarily attributable to lower commissions and decreased aftermarket subsidies, as we continued to reduce manufacturing and chip set costs, offset by increased OEM hardware subsidies due to higher production volume and provisions for inventory allowance. Stock-based compensation decreased $8,019 primarily due to the timing of third parties achieving milestones and changes in the fair market value of such awards.
We expect total subscriber acquisition costs, excluding stock-based compensation expense, to decrease as increases in our gross subscriber additions are offset by continuing declines in the costs of subsidized components of SIRIUS radios. We intend to continue to offer subsidies, commissions and other incentives to acquire subscribers.
Future expense associated with stock-based compensation is contingent upon a number of factors, including the number of stock-based awards granted, the price of our common stock, assumptions used in estimating the fair value of stock-based awards, estimates for forfeitures, vesting provisions and the timing as to when certain performance criteria are met, and could materially change.
General and Administrative. General and administrative expenses include rent and occupancy, finance, legal, human resources, information technology and investor relations costs.
For the three months ended March 31, 2007 and 2006, general and administrative expenses were $35,343 and $31,873, respectively, an increase of $3,470. Excluding stock-based compensation of $11,940 and $14,506 for the three months ended March 31, 2007 and 2006, respectively, general and administrative expenses increased $6,036 from $17,367 to $23,403. This increase of $6,036 was primarily a result of legal fees and employment related and information technology costs to support the growth of our business. Stock-based compensation decreased $2,566 primarily as a result of restricted stock units that vested in the first quarter of 2006.
We expect our general and administrative expenses, excluding stock-based compensation expense, to increase in future periods as a result of higher personnel, information technology, and facilities costs, as well as increased legal fees to support the growth of our business.
Future expense associated with stock-based compensation is contingent upon a number of factors, including the number of stock-based awards granted, the price of our common stock, assumptions used in estimating the fair value of stock-based awards, estimates for forfeitures, vesting provisions and the timing as to when certain performance criteria are met, and could materially change.
Engineering, Design and Development. Engineering, design and development expenses include costs to develop our future generation of chip sets and new products and costs associated with the incorporation of SIRIUS radios into vehicles manufactured by automakers.
For the three months ended March 31, 2007 and 2006, engineering, design and development expenses were $12,411 and $19,712, respectively, a decrease of $7,301. Excluding stock-based compensation of $1,006 and $7,033 for the three months ended March 31, 2007 and 2006, respectively, engineering, design and development expenses
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decreased $1,274 from $12,679 to $11,405. This decrease of $1,274 was primarily attributable to a decrease in costs associated with the manufacturing of SIRIUS radios and OEM tooling and manufacturing upgrades, offset by increases in employment related costs. Stock-based compensation decreased $6,027 primarily due to the timing of third parties achieving certain production milestones.
We expect engineering, design and development expenses, excluding stock-based compensation expense, to decrease, as the work required to incorporate SIRIUS radios and accessories in a significant number of vehicle models was completed in 2006.
Other Income (Expense)
Interest and Investment Income. Interest and investment income includes realized gains and losses, dividends and interest income, including amortization of the premium and discount arising at purchase.
For the three months ended March 31, 2007 and 2006, interest and investment income was $6,042 and $9,937, respectively, a decrease of $3,895. The decrease was attributable to a lower average cash balance.
Interest Expense. Interest expense includes interest on outstanding debt, reduced by interest capitalized in connection with the construction of our new satellite and launch vehicle.
For the three months ended March 31, 2007 and 2006, interest expense was $15,192 and $17,124, respectively, a decrease of $1,932. The decrease was primarily the result of capitalized interest in 2007 associated with satellite construction and the related launch vehicle.
Equity in Net Loss of Affiliate. Equity in net loss of affiliate includes our share of SIRIUS Canada’s net loss.
We recorded $0 and $4,445 for the three months ended March 31, 2007 and 2006, respectively, for our share of SIRIUS Canada’s net loss.
As of March 31, 2007, our investment in SIRIUS Canada was $0 as we fully recognized our share of SIRIUS Canada’s net loss to the extent we have funded it. We do not expect to recognize future net losses unless we commit to additional funding.
Income Taxes
Income Tax Expense. Income tax expense represents the recognition of a deferred tax liability related to the difference in accounting for our FCC license, which is amortized over 15 years for tax purposes but not amortized for book purposes in accordance with U.S. generally accepted accounting principles.
We recorded income tax expense of $555 and $753 for the three months ended March 31, 2007 and 2006, respectively.
Footnotes to Results of Operations
| (1) | Average monthly churn represents the number of deactivated subscribers divided by average quarterly subscribers. |
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| (2) | ARPU is derived from total earned subscriber revenue and net advertising revenue divided by the daily weighted average number of subscribers for the period. ARPU is calculated as follows: |
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| | | For the Three Months Ended |
| | | | March 31, | | | | December 31, | | | September 30, | | | June 30, | | | | March 31. | |
| | | | 2007 | | | | 2006 | | | 2006 | | | 2006 | | | | 2006 | |
| Subscriber revenue | | $ | 190, 796 | | | $ | 167,210 | | | $ | 155,373 | | | $ | 137,640 | | | $ | 115,181 | |
| Net advertising revenue | | | 6,721 | | | | 8,451 | | | | 7,130 | | | | 8,125 | | | | 7,338 | |
| Total subscriber and net advertising revenue | | $ | 197,517 | | | $ | 175,661 | | | $ | 162,503 | | | $ | 145,765 | | | $ | 122,519 | |
| Daily weighted average number of subscribers | | | 6,295,282 | | | | 5,361,322 | | | | 4,848,293 | | | | 4,354,447 | | | | 3,782,543 | |
| ARPU | | $ | 10.46 | | | $ | 10.92 | | | $ | 11.17 | | | $ | 11.16 | | | $ | 10.80 | |
| (3) | SAC, as adjusted, per gross subscriber addition is derived from subscriber acquisition costs, excluding stock-based compensation, and margins from the direct sale of SIRIUS radios and accessories divided by the number of gross subscriber additions for the period. SAC, as adjusted, per gross subscriber addition is calculated as follows: |
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| | | For the Three Months Ended |
| | | | March 31, | | | | December 31, | | | September 30, | | | June 30, | | | | March 31. | |
| | | | 2007 | | | | 2006 | | | 2006 | | | 2006 | | | | 2006 | |
| Subscriber acquisition costs | | $ | 100,117 | | | $ | 122,196 | | | $ | 79,812 | | | $ | 130,563 | | | $ | 119,043 | |
| Less: stock-based compensation | | | (1,880 | ) | | | (1,150 | ) | | | 1,051 | | | | (21,900 | ) | | | (9,899 | ) |
| Add: margin from direct sale of SIRIUS | | | | | | | | | | | | | | | | | | | | |
| radios and accessories | | | 4,621 | | | | 5,674 | | | | 2,617 | | | | 371 | | | | (227 | ) |
| SAC, as adjusted | | $ | 102,858 | | | $ | 126,720 | | | $ | 83,480 | | | $ | 109,034 | | | $ | 108,917 | |
| Gross subscriber additions | | | 988,458 | | | | 1,234,576 | | | | 732,406 | | | | 830,571 | | | | 960,610 | |
| SAC, as adjusted, per gross subscriber addition | | $ | 104 | | | $ | 103 | | | $ | 114 | | | $ | 131 | | | $ | 113 | |
| (4) | Customer service and billing expenses, as adjusted, per average subscriber is derived from total customer service and billing expenses, excluding stock-based compensation, divided by the daily weighted average number of subscribers for the period. Customer service and billing expenses, as adjusted, per average subscriber is calculated as follows: |
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| | | For the Three Months Ended |
| | | | March 31, | | | | December 31, | | | September 30, | | | June 30, | | | | March 31. | |
| | | | 2007 | | | | 2006 | | | 2006 | | | 2006 | | | | 2006 | |
| Customer service and billing expenses | | $ | 21,853 | | | $ | 25,912 | | | $ | 16,822 | | | $ | 15,866 | | | $ | 17,862 | |
| Less: stock-based compensation | | | (199 | ) | | | (167 | ) | | | (197 | ) | | | (204 | ) | | | (244 | ) |
| Customer service and billing expenses, as adjusted | | $ | 21,654 | | | $ | 25,745 | | | $ | 16,625 | | | $ | 15,662 | | | $ | 17,618 | |
| Daily weighted average number of subscribers | | | 6,295,282 | | | | 5,361,322 | | | 4,848,293 | | | | 4,354,447 | | | | 3,782,543 | |
| Customer service and billing expenses, | | | | | | | | | | | | | | | | | | | | |
| as adjusted, per average subscriber | | $ | 1.15 | | | $ | 1.60 | | | $ | 1.14 | | | $ | 1.20 | | | $ | 1.55 | |
| (5) | Free cash flow is derived from cash flow (used in) provided by operating activities, capital expenditures and restricted and other investment activity. Free cash flow is calculated as follows: |
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| | | For the Three Months Ended |
| | | | March 31, | | | | December 31, | | | | September 30, | | | | June 30, | | | | March 31. | |
| | | | 2007 | | | | 2006 | | | | 2006 | | | | 2006 | | | | 2006 | |
| Net cash (used in) provided by operating activities | | $ | (133,947 | ) | | $ | 34,868 | | | $ | (183,330 | ) | | $ | (108,915 | ) | | $ | (157,172 | ) |
| Additions to property and equipment | | | (12,458 | ) | | | (5,459 | ) | | | (66,588 | ) | | | (22,284 | ) | | | (5,496 | ) |
| Restricted and other investment activity | | | (310 | ) | | | 1,000 | | | | 17,562 | | | | (2,032 | ) | | | (2,869 | ) |
| Free cash flow | | $ | (146,715 | ) | | $ | 30,409 | | | $ | (232,356 | ) | | $ | (133,231 | ) | | $ | (165,537 | ) |
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| (6) | Average monthly churn; ARPU; SAC, as adjusted, per gross subscriber addition; customer service and billing expenses, as adjusted, per average subscriber; and free cash flow are not measures of financial performance under U.S. generally accepted accounting principles (“GAAP”). We believe these non-GAAP financial measures provide meaningful supplemental information regarding our operating performance and are used by us for budgetary and planning purposes; when publicly providing our business outlook; as a means to evaluate period-to-period comparisons; and to compare our performance to that of our competitors. We also believe that investors also use our current and projected metrics to monitor the performance of our business and make investment decisions. |
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| | We believe the exclusion of stock-based compensation expense in our calculations of SAC, as adjusted, per gross subscriber addition and customer service and billing expenses, as adjusted, per average subscriber is useful given the significant variation in expense that can result from changes in the fair market value of our common stock, the effect of which is unrelated to the operational conditions that give rise to variations in the components of our subscriber acquisition costs and customer service and billing expenses. Specifically, the exclusion of stock-based compensation expense in our calculation of SAC, as adjusted, per gross subscriber addition is critical in being able to understand the economic impact of the direct costs incurred to acquire a subscriber and the effect over time as economies of scale are reached. |
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| | These non-GAAP financial measures are used in addition to and in conjunction with results presented in accordance with GAAP. These non-GAAP financial measures may be susceptible to varying calculations; may not be comparable to other similarly titled measures of other companies; and should not be considered in isolation, as a substitute for, or superior to measures of financial performance prepared in accordance with GAAP. |
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| (7) | We refer to net loss before taxes; other income (expense)-including interest and investment income, interest expense, loss from redemption of debt and equity in net loss of affiliate; depreciation; impairment charges; and stock-based compensation expense as adjusted loss from operations. Adjusted loss from operations is not a measure of financial performance under U.S. GAAP. We believe adjusted loss from operations is a useful measure of our operating performance. We use adjusted loss from operations for budgetary and planning purposes; to assess the relative profitability and on-going performance of our consolidated operations; to compare our performance from period to period; and to compare our performance to that of our competitors. We also believe adjusted loss from operations is useful to investors to compare our operating performance to the performance of other communications, entertainment and media companies. We believe that investors use current and projected adjusted loss from operations to estimate our current or prospective enterprise value and make investment decisions. |
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| | Because we fund and build-out our satellite radio system through the periodic raising and expenditure of large amounts of capital, our results of operations reflect significant charges for interest and depreciation expense. We believe adjusted loss from operations provides useful information about the operating performance of our business apart from the costs associated with our capital structure and physical plant. The exclusion of interest and depreciation expense is useful given fluctuations in interest rates and significant variation in depreciation expense that can result from the amount and timing of capital expenditures and potential variations in estimated useful lives, all of which can vary widely across different industries or among companies within the same industry. We believe the exclusion of taxes is appropriate for comparability purposes as the tax positions of companies can vary because of their differing abilities to take advantage of tax benefits and because of the tax policies of the various jurisdictions in which they operate. We also believe the exclusion of stock-based compensation expense is useful given the significant variation in expense that can result from changes in the fair market value of our common stock. Finally, we believe that the exclusion of our equity in net loss of affiliate (SIRIUS Canada Inc.) is useful to assess the performance of our core consolidated operations in the continental United States. To compensate for the exclusion of taxes, other income (expense), depreciation, impairment charges and stock-based compensation expense, we separately measure and budget for these items. |
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| | There are material limitations associated with the use of adjusted loss from operations in evaluating our company compared with net loss, which reflects overall financial performance, including the effects of taxes, other income (expense), depreciation, impairment charges and stock-based compensation expense. We use adjusted loss from operations to supplement GAAP results to provide a more complete understanding of the factors and trends affecting the business than GAAP results alone. Investors that wish to compare and evaluate our operating results after giving effect for these costs, should refer to net loss as disclosed in our unaudited consolidated statements of operations. Since adjusted loss from operations is a non-GAAP financial measure, our calculation of adjusted loss from operations may be susceptible to varying calculations; may not be comparable to other similarly titled measures of other companies; and should not be considered in isolation, as a substitute for, or superior to measures of financial performance prepared in accordance with GAAP. |
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| | Adjusted loss from operations is calculated as follows: |
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| | | For the Three Months Ended |
| | | | March 31, | | | | December 31, | | | | September 30, | | | | June 30, | | | | March 31. | |
| | | | 2007 | | | | 2006 | | | | 2006 | | | | 2006 | | | | 2006 | |
| Net loss | | $ | (144,745 | ) | | $ | (245,597 | ) | | $ | (162,898 | ) | | $ | (237,828 | ) | | $ | (458,544 | ) |
| Impairment loss | | | - | | | | - | | | | - | | | | 10,917 | | | | - | |
| Depreciation | | | 26,786 | | | | 27,495 | | | | 27,583 | | | | 25,738 | | | | 24,933 | |
| Stock-based compensation | | | 24,260 | | | | 42,625 | | | | 43,418 | | | | 67,289 | | | | 284,586 | |
| Other expense | | | 9,145 | | | | 8,512 | | | | 8,166 | | | | 6,778 | | | | 11,622 | |
| Income tax expense | | | 555 | | | | 156 | | | | 578 | | | | 578 | | | | 753 | |
| Adjusted loss from operations | | $ | (83,999 | ) | | $ | (166,809 | ) | | $ | (83,153 | ) | | $ | (126,528 | ) | | $ | (136,650 | ) |
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Liquidity and Capital Resources
Cash Flows for the Three Months Ended March 31, 2007 Compared with the Three Months Ended March 31, 2006
As of March 31, 2007, we had $259,162 in cash and cash equivalents compared with $630,831 as of March 31, 2006 and $393,421 as of December 31, 2006.
The following table presents a summary of our cash flow activity for the periods set forth below:
| | | | For the Three Months | | | | | |
| | | | Ended March 31, | | | | | |
| | | | 2007 | | | | 2006 | | | | Variance | |
| Net cash used in operating activities | | $ | (133,947 | ) | | $ | (157,172 | ) | | $ | 23,225 | |
| Net cash (used in) provided by investing activities | | | (1,822 | ) | | | 24,537 | | | | (26,359 | ) |
| Net cash provided by financing activities | | | 1,510 | | | | 1,459 | | | | 51 | |
| Net decrease in cash and cash equivalents | | | (134,259 | ) | | | (131,176 | ) | | | (3,083 | ) |
| Cash and cash equivalents at beginning of period | | | 393,421 | | | | 762,007 | | | | (368,586 | ) |
| Cash and cash equivalents at end of period | | $ | 259,162 | | | $ | 630,831 | | | $ | (371,669 | ) |
Net Cash Used in Operating Activities
Net cash used in operating activities decreased $23,225 to $133,947 for the three months ended March 31, 2007 from $157,172 for the three months ended March 31, 2006. Such decrease in the net outflows of cash was attributable to an increase in the cash collected for subscribers electing annual and other prepaid subscription programs, offset by payments for increased operating expenses and higher purchases of inventory to support production of SIRIUS radios and higher sales volumes through our direct to consumer distribution channel.
Net Cash Used in Investing Activities
Net cash used in investing activities was $1,822 for the three months ended March 31, 2007 compared with net cash provided by investing activities of $24,537 for the three months ended March 31, 2006. The $26,359 increase was primarily a result of higher net sales activity of available-for-sale securities in the first quarter of 2006, offset by an increase in capital expenditures of $6,962 primarily as a result of costs associated with our satellite construction and launch vehicle.
We will incur significant capital expenditures to construct and launch our new satellite and to improve our terrestrial repeater network and broadcast and administrative infrastructure. These capital expenditures will support our growth and the resiliency of our operations, and will also support the delivery of future new revenue streams.
Net Cash Provided by Financing Activities
Net cash provided by financing activities increased $51 to $1,510 for the three months ended March 31, 2007 from $1,459 for the three months ended March 31, 2006. The increase was a result of increased proceeds from the exercise of stock options.
Financings and Capital Requirements
We have historically financed our operations through the sale of debt and equity securities. For the first three months ended March 31, 2007 and 2006, we did not enter into any new debt or equity financing transactions.
Future Liquidity and Capital Resource Requirements
Based upon our current plans, we believe that our cash, cash equivalents and marketable securities will be sufficient to cover our estimated funding needs through cash flow breakeven, the point at which our revenues are sufficient to fund expected operating expenses, capital expenditures, working capital requirements, interest and principal payments and taxes. In light of our pending merger with XM Radio, and the uncertainty surrounding the timing and financial impact, we are no longer currently providing cash flow guidance for the year ending December 31, 2007. Our financial projections are based on assumptions, which we believe are reasonable but contain significant uncertainties.
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Our business is in its early stages, and we regularly evaluate our plans and strategy. These evaluations often result in changes to our plans and strategy, some of which may be material and significantly change our cash requirements or cause us to achieve cash flow breakeven at a later date. These changes in our plans or strategy may include: the acquisition of unique or compelling programming; the introduction of new features or services; significant new or enhanced distribution arrangements; investments in infrastructure, such as satellites, equipment or radio spectrum; and acquisitions of third parties that own programming, distribution, infrastructure, assets, or any combination of the foregoing.
In June 2006, we entered into a Credit Agreement with Space Systems/Loral (the “Credit Agreement”). Under the Credit Agreement, Space Systems/Loral has agreed to make loans to us in an aggregate principal amount of up to $100,000 to finance the purchase of our new satellite. Loans made under the Credit Agreement will be secured by our rights under the Satellite Purchase Agreement with Space Systems/Loral, including our rights to the new satellite. The loans are also entitled to the benefits of a subsidiary guarantee from Satellite CD Radio, Inc., our subsidiary that holds our FCC license, and any future material subsidiary that may be formed by us. The maturity date of the loans is the earliest to occur of (i) April 6, 2009, (ii) 90 days after the new satellite becomes available for shipment, and (iii) 30 days prior to the scheduled launch of the new satellite. Any loans made under the Credit Agreement generally will bear interest at a variable rate equal to three-month LIBOR plus 4.75%. The Credit Agreement permits us to prepay all or a portion of the loans outstanding without penalty. We have no current plans to draw under this Credit Agreement.
To fund incremental cash requirements, or as market opportunities arise, we may choose to raise additional funds through the sale of additional debt securities, equity securities or a combination of debt and equity securities. The incurrence of additional indebtedness would result in increased fiscal obligations and could contain restrictive covenants. The sale of additional equity or convertible debt securities may result in dilution to our stockholders. These additional sources of funds may not be available or, if available, may not be available on terms favorable to us. Our merger agreement with XM Radio restricts our ability to incur additional debt financing beyond our existing credit facility (or equivalent funding) and limits the amount of new equity we can issue, in each case without approval from XM Radio.
2003 Long-Term Stock Incentive Plan
In January 2003, our board of directors adopted the Sirius Satellite Radio 2003 Long-Term Stock Incentive Plan (the “2003 Plan”), and on March 4, 2003 our stockholders approved this plan. On May 25, 2004, our stockholders approved an amendment to the 2003 Plan to include members of our board of directors as eligible participants. Employees, consultants and members of our board of directors are eligible to receive awards under the 2003 Plan. The 2003 Plan provides for the grant of stock options, restricted stock, restricted stock units and other stock-based awards that the compensation committee of our board of directors may deem appropriate.
Vesting and other terms of stock-based awards are set forth in the agreements with the individuals receiving the awards. Stock-based awards granted under the 2003 Plan are generally subject to a vesting requirement that includes one or all of the following: (1) over time, generally three to five years from the date of grant; (2) on a specific date in future periods, with acceleration to earlier periods if performance criteria are satisfied; or (3) as certain performance targets set at the time of grant are achieved. Stock-based awards generally expire ten years from date of grant. Each restricted stock unit entitles the holder to receive one share of our common stock upon vesting.
As of March 31, 2007, approximately 86,213,000 stock options, shares of restricted stock and restricted stock units were outstanding. As of March 31, 2007, approximately 74,235,000 shares of our common stock were available for grant under the 2003 Plan. During the three months ended March 31, 2007, employees exercised 286,202 stock options at exercise prices ranging from $0.65 to $3.30 per share, resulting in proceeds to us of $356. The exercise of the remaining outstanding, vested options could result in an inflow of cash in future periods.
Contractual Cash Commitments
For a discussion of our “Contractual Cash Commitments” refer to Note 11 to the unaudited consolidated financial statements, Commitments and Contingencies, of this Form 10-Q.
Critical Accounting Policies
For a description of our Critical Accounting Policies refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” within our Annual Report on Form 10-K for the year ended
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December 31, 2006 and Note 3 to the unaudited consolidated financial statements, Summary of Significant Accounting Policies, of this Form 10-Q.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
As of March 31, 2007, we did not have any derivative financial instruments and we do not intend to use derivatives. We do not hold or issue any free-standing derivatives. We hold investments in marketable securities, which consist of certificates of deposit and auction rate securities. We classify our marketable securities as available-for-sale. These securities are consistent with the investment objectives contained within our investment policy. The basic objectives of our investment policy are the preservation of capital, maintaining sufficient liquidity to meet operating requirements and maximizing yield. Despite the underlying long-term maturity of auction rate securities, from the investor’s perspective, such securities are priced and trade as short-term investments because of the interest rate reset feature. Interest rates are reset through an auction process at predetermined periods of 28 or 35 days. Failed auctions rarely occur. As of March 31, 2007, we did not hold any auction rate securities.
Our long-term debt includes fixed interest rates and the fair market value of the debt is sensitive to changes in interest rates. Under our current policies, we do not use interest rate derivative instruments to manage our exposure to interest rate fluctuations.
Item 4. Controls and Procedures
As of March 31, 2007, an evaluation was performed under the supervision and with the participation of our management, including Mel Karmazin, our Chief Executive Officer, and David J. Frear, our Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of March 31, 2007. There have been no significant changes in our internal control over financial reporting or in other factors that could materially affect, or is reasonably likely to materially affect, our internal control over financial reporting for the three months ended March 31, 2007.
34
Part II
Other Information
Item 1. Legal Proceedings
FCC Inquiry.InApril 2006, we learned that XM Radio and two manufacturers of SIRIUS radios had received inquiries from the Federal Communications Commission as to whether the FM transmitters in their products complied with the FCC’s emissions and frequency rules. We promptly began an internal review of the compliance of the FM transmitters in a number of our radios. In June 2006, we learned that a third manufacturer of SIRIUS radios had received an inquiry from the Federal Communications Commission as to whether the FM transmitters in its products complied with the FCC’s emissions and frequency rules. In June 2006, we received a letter from the FCC making similar inquiries. In July 2006, we responded to the letter from the FCC in respect of the preliminary results of our review. In August 2006, we received a follow-up letter of inquiry from the FCC and responded to the FCC’s further inquiry. We continue to cooperate with the FCC’s inquiry.
During our internal review, we determined that certain of our radios with FM transmitters were not compliant with FCC rules. We have taken a series of actions to correct the problem.
In connection with our internal review, we discovered that certain SIRIUS personnel requested manufacturers to produce SIRIUS radios that were not consistent with the FCC’s rules. As a result of this review, we are taking significant steps to ensure that this situation does not happen again, including the adoption of a compliance plan, approved by our board of directors, to ensure that in the future our products comply with all applicable FCC rules.
The FCC’s laboratory has tested a number of our products and found them to be compliant with the FCC’s rules. We believe our radios that are currently in production comply with applicable FCC’s rules. No health or safety issues are involved with these SIRIUS radios and radios which are factory-installed in new vehicles are not affected.
We have retained the services of an engineering compliance officer to report to our Vice President of Internal Audit, who reports to our Audit Committee.
In October 2006, we ceased operating 11 of our terrestrial repeaters which we discovered had been operating at variance to the specifications and applied to the FCC for new authority to resume operating these repeaters.
Copyright Royalty Board Proceeding. We are a party to a proceeding before the Copyright Royalty Board of the Library of Congress to establish the royalty rate and terms for the sound recordings we use on our satellite radio service for the period for 2007 through 2012. In October 2006, we and XM Radio filed our direct case in this proceeding with the Copyright Royalty Board and proposed a royalty rate of 0.88% of our satellite radio subscription revenue. SoundExchange, the organization that collects and distributes royalties from various digital music services on behalf of artists and music labels, simultaneously submitted its direct case in this proceeding and proposed an increasing royalty rate, beginning at 10% of our gross revenues in the first year and culminating at 23% of our gross revenues in the sixth year. This submission of direct cases is the beginning of a twelve to eighteen month process which, absent an agreement among the parties, will result in a determination by the Copyright Royalty Board of an applicable royalty rate. Discovery in this matter is ongoing.
The Copyright Royalty Board must set a rate that is calculated to achieve four statutory objectives:
to maximize the availability of creative works to the public;
to afford the copyright owner a fair return for his creative work and the copyright user a fair income under existing economic conditions;
to reflect the relative roles of the copyright owner and the copyright user in the product made available to the public with respect to relative creative contribution, technological contribution, capital investment, cost, risk and contribution to the opening of new markets for creative expression and media for their communication; and
35
We believe that the fee we proposed achieves these objectives and is consistent in principle with the fee established under the same standard for digital cable audio.
U.S. Electronics Arbitration. U.S. Electronics Inc., a licensed distributor and a former licensed manufacturer of SIRIUS radios, has commenced an arbitration proceeding against us. U.S. Electronics alleges that we breached our contract; failed to pay monies owed under the contract; tortiously interfered with U.S. Electronics’ relationships with retailers and manufacturers; withheld information relating to the FCC’s inquiring into SIRIUS radios that include FM modulators; and otherwise acted in bad faith. U.S. Electronics is seeking at least $48 million in damages. We believe that a substantial portion of these damages are barred by the limitation of liability provisions contained in the contract between us and U.S. Electronics. U.S. Electronics contends, and will be permitted to try to prove in the arbitration, that these provisions do not bar its damages because of, among other reasons, our alleged bad faith and tortious conduct. We are vigorously defending this action.
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.
Item 1A. Risk Factors
Reference is made to the Risk Factors set forth in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2006. The Risk Factors remain applicable from our Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits
See Exhibit Index attached hereto.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| SIRIUS SATELLITE RADIO INC. |
| |
| By: | | /s/ DAVID J. FREAR |
| | | David J. Frear |
| | | Executive Vice President and |
| | | Chief Financial Officer |
| | | (Principal Financial Officer) |
May 10, 2007
37
EXHIBIT INDEX
| Exhibit | | Description |
| 2.1 | — | Agreement and Plan of Merger, dated as of February 19, 2007, by and among the Company., Vernon |
| | | Merger Corporation and XM Satellite Radio Holdings Inc. (incorporated by reference to Exhibit 2.1 to |
| | | the Company’s Current Report on Form 8-K dated February 21, 2007). |
| |
| 3.1 | — | Amended and Restated Certificate of Incorporation dated March 4, 2003 (incorporated by reference to |
| | | Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002). |
| |
| 3.2 | — | Amended and Restated By-Laws (incorporated by reference to Exhibit 3.2 to the Company’s Quarterly |
| | | Report on Form 10-Q for the quarter ended September 30, 2001). |
| |
| 4.1 | — | Form of certificate for shares of Common Stock (incorporated by reference to Exhibit 4.3 to the |
| | | Company’s Registration Statement on Form S-1 (File No. 33-74782)). |
| |
| 4.2 | — | Warrant Agreement, dated as of May 15, 1999, between the Company and United States Trust Company |
| | | of New York, as warrant agent (incorporated by reference to Exhibit 4.4.4 to the Company’s Registration |
| | | Statement on Form S-4 (File No. 333-82303)). |
| |
| 4.3 | — | Indenture, dated as of September 29, 1999, between the Company and United States Trust Company of |
| | | Texas, N.A., as trustee, relating to the Company’s 8¾% Convertible Subordinated Notes due 2009 |
| | | (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on October |
| | | 13, 1999). |
| |
| 4.4 | — | First Supplemental Indenture, dated as of September 29, 1999, between the Company and United States |
| | | Trust Company of Texas, N.A., as trustee, relating to the Company’s 8¾% Convertible Subordinated |
| | | Notes due 2009 (incorporated by reference to Exhibit 4.01 to the Company’s Current Report on Form 8- |
| | | K filed on October 1, 1999). |
| |
| 4.5 | — | Second Supplemental Indenture, dated as of March 4, 2003, among the Company, The Bank of New York |
| | | (as successor to United States Trust Company of Texas, N.A.), as resigning trustee, and HSBC Bank |
| | | USA, as successor trustee, relating to the Company’s 8¾% Convertible Subordinated Notes due 2009 |
| | | (incorporated by reference to Exhibit 4.16 to the Company’s Annual Report on Form 10-K for the year |
| | | ended December 31, 2002). |
| |
| 4.6 | — | Third Supplemental Indenture, dated as of March 7, 2003, between the Company and HSBC Bank USA, |
| | | as trustee, relating to the Company’s 8¾% Convertible Subordinated Notes due 2009 (incorporated by |
| | | reference to Exhibit 4.17 to the Company’s Annual Report on Form 10-K for the year ended December |
| | | 31, 2002). |
| |
| 4.7 | — | Form of 8¾% Convertible Subordinated Note due 2009 (incorporated by reference to Article VII of Exhibit |
| | | 4.01 to the Company’s Current Report on Form 8-K filed on October 1, 1999). |
| |
| 4.8 | — | Indenture, dated as of May 23, 2003, between the Company and The Bank of New York, as trustee |
| | | (incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K dated May 30, |
| | | 2003). |
| |
| 4.9 | — | First Supplemental Indenture, dated as of May 23, 2003, between the Company and The Bank of New York, |
| | | as trustee, relating to the Company’s 3½% Convertible Notes due 2008 (incorporated by reference to |
| | | Exhibit 99.3 to the Company’s Current Report on Form 8-K dated May 30, 2003). |
| |
| 4.10 | — | Second Supplemental Indenture, dated as of February 20, 2004, between the Company and The Bank of |
| | | New York, as trustee, relating to the Company’s 2½% Convertible Notes due 2009 (incorporated by |
| | | reference to Exhibit 4.20 to the Company’s Annual Report on Form 10-K for the year ended December 31, |
| | | 2003). |
38
| Exhibit | | Description |
| 4.11 | — | Third Supplemental Indenture, dated as of October 13, 2004, between the Company and The Bank of New |
| | | York, as trustee, relating to the Company’s 3¼% Convertible Notes due 2011 (incorporated by reference to |
| | | Exhibit 4.1 to the Company’s Current Report on Form 8-K dated October 13, 2004). |
| |
| 4.12 | — | Indenture, dated as of August 9, 2005, between the Company and The Bank of New York, as trustee relating |
| | | to the Company’s 95/8% Senior Notes due 2013 (incorporated by reference to Exhibit 4.1 to the Company's |
| | | Current Report on Form 8-K filed on August 12, 2005). |
| |
| 4.13 | — | Common Stock Purchase Warrant granted by the Company to DaimlerChrysler AG dated October 4, 2005 |
| | | (incorporated by reference to Exhibit 4.13 to the Company’s Quarterly Report on Form 10-Q for the quarter |
| | | ended September 30, 2005). |
| |
| 4.14 | — | Common Stock Purchase Warrant granted by the Company to Ford Motor Company dated October 7, 2002 |
| | | (incorporated by reference to Exhibit 4.16 to the Company’s Quarterly Report on Form 10-Q for the quarter |
| | | ended September 30, 2002). |
| |
| 4.15 | — | Form of Media-Based Incentive Warrant dated February 3, 2004 issued by the Company to NFL Enterprises |
| | | LLC (incorporated by reference to Exhibit 4.25 to the Company’s Annual Report on Form 10-K for the year |
| | | ended December 31, 2003). |
| |
| 4.16 | — | Bounty-Based Incentive Warrant dated February 3, 2004 issued by the Company to NFL Enterprises LLC |
| | | (incorporated by reference to Exhibit 4.26 to the Company’s Annual Report on Form 10-K for the year |
| | | ended December 31, 2003). |
| |
| 4.17 | — | Amended and Restated Warrant Agreement, dated as of December 27, 2000, between the Company and |
| | | United States Trust Company of New York, as warrant agent and escrow agent (incorporated by reference |
| | | to Exhibit 4.27 to the Company’s Registration Statement on Form S-3 (File No. 333-65602)). |
| |
| 4.18 | — | Customer Credit Agreement, dated as of May 31, 2006, between the Company and Space Systems/Loral, |
| | | Inc. (incorporated by reference to Exhibit 4.18 to the Company’s Quarterly Report on Form 10-Q for the |
| | | quarter ended June 30, 2006). |
| |
| 10.1.1 | — | Lease Agreement, dated as of March 31, 1998, between Rock-McGraw, Inc. and the Company (incorporated |
| | | by reference to Exhibit 10.1.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June |
| | | 30, 1998). |
| |
| 10.1.2 | — | Supplemental Indenture, dated as of March 22, 2000, between Rock-McGraw, Inc. and the Company |
| | | (incorporated by reference to Exhibit 10.1.2 to the Company’s Quarterly Report on Form 10-Q for the |
| | | quarter ended March 31, 2000). |
| |
| *10.2 | — | Employment Agreement dated November 18, 2004 between the Company and Mel Karmazin (incorporated |
| | | by reference to Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December |
| | | 31, 2004). |
| |
| *10.3 | — | Employment Agreement, dated as of June 3, 2003, between the Company and David J. Frear (incorporated |
| | | by reference to Exhibit 10.7 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June |
| | | 30, 2003). |
| |
| *10.4 | — | First Amendment, dated as of August 10, 2005, to the Employment Agreement, dated as of June 3, 2003, |
| | | between the Company and David Frear (incorporated by reference to Exhibit 10.2 to the Company's Current |
| | | Report on Form 8-K dated August 12, 2005). |
| |
| *10.5 | — | Employment Agreement, dated as of May 5, 2004, between the Company and Scott A. Greenstein |
| | | (incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the quarter |
| | | ended June 30, 2004). |
39
| Exhibit | | Description |
| *10.6 | — | First Amendment, dated as of August 8, 2005, to the Employment Agreement, dated as of May 5, 2004, |
| | | between the Company and Scott Greenstein (incorporated by reference to Exhibit 10.1 to the Company's |
| | | Current Report on Form 8-K dated August 12, 2005). |
| |
| *10.7 | — | Restricted Stock Unit Agreement, dated as of August 9, 2005, between the Company and James E. Meyer |
| | | (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K dated August 12, |
| | | 2005). |
| |
| *10.8 | — | CD Radio Inc. 401(k) Savings Plan (incorporated by reference to Exhibit 4.4 to the Company’s Registration |
| | | Statement on Form S-8 (File No. 333-65473)). |
| |
| *10.9 | — | Amended and Restated Sirius Satellite Radio 2003 Long-Term Stock Incentive Plan (incorporated by |
| | | reference to Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, |
| | | 2004). |
| |
| *10.10 | — | Form of Option Agreement, dated as of December 29, 1997, between the Company and each Optionee |
| | | (incorporated by reference to Exhibit 10.16.2 to the Company’s Quarterly Report on Form 10-Q for the |
| | | quarter ended June 30, 1998). |
| |
| †10.11 | — | Joint Development Agreement, dated as of February 16, 2000, between the Company and XM Satellite |
| | | Radio Inc. (incorporated by reference to Exhibit 10.28 to the Company’s Quarterly Report on Form 10-Q |
| | | for the quarter ended March 31, 2000). |
| |
| 31.1 | — | Certificate of Mel Karmazin, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of |
| | | 2002 (filed herewith) |
| |
| 31.2 | — | Certificate of David J. Frear, Executive Vice President and Chief Financial Officer, pursuant to Section 302 |
| | | of the Sarbanes-Oxley Act of 2002 (filed herewith). |
| |
| 32.1 | — | Certificate of Mel Karmazin, Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted |
| | | pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
| |
| 32.2 | — | Certificate of David J. Frear, Executive Vice President and Chief Financial Officer, pursuant to 18 U.S.C. |
| | | Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
|
| * | This document has been identified as a management contract or compensatory plan or arrangement. |
| | |
| † | Portions of this exhibit have been omitted pursuant to Applications for Confidential treatment filed by the Company with the Securities and Exchange Commission.+ |
40
