Canadian Satellite Radio Holdings Inc. Management s Discussion and Analysis SECOND QUARTER 2012
Management s Discussion and Analysis of Financial Condition and Results of Operations Management s discussion and analysis ( MD&A ) discusses the significant factors affecting the results of operations and financial position of Canadian Satellite Radio Holdings Inc. ( CSRH, we, us, our or the Company ). Under International Financial Reporting Standards ( IFRS ), the June 21, 2011 business combination was accounted for as a reverse takeover whereby Sirius Canada Inc. ( Sirius Canada ) was deemed to be the acquirer of CSRH, using the purchase method of accounting. CSRH historically operated the XM Canada business. Therefore, these interim results for the three and six months (the second quarter and year-todate ) ended February 29, 2012 include both the results of Sirius Canada and XM Canada. The comparative results for the Company are only those of Sirius Canada and they are for the three and six months ended May 31, 2011 as this was the second quarter of the previous fiscal year. In order to provide comparable information we have also presented Combined Information for the comparative periods. The comparative information are constructed periods for the three and six months ended February 28, 2011 and does not reflect adjustments for purchase accounting. The six month period does not conform to our interim financial periods at the time. We believe this information is more relevant as it provides analysis of comparable information to understand trends in our combined business. See section entitled Discussion of Combined Information Financial Results for further details. This MD&A which is current as of April 11, 2012, should be read in conjunction with the Company s Interim Unaudited Consolidated Financial Statements dated February 29, 2012 and Notes thereto, the Company s 2011 Annual MD&A and the Company s 2011 Annual Audited Consolidated Financial Statements and Notes thereto and other recent securities filings available on SEDAR at sedar.com. The financial information presented herein has been prepared on the basis of IFRS for interim financial statements and is expressed in Canadian dollars unless otherwise noted. Please refer to Note 20 of the Company s Interim Unaudited Financial Statements dated February 29, 2012 for a summary of the differences between the financial statements previously prepared under Canadian GAAP and to those under IFRS for the three and six months ended May 31, 2011. Please also refer to our interim financial statements for the three months ended November 30, 2011 for a summary of our accounting policies under IFRS, which are included in note 3 of those financial statements The unaudited IFRS amounts included in this MD&A have been prepared using the standards and interpretations currently effective and expected to be effective at the end of the Company s first annual IFRS reporting period, which will be August 31, 2012. Certain accounting policies expected to be adopted under IFRS may not be adopted and the application of such policies to certain transactions or circumstances may be modified and as a result, the February 29, 2012 and May 31, 2011 underlying values prepared on a basis consistent with IFRS are subject to change. Page 1
Forward-Looking Disclaimer This discussion contains certain information that may constitute forward-looking statements within the meaning of securities laws. These statements relate to future events or future performance and reflect management s expectations and assumptions regarding the growth, results of operations, performance and business prospects and opportunities of the Company on a consolidated basis. In some cases, forwardlooking statements can be identified by terminology such as may, would, could, will, should, expect, plan, intend, anticipate, believe, estimate, predict, potential, continue, seek or the negative of these terms or other similar expressions concerning matters that are not historical facts. In particular, statements regarding the Company s objectives, plans and goals, including future operating results, economic performance and subscriber recruitment efforts involve forward-looking statements. A number of factors could cause actual events, performance or results to differ materially from what is projected in the forward-looking statements. Although the forward-looking statements contained in this discussion are based on what management of the Company considers are reasonable assumptions based on information currently available to it, there can be no assurance that actual events, performance or results will be consistent with these forward-looking statements, and management s assumptions may prove to be incorrect. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Our financial projections are based on estimates regarding expected future costs and expected revenue, which are fully described in this MD&A. Among the significant factors that could cause our results to differ from those expressed in the forwardlooking statements are: The Company s reliance on its exclusive relationship with Sirius XM Radio Inc. ( Sirius XM ); The Company s reliance on automakers and automobile industry sales in Canada; The Company s ability to manage customer attrition and average monthly subscription revenue per subscriber; General economic conditions in Canada; The Company s competitive position versus other forms of audio and video entertainment; The impact of any application of or changes to governmental regulations, including any copyright legislation; The Company s ability to achieve cost synergies; and The factors discussed in the section entitled Risks and Uncertainties of this MD&A and in the section entitled Risk Factors in the Company s Annual Information Form for the financial year ended August 31, 2011 dated November 16, 2011. Page 2
Other than as required by applicable Canadian securities law, the Company does not update or revise any forward-looking statements to reflect new information, future events or otherwise. These forward-looking statements are subject to risks and uncertainties that could cause actual results or events to differ materially from expectations. These include but are not limited to the risk factors included in this MD&A (including those listed under the heading Risks and Uncertainties ) in addition to the risks itemized in our Annual Information Form ( AIF ) for the fiscal year ended August 31, 2011. Readers are advised to review these risk factors for a detailed discussion of the risks and uncertainties affecting the Company s business. Readers should not place undue reliance on forward-looking statements. This MD&A contains the following sections: Forward-Looking Disclaimer... 2 Our Business and Strategy... 4 Financial and Operational Highlights... 5 Discussion of Combined Information Financial Results... 7 Results of Operations Combined Information Metrics... 9 Selected Consolidated Interim IFRS Financial Information... 22 Liquidity and Capital Resources... 31 Compilation of Combined Financial Information... 34 Off-Balance Sheet Arrangements... 37 Arrangements, Relationships and Transactions with Related Parties... 37 Critical Accounting Policies and Estimates... 39 International Financial Reporting Standards ( IFRS )... 41 Risk and Uncertainties... 42 Outstanding Share Data and Other Information... 42 Definitions of Industry Terminology... 42 Non-GAAP Financial Measures... 44 OVERVIEW On June 21, 2011 Canadian Satellite Radio Holdings Inc. and Sirius Canada Inc. completed the previously announced combination transaction and Sirius XM Canada Inc. ( SiriusXM Canada ) was formed. By combining complementary strengths in the automotive and aftermarket businesses, we created a business currently in excess of 2.0 million subscribers, which ranks SiriusXM Canada as one of the largest subscriber based media and entertainment businesses in Canada. We believe that the newly created entity can grow subscribers and cash flow faster than either XM Canada or Sirius Canada could have on their own. The Company expects to achieve this objective by: Integrating the businesses to generate revenue growth; Realizing costs synergies in excess of $20 million on an annual basis; Leveraging the scalable business model and improve liquidity to maximize shareholder return. For informational purposes, we have also provided the comparative period Combined Information results in this MD&A, which present the hypothetical performance of the business as if the businesses had been combined for the three and six months ended February 28, 2011. See the sections of this MD&A entitled Discussion of Combined Information Financial Results for more information. This MD&A has been prepared as of April 11, 2012 at which time 61,009,352 Class A Subordinate Voting shares and 186,295,585 Class B Voting shares are outstanding. Page 3
Our Business and Strategy Our vision is to be the leading premium digital audio entertainment and information service provider in Canada. Our strategy is founded on the principles of acquiring subscribers in the most cost effective manner, retaining subscribers through enhancing the value proposition to our subscribers and improving business efficiencies. Satellite Radio in Canada offers 120-130 channels, including commercial-free music as well as news, talk, sports and children s programming. This includes over 12 Canadian channels designed and developed from studios in Toronto, Ontario, Montreal, Quebec and Vancouver, British Columbia. We continue to leverage our unique programming assets, such as our exclusive broadcasting agreement with the Canadian Football League ( CFL ) and our agreement with the Canadian Broadcasting Corporation ( CBC ). There are exclusive agreements through Sirius XM Radio Inc. for the National Hockey League ( NHL ), National Football League ( NFL ), Major League Baseball ( MLB ), National Basketball Association ( NBA ), Oprah, Martha Stewart, Howard Stern, Nascar, Professional Golfers Association of America ( PGA ) and more. Our target market in Canada includes more than 23 million registered vehicles on the road, and an estimated 1.6 million new vehicles forecasted to be sold in calendar year 2012. Currently all major automobile manufacturers in Canada have agreements with SiriusXM Canada for the installation of satellite radios. We are the leader in digital audio entertainment distribution and information delivered via satellite to new vehicles sold in Canada. The Satellite radio service is expected to be factory-installed in more than 53% of new vehicles to be sold in model year 2012. Sirius and XM satellite radio receivers are available at leading retailers across Canada such as Best Buy, Canadian Tire, Costco, Future Shop, The Source, Wal-Mart and other national, regional and independent retailers. Our primary source of revenue is subscription fees, with most of our customers subscribing on an annual, quarterly, or monthly basis. Discounts are offered for long-term, prepaid subscription plans, as well as discounts for multiple subscriptions on each platform. Other sources of revenue include music royalty fees, activation and other subscription-related fees, advertising revenues, the direct sale of satellite radios and accessories through our call centers and websites, and other ancillary services such as data and weather services. In certain instances, automakers include a subscription to our radio services in the sale or lease of their vehicles. The length of these prepaid subscriptions varies from three to twelve months. In certain instances we also receive subscription payments from automakers in advance of our service being activated. We also reimburse various automakers for certain costs associated with the installation of satellite radios in their vehicles. These costs which we refer to as subsidies and distribution costs in this MD&A tend to follow seasonal patterns and are higher in the second half of the fiscal year. Consequently, EBITDA and other financial metrics may vary on a quarterly basis. The Company s goal is to accelerate EBITDA and cash flow growth by maximizing our revenues primarily through subscriptions, advertising and other ancillary opportunities as well as maintaining effective cost controls, managing subscriber acquisition costs and by creating a long-term customer base by offering quality service. We believe that a premium service will attract a premium customer. The shares of Canadian Satellite Radio Holdings Inc. trade on the Toronto Stock Exchange under the stock symbol XSR. Page 4
Financial and Operational Highlights Quarterly and year to date results compared to the constructed periods ( Combined Information ) for the three and six months ended February 29, 2012 The following are highlights for the three and six months ended February 29, 2012 in comparison to the results of the combined business for the comparative periods ended February 28, 2011. Three months Adjusted EBITDA 1 improved 152.4% to $11.9 million from $4.7 million (an improvement of $7.2 million); Revenue increased by 9.4% to $63.8 million from $58.3 million; Self-Paying Subscribers increased 12.5% to 1,454,500 from 1,292,600; Total Subscribers increased 10.6% to 2,016,200 from 1,823,600; SAC decreased 16.0% to $46 from $55; Fixed cash operating expense decreased by $2.1 million 2 or 11.2%; Generated $12.0 million in cash from operations during the quarter and repaid $11.2 million in promissory notes to the former shareholders of Sirius Canada; Cash and cash equivalents of $36.1 million at February 29, 2012; Subsequent to the quarter, on March 26, 2012, the Company announced the completion of a secondary offering of securities where two of shareholders (Slaight Communications Inc. ( Slaight ), and CSRI Inc. ( CSRI )) sold an aggregate of 8,000,000 of Class A Subordinate Voting Shares of the Company at a price of $3.00 per share. Six months On a year to date basis, Adjusted EBITDA improved 152.2% to $24.8 million from $9.8 million (an improvement of $15.0 million); On a year to date basis, revenue increased 8.0% to $126.9 million from $117.5 million; On a year to date basis, generated $22.0 million in cash from operations during the period. Quarterly and year to date results compared to last year for the three and six month periods The following are highlights for the three and six months ended February 29, 2012 in comparison to IFRS results of the three and six months ended May 31, 2011, which were the results of Sirius Canada only. For a 1 A reconciliation of Operating Income to Adjusted EBITDA (a non-gaap measure) is provided on page 8. 2 Table showing calculation of Fixed Cash Operating Expenses is provided on page 8. Page 5
complete discussion of these interim IFRS financial results please refer to the sections entitled Selected Consolidated Interim IFRS Financial Information and Liquidity and Capital Resources. Three months ended (February 29, 2012 vs. May 31, 2011) Adjusted EBITDA improved 64.2% to $11.9 million from $7.2 million (an improvement of $4.7 million); EBITDA improved 58.6% to $10.8 million from $6.8 million (an improvement of $4.0 million); Revenue increased by 48.5% to $63.8 million from $43.0 million; Generated $12.0 million in cash from operations and repaid $11.2 million in related party promissory notes during the quarter. Six months ended (February 29, 2012 vs. May 31, 2011) Adjusted EBITDA improved 92.9% to $24.8 million from $12.8 million; EBITDA improved 93.6% to $22.0 million from $11.4 million; Revenue increased 48.5% to $126.9 million from $85.4 million; The Company generated $22.0 million in cash from operations during the period. Page 6
Discussion of Combined Information Financial Results The following table presents a partial view of the Company s unaudited Consolidated Interim Statement of Operations Unaudited Three Months Ended Six Months Ended ( in $) Feb 29, 2012 Feb 28, 2011 Feb 29, 2012 Feb 28, 2011 IFRS Combined IFRS Combined Q2 2012 Q2 2011 Q2 2011 Q2 2011 REVENUE 63,774,132 58,301,865 126,885,377 117,526,530 OPERATING EXPENSES Cost of Revenue Revenue share and royalties 20,401,223 18,076,529 40,948,907 36,233,501 Customer care & billing operations 4,568,860 4,444,305 8,798,329 8,268,911 Cost of merchandise 836,351 1,086,410 1,521,013 1,985,205 Broadcast and operations 401,718 522,009 881,206 981,571 Programming and content 3,003,921 3,359,831 5,211,937 5,983,873 Total Cost of Revenue 29,212,073 27,489,084 57,361,392 53,453,061 General and administrative 2,720,237 2,935,020 5,303,634 6,521,760 Information Technology 3,167,659 2,899,118 5,991,426 5,916,826 Stock based compensation 433,206 23,331 827,127 63,042 Marketing support 1,876,399 2,088,010 3,618,904 4,425,026 Subsidies and distribution 9,435,173 10,897,588 19,315,495 23,208,715 Marketing 5,776,430 7,277,835 11,175,126 14,175,531 Total operating expenses 52,621,177 53,609,986 103,593,104 107,763,961 Severance and merger costs 358,939 3,025,402 1,276,962 5,501,394 Depreciation and amortization 10,044,378 6,741,164 20,984,463 13,716,923 Operating income (loss) 749,638 (5,074,686) 1,030,848 (9,455,747) The comparative figures for the three months ended February 28, 2011 are prepared on a combined basis by adding the historical results of XM Canada and Sirius Canada for the three months ended February 28, 2011. The six- month results have been prepared by adding the historical results of XM Canada and the internal results of Sirius Canada for the periods ended February 28, 2011. The sixmonth period does not agree to the published results and are not consistent with our actual reported period. Please see pages 34 and 35 of this MD&A to see how the comparative results have been assembled. Page 7
The following table is a reconciliation of Operating income (loss) to EBITDA and Adjusted EBITDA for the three and six months ended February 29, 2012. Reconciliation In ($000 s) Feb 29, 2012 (IFRS) Three Months Ended Feb 28, 2011 (Combined) Feb 29, 2012 (IFRS) Six Months Ended Feb 28, 2011 (Combined) Operating Income (Loss) 750 (5,075) 1,031 (9,456) Amortization 10,044 6,741 20,984 13,717 EBITDA 10,794 1,666 22,015 4,261 Stock-based compensation 433 23 827 63 Severance and merger costs 359 3,026 1,277 5,501 Fair value adjustments* 317 663 Adjusted EBITDA 11,903 4,715 24,782 9,826 * Fair value adjustment relates to reduction in revenue due to valuation of deferred revenue as per purchase price accounting The following provides a summary of the change in Fixed Cash Operating Expenses for the three and six months ended February 29, 2012 compared to same quarter prior year. Fixed Cash Operating Expenses Three Months Ended Six Months Ended Feb 29, Feb 28, Feb 29, Feb 28, In ($000 s) Change Change 2012 2011 2012 2011 Broadcast and operations 402 522 (120) 881 982 (100) Programming and content 3,004 3,360 (356) 5,212 5,984 (772) General and administrative* 2,720 2,935 (215) 5,304 6,522 (1,218) Information Technology 3,168 2,899 269 5,991 5,917 75 Marketing Support 1,876 2,088 (212) 3,619 4,425 (806) Marketing 5,776 7,278 (1,502) 11,175 14,176 (3,000) Total 16,946 19,082 (2,135) 32,182 38,005 (5,822) *Includes one-time costs of $ 0.2 million pertaining to the Secondary Offering for the quarter ended February 29, 2012 Page 8
Results of Operations Combined Information Metrics The following table is a summary of the key financial and operating metrics that the Company uses to help measure the success of operations. Please refer to the section Definitions of Industry Terminology at the end of this MD&A for an overview of the metrics noted below. Financial and Operating Metrics Three Months Ended Six Months Ended Feb 29, 2012 Feb 28, 2011 Feb 29, 2012 Feb 28, 2011 Self-Paying 1,454,500 1,292,600 1,454,500 1,292,600 Paid Promotional 482,800 468,600 482,800 468,600 Non Paid Promotional 78,900 62,400 78,900 62,400 Ending Subscribers 2,016,200 1,823,600 2,016,200 1,823,600 Self Pay 38,500 48,500 61,700 77,700 Paid/Non Paid Net Additions (36,600) (21,900) (28,600) 14,200 Total Net Additions 1,900 26,600 33,100 91,900 Average Self Pay Churn 2.06% 2.00% 2.06% 1.94% ARPU $11.57 $11.73 $11.58 $12.17 SAC $46 $55 $50 $59 CPGA $74 $92 $78 $95 Subscribers 2,016,200 561,700 1,823,600 531,000 1,454,500 1,292,600 Q2 2012 Q2 2011 Self Paying Paying & Non Paying Promotional Page 9
As at February 29, 2012, we had total subscribers of 2,016,200, representing 1,454,500 Self Paying Subscribers and 561,700 Paid Promotional Subscribers and Non Paid Promotional Subscribers. Self-Paying Subscribers increased 12.5% versus the second quarter of 2011, driven largely by growth in OEM gross additions. OEM gross additions increased in the second quarter of 2012 compared to the second quarter of 2011 due to an increase in the conversion rate. Paid Promotional Subscribers and Non Paid Promotional Subscribers increased 5.8% compared to the corresponding period of 2011 due continued increase in vehicles equipped with satellite radio (referred to as penetration rate ). Churn 2.06% 2.00% Q2 2012 Q2 2011 Self-pay monthly churn increased to 2.06% in the second quarter of 2012 from 2.00% in the corresponding quarter of 2011. The slight increase in churn is as a result of a planned reduction of discounting associated with retention programs in the second quarter of 2012 compared to the second quarter 2011. The Company experiences mild seasonal variations in churn. Self-pay churn may return to a level of less than 2.0% in the second half of the year upon successful execution of retention programs. On a year to date basis, churn was 2.06% and 1.94% in 2012 and 2011, respectively. Page 10
ARPU $11.57 $11.73 Q2 2012 Q2 2011 ARPU was $11.57 and $11.73 for the second quarters of 2012 and 2011, respectively. ARPU decreased by 1.4% in the second quarter of 2012 compared to the second quarter of 2011. On a year to date basis, ARPU was $11.58 in 2012 compared to $12.17 in 2011. The decrease in ARPU is due primarily to the following reasons: (i) (ii) (iii) (iv) an increase in automotive Self-Paying Subscribers which have a lower ARPU due to higher price discounts being offered to these subscribers; revenue from some customers on lifetime plans being fully amortized; increase in promotional activity; and contractual changes with our OEM partners on paid trial subscriptions. ARPU is below the basic service price due to promotions offered to new OEM Self-Paying Subscribers, Paid Promotional Subscriptions by automakers, family plan subscribers, discounts offered to renewing self-paying subscribers across all channels and discounted multi-year plans that provide the Company with a significant working capital benefit. As the Company continues to grow the business it is currently anticipated that ARPU may fluctuate due to multi-year plans and promotional discounts offered to attract and retain its Self-Paying Subscriber base. The Company currently expects downward pressure on ARPU in the short term as the business optimizes conversion in the automotive segment and as the proportion of OEM subscribers relative to total subscribers increases. The Company has implemented tactics to mitigate the impact and grow ARPU. The Company plans to implement additional revenue generating initiatives in the future, which we believe will positively impact ARPU. Revenue Revenue includes subscription revenue, activation fees, sale of merchandise through direct fulfillment channels, advertising revenue from Canadian-produced channels and certain other revenue. Page 11
Revenue ($ millions) $126.9 $117.5 $63.8 $58.3 Q2 2012 Q2 2011 FY 2012 FY 2011 Second quarter: Revenue increased by $5.5 million or 9.4%, to $63.8 million in the second quarter of 2012 from $58.3 million in the second quarter of 2011. The increase was attributable to the Company s growing subscriber base offset by a decrease in ARPU to $11.57 from $11.73 over the comparable period in 2011. Ending self-paying subscribers increase by 12.5% over the comparative periods. Year to date: Revenue increased by $9.4 million, or 8.0% to $126.9 million from $117.5 million in 2012 compared to 2011. The increase is due to the Company s increased subscriber base offset by the lower ARPU compared to last year. Cost of Revenue Cost of revenue increased by $1.7 million or 6.3% to $29.2 million in the second quarter of 2012 from $27.5 million in the second quarter of 2011. The reasons for the increase in cost of revenue are discussed below. Cost of revenue is comprised of the following: Revenue share & royalties This category includes revenue share payments to the OEM partners, Canadian Radio-television Telecommunications Commission ( CRTC ) fees, Canadian content development ( CCD ), tariff obligations to composers, artists, and copyright owners for public performances and reproduction of their works broadcast on the Company s satellite radio service and fees paid to Sirius XM, including a royalty based on a percentage of all subscriber revenue. Second quarter: Revenue share & royalties increased by $2.3 million or 12.9%, to $20.4 million in the second quarter of 2012 from $18.1 million in the second quarter of 2011. Revenue share & royalties increased in the second quarter of 2012 compared to the second quarter of 2011 due to (a) higher revenue in the current quarter (b) higher effective revenue share paid to various automakers as the Company achieved certain thresholds which resulted in higher Page 12
effective rates during the current period as compared to the corresponding period in the prior year. Year to date: Revenue share & royalties increased by $4.7 million or 13.0%, to $40.9 million from $36.2 million in 2012 compared to 2011. Revenue share & royalties increased in 2012 compared to 2011 due to (a) higher revenue in the current period (b) higher effective revenue share paid to various automakers as the Company achieved certain thresholds which resulted in higher effective rates during the current period as compared to the corresponding prior year period. Customer care & billing operations This category consists primarily of personnel and related costs associated with the ongoing operations of call centres as well as credit card payment processing fees. The Company operates onshore and offshore customer support centers through third party vendors and the objective is to continue to find the optimum blend of onshore and offshore volume allocation in order to maximize cost efficiencies. Since the closing of the merger, the Company has reduced costs in this area based on a cost per subscriber basis and will continue to seek further cost reduction opportunities as we realize synergies for the legacy businesses (XM Canada and Sirius Canada) across the entire customer care platform. A larger subscriber base presents additional opportunities to reduce billing costs. Second quarter: Customer care & billing operations cost increased by $0.1 million or 2.8% to $4.6 million in the second quarter of 2012 from $4.5 million in the second quarter of 2011. Customer care & billing operations costs are primarily driven by the volume derived from the Company s growing subscriber base. While self-paying subscribers increased by 12.5%, these costs increased by only 2.8% as a portion is fixed and does not increase with volume and as the company continues to leverage a larger subscriber base to its advantage and realize synergies from the legacy businesses. Year to date: Customer care & billing operations cost increased by $0.5 million or 6.4% to $8.8 million from $8.3 million in 2012 compared to 2011. Customer care & billing operations costs are primarily driven by the volume derived from the Company s growing subscriber base. While selfpaying subscribers increased by 12.5%, these costs increased by 6.4% as a portion is fixed and does not increase with volume and as the Company continues to seek cost reductions from its operations and realize synergies from the legacy businesses. Monthly Customer Care and Billing Costs per Self-Paying Subscriber Second quarter: As shown below, monthly customer care & billing costs per Self-Paying Subscriber decreased to $1.06 in the three months ended February 29, 2012 from $1.16 in the three months ended February 28, 2011 as higher operating costs were more than offset by a higher subscriber base, increased efficiencies and synergies due to the harmonization of best practices across legacy businesses. Year to date: As shown below, monthly customer care & billing costs per Self-Paying Subscriber decreased to $1.03 in the six months ended February 29, 2012 from $1.10 in the six months ended February 28, 2011 as higher operating costs were more than offset by a higher subscriber base, increased efficiencies and synergies due to the harmonization of best practices across legacy businesses. Page 13
Monthly Customer Care and Billing per Self Paying Subscriber ($/Sub) $1.06 $1.16 $1.03 $1.10 Q2 2012 Q2 2011 FY 2012 FY 2011 Cost of merchandise The Company sells merchandise under normal business terms directly to new and existing subscribers who purchase additional radios, and to commercial accounts through our direct fulfillment channel including through our online store. Cost of merchandise consists primarily of the cost of radios and accessories and related fulfillment costs associated with the direct sale of this merchandise. Second quarter: Cost of merchandise decreased by $0.3 million to $0.8 million in the second quarter of 2012 from $1.1 million in the second quarter of 2011. These costs are primarily driven by the volume and levels of discounts on radio sales, which are mostly affected by promotional programs and commercial accounts. Although sales volume increased 5% during the current period compared to the same period in the prior year, costs decreased due to a change in product mix to lower priced products in the current period compared to the second quarter of 2011. Year to date: Cost of merchandise decreased by $0.5 million to $1.5 million from $2.0 million in 2012 compared to 2011. These costs are primarily driven by the volume and levels of discounts on radio sales, which are mostly affected by promotional programs and commercial accounts. Although sales volume increased 8% during the current period compared to the same period in the prior year, costs decreased due to a change in product mix to lower priced products in the current period compared to the same period of 2011. Broadcast & operations Includes costs associated with operating our terrestrial repeater network, the management and maintenance of systems and facilities as well as information technology expense related to the Company s studios. Specifically, broadcast expenses include costs associated with the management and maintenance of the systems, software, hardware, production and performance studios used in the creation and distribution of Canadian-produced channels. Operations expenses include operating costs of facilities and the terrestrial repeater network and information technology expenses related to the broadcast facilities. Page 14
Second quarter: Broadcast & operations expenses decreased by $0.1 million to $0.4 million in the second quarter of 2012 from $0.5 million in the second quarter 2011. These expenses declined compared to the same period prior year due to a reduction in maintenance costs as a result of modifications to existing agreements and insourcing of channel recording for regulatory purposes as part of the Company s ongoing efforts to drive synergies. Broadcast and operations expenses may fluctuate from quarter to quarter depending on the timing of maintenance and repairs on the Company s broadcast repeaters. Year to date: Broadcast & operations expenses decreased by $0.1 million to $0.9 million from $1.0 million in 2012 compared to 2011. These expenses declined compared to the same period prior year due to a reduction in maintenance costs as a result of modifications to existing agreements and insourcing of channel recording for regulatory purposes as part of the Company s ongoing efforts to drive synergies. Broadcast and operations expenses may fluctuate from quarter to quarter depending on the timing of maintenance and repairs on the Company s broadcast repeaters. Programming & content Includes the creative, production and licensing costs for live NHL programming associated with the Company s Canadian-produced channels, which includes third party content acquisition that are driven by programming initiatives. Programming & content also includes licensing costs paid to the CBC. The Company views programming & content as a cost of attracting and retaining subscribers. The NHL License cost is amortized over the NHL season, which runs for a nine month period beginning in October of each year. Second quarter: Programming & content expenses decreased by $0.4 million or 10.6%, to $3.0 million in the second quarter of 2012 from $3.4 million in corresponding quarter of 2011. The decrease is due to lower costs associated with third party acquired programming in the current period compared to the same period last year. In the current quarter the Company produced certain programming in-house that had previously been outsourced, resulting in lower programming costs compared to the same period prior year. Year to date: Programming & content expenses decreased by $0.8 million, or 12.9% to $5.2 million from $6.0 million in 2012 compared to 2011, respectively. Programming & content costs decreased due to lower costs associated with third party acquired programming in the current period compared to the same period last year. In the current quarter the Company produced certain programming in-house that had previously been outsourced, resulting in lower programming costs compared to the same period prior year. Marketing support Marketing support includes staffing directly associated with selling radio receivers through third party distribution channels, converting OEM trial customers into Self-Paying Subscribers, retaining our customer base, costs related to winning back churned subscribers and marketing the Sirius and XM brands. Second quarter: Marketing support costs decreased by $0.2 million or 10.1% to $1.9 million in the second quarter of 2012 from $2.1 million in the second quarter of 2011. Inflationary increases were offset by lower headcount for the comparable periods. Year to date: Marketing support costs decreased by $0.8 million to $3.6 million in 2012 from $4.4 million in 2011. Inflationary increases were offset by lower headcount for the comparable periods. Page 15
Subsidies & distribution These direct costs include the subsidization of radios, commissions paid with respect to the sale and activation of radios, chipset costs, warranty costs and certain promotional costs. Second quarter: Subsidies & distribution costs decreased by $1.5 million or 13.4%, to $9.4 million in the second quarter of 2012 from $10.9 million in the second quarter 2011. Subsidies & distribution expenses decreased due to lower costs in the Aftermarket channel as a result of lower volume of radios sold resulting in lower subsidy and commission payments and to synergies in promotional activities offset by higher subsidy costs due to a change in product mix. Year to date: Subsidies & distribution costs decreased by $3.9 million or 16.8%, to $19.3 million in 2012 from $23.2 million in 2011. Subsidies & distribution expenses decreased primarily due to lower costs in both the aftermarket and automotive channels. Subsidies & distribution expenses decreased due to lower costs in the Aftermarket channel as a result of lower volume of radios sold resulting in lower subsidy and commission payments as well as lower promotional spending during the holiday season. Subsidies and distribution expenses decreased in the automotive channel due to a shift in the mix of vehicles equipped with satellite receivers for certain partners where subsidies are paid based on vehicles shipped compared to partners where subsidies are paid based on vehicles sold. Lower per-unit contractual rate was also a contributing factor to lower subsidies and distribution costs in the automotive channel. SAC $55 $46 Q2 2012 Q2 2011 Subscriber Acquisition Costs SAC was $46 and $55 for the second quarters of 2012 and 2011, respectively. The decrease in SAC is mainly attributable to lower subsidies and distribution costs in the aftermarket channel due primarily to synergies in promotional spending activities somewhat offset by higher subsidies due to a change in product mix. On a year to date basis, SAC decreased to $50 in 2012 from $59 in 2011. Marketing Include costs related to communications associated with converting trial subscribers to self-paying subscribers, retail advertising through various media, co-operative advertising with Page 16
distribution partners, sponsorships, and ongoing market research. These costs fluctuate based on the timing of these activities. Second quarter: Marketing expenses decreased by $1.5 million or 20.6% to $5.8 million in the second quarter of 2012 from $7.3 million in the comparable quarter in 2011 primarily due to synergies in general advertising and brand marketing costs. Year to date: Marketing expenses decreased by $3.0 million or 21.2% to $11.2 million in 2012 from $14.2 million in 2011 primarily due to lower general advertising and brand marketing costs and synergies associated with the rationalization of agency relationships. CPGA $92 $74 Q2 2012 Q2 2011 Cost Per Gross Addition CPGA was $74 and $92 for the second quarters of 2012 and 2011, respectively. CPGA declined period-over-period due to lower SAC and marketing costs coupled with higher gross subscriber additions in the current period compared to the same period prior year. The Company currently expects CPGA on a full-year basis to continue to be favorable year over year as it seeks efficiencies in marketing costs and continues to generate annual growth in subscribers by increasing its penetration of vehicles equipped with satellite receivers, improving its conversion rate and capitalizing on the pre-owned vehicle channel. CPGA is generally lower for subscribers gained through the pre-owned market as compared to subscribers gained through the new vehicle channel. On a year to date basis, CPGA decreased to $78 in 2012 from $95 in 2011. General & Administrative Expenses General & administrative expenses primarily include compensation, as well as other expenses which include public company costs, office occupancy expenses and other corporate expenses. Second quarter: General & administrative expenses decreased by $0.2 million or 7.3% to $2.7 million in the second quarter of 2012 from $2.9 million in the second quarter of 2011. In addition, Page 17
approximately $0.2 million in costs were incurred during the quarter to support activities that are not expected to occur on a regular basis. The main components of general & administrative expenses are the following: o o Compensation expenses: These costs decreased by $0.6 million in the second quarter of 2012 compared to the same period in 2011. The decrease is due primarily to lower headcount. Other expenses: These costs, which include public company costs, professional fees and other general corporate expenses, increased by $0.4 million for the second quarter of 2012 compared to the corresponding prior year period 2011. The increase in other expenses is due primarily to higher legal costs incurred during the quarter compared to the corresponding quarter last year. The increase in legal costs is due to costs associated with a secondary offering of securities which closed subsequent to the end of the quarter as well as costs associated with the Company s license renewal application with the Canadian Radio and Telecommunications Commission ( CRTC ). Year to date: General & administrative expenses decreased by $1.2 million or 18.7% to $5.3 million in 2012 from $6.5 million in 2011 despite the incurrence of approximately $0.2 million in costs incurred during the period to support activities that are not expected to occur on a regular basis. The main components of general & administrative expenses are the following: o Compensation expenses: These costs decreased by $1.6 million in 2012 compared to same period of 2011. The decrease is due primarily to lower headcount. o Other expenses: These costs, which include public company costs, professional fees and other general corporate expenses, increased by $0.3 million in 2012 compared to the corresponding period in 2011. The increase in other expenses is due primarily to higher legal costs incurred during the period compared to the corresponding period last year. The increase in legal costs is due to costs associated with a secondary offering of securities which closed subsequent to the end of the quarter as well as costs associated with the Company s license renewal application with the Canadian Radio and Telecommunications Commission ( CRTC ). Information Technology Information Technology expenses primarily include costs related to our subscriber management systems, data processing, communications cost, broadcast infrastructure cost and people costs. Page 18
Second quarter: Information technology expenses increased by $0.3 million or 9.3% to $3.2 million in the second quarter of 2012 from $2.9 million in the second quarter of 2011. The increase in these costs is due to higher costs associated with upgrades to the Company s subscriber management system. Year to date: Information technology expenses increased by $0.1 million or 1.3% to $6.0 million in 2012 from $5.9 million in 2011. The increase in these costs is due to higher costs associated with upgrades to the Company s subscriber management system. The Company will seek to realize savings in this area by streamlining communications and data processing costs and consolidating operating systems across a single platform. The Company expects to incur capital costs over the next two years to consolidate its operating systems. Severance and merger costs The Company incurred $0.4 million of merger and restructuring costs primarily related to severance costs and withholding taxes on payments related to SXM s portion of the $11.2 million Promissory Note paid during the quarter. Severance and merger costs of $3.0 million in the corresponding period last year were in respect of legal and professional fees, fees to review the merger agreement and fees paid to members of the board of directors related to a committee of independent directors to review the transaction. The Company does not expect to incur significant restructuring costs in the remainder of fiscal 2012. On a year to date basis, the Company incurred $1.3 million of merger and restructuring costs primarily related to severance costs compared to $5.5 million in 2011. Stock-based Compensation Stock-based compensation expenses are related to the issuance of stock options. Second quarter: Stock-based compensation expenses increased to $0.4 million in the second quarter of 2012 from less than $0.1 million in 2011. The increase in stock-based compensation is a result of expenses associated with options granted in the fourth quarter of fiscal 2011 and the second quarter of fiscal 2012 as well as the recognition of stock compensation of unvested options assumed on the merger, which were revalued under purchase accounting. Year to date: Stock-based compensation expenses increased to $0.8 million in 2012 from less than $0.1 million in 2011. The increase in stock-based compensation is a result of expenses associated with options granted in the fourth quarter of fiscal 2011 and the second quarter of fiscal 2012 as well as the recognition of stock compensation of unvested options assumed on the merger, which were revalued under purchase accounting. Page 19
EBITDA $22.0 $10.8 $1.7 $4.3 Q2 2012 Q2 2011 FY 2012 FY 2011 The Company intends to use EBITDA and its variants such as Adjusted EBITDA, as included in the Non GAAP Financial Measures section, to gauge the performance of the business going forward. Second quarter: EBITDA improved by $9.1 million or 547.7% to $10.8 million from $1.7 million in the second quarters of 2012 and 2011, respectively. EBITDA improved compared to the same period in the prior year primarily due to a $5.5 million revenue improvement (including fair value adjustments of $0.3 million as a result of purchase price accounting), a $3.2 million decrease in marketing expenses, and lower severance and merger costs of $2.7 million offset by higher cost of revenue of $1.7 million and a $0.4 million increase in stock based compensation. As a percentage of revenue EBITDA improved to 16.9% in the second quarter of 2012 from 2.9% in the second quarter of 2011. The improvement in EBITDA is a function of both operational leverage and the realization of synergies in areas such as programming and marketing. Year to date: EBITDA improved by $17.7 million or 416.6% to $22.0 million from $4.3 million in 2012 compared to 2011, respectively. EBITDA improved compared to the same period in the prior year primarily due to a $9.4 million revenue improvement (including fair value adjustments of $0.7 million as a result of purchase price accounting), a $1.2 million decrease in general and administrative costs, lower marketing costs of $7.7 million and lower severance and merger costs of $4.2 million offset by higher cost of revenue of $3.9 million and a $0.8 million increase in stock based compensation. As a percentage of revenue EBITDA improved to 17.4% in 2012 from 3.6% in 2011. The improvement in EBITDA is a function of both operational leverage and the realization of synergies in areas such as programming, general and administrative expenses as well as marketing. Page 20
Adjusted EBITDA $24.8 $11.9 $9.8 $4.7 Q2 2012 Q2 2011 FY 2012 FY 2011 Adjusted EBITDA Second quarter: Adjusted EBITDA improved by $7.2 million or 152.4% to $11.9 million in the second quarter of 2012 from $4.7 million in the second quarter 2011. Adjusted EBITDA improved compared to the same period in the prior year primarily due to a $5.5 million revenue improvement (including fair value adjustments of $0.3 million as a result of purchase price accounting), a $3.2 million decrease in marketing expenses, offset by higher cost of revenue of $1.7 million. As a percentage of revenue, Adjusted EBITDA improved to 18.7% in the second quarter of 2012 from 8.1% in the second quarter of 2011. The improvement in Adjusted EBITDA is a function of both operational leverage and the realization of synergies in areas such as programming and marketing. Year to date: Adjusted EBITDA improved by $15.0 million or 152.2% to $24.8 million in 2012 from $9.8 million in 2011. Adjusted EBITDA improved compared to the same period in the prior year primarily due to a $9.4 million revenue improvement (including fair value adjustments of $0.7 million as a result of purchase price accounting), a $1.2 million decrease in general and administrative costs, lower marketing costs of $7.7 million offset by higher cost of revenue of $3.9 million. As a percentage of revenue Adjusted EBITDA improved to 19.5% in 2012 from 8.4% in 2011. The improvement in Adjusted EBITDA is a function of both operational leverage and the realization of synergies in areas such as programming, general and administrative expenses as well as marketing. Page 21
Selected Consolidated Interim IFRS Financial Information The following selected consolidated interim financial information has been derived from our unaudited consolidated financial statements for the period ended February 29, 2012. The previous annual financial year-end of Sirius Canada Inc. was November 30, 2010; however, in conjunction with the acquisition, the year-end was changed to August 31. These interim financial results for the Company therefore include the results for the three and six months period for CSRH (which includes both Sirius and XM Canada businesses) from September 1, 2011, to February 29, 2012 with the comparative interim financial results for three and six months of Sirius Canada only from December 1, 2010 to May 31, 2011. This information should be read in conjunction with our audited consolidated financial statements and related notes thereto. The results of the second quarter and year-to-date of fiscal 2012 are not directly comparable to the second quarter and year-to-date results of 2011 due to the inclusion of financial results in the prior period for Sirius Canada only compared to financial results of the combined entity for the current period. Hence, the two reporting periods cannot be compared in a meaningful way. For a qualitative assessment of reasons or factors that caused variances in results from period to period, management directs the reader to the Combined Financial Information discussion provided earlier, which is substantially applicable to the reported results. Page 22
The following table presents the Company s unaudited Consolidated interim Statement of Operations and Comprehensive Income. Unaudited Three Months Ended Six Months Ended ( in $) Feb 29, 2012 May 31, 2011 Feb 29, 2012 May 31, 2011 Q2 2012 Q2 2011 YTD 2012 YTD 2011 REVENUE 63,774,132 42,953,260 126,885,377 85,452,356 OPERATING EXPENSES Cost of Revenue Revenue share and royalties 20,401,223 13,078,678 40,948,907 26,091,516 Customer care & billing operations 4,568,860 2,816,794 8,798,329 5,631,825 Cost of merchandise 836,351 601,571 1,521,013 1,352,961 Broadcast and operations 401,718 139,854 881,206 274,941 Programming and content 3,003,921 1,134,997 5,211,937 2,270,484 Total Cost of Revenue 29,212,073 17,771,894 57,361,392 35,621,727 General and administrative 2,720,237 1,685,823 5,303,634 3,412,955 Information Technology 3,167,659 1,484,151 5,991,426 2,896,145 Stock based compensation 433,206-827,127 - Marketing support 1,876,399 1,088,267 3,618,904 2,401,531 Subsidies and distribution 9,435,173 10,083,050 19,315,495 19,443,221 Marketing 5,776,430 3,590,539 11,175,126 8,831,816 Total operating expenses 52,621,177 35,703,724 103,593,104 72,607,395 Severance and merger costs 358,939 444,516 1,276,962 1,475,318 Depreciation and amortization 10,044,378 795,145 20,984,463 1,747,621 Operating income 749,638 6,009,875 1,030,848 9,622,022 Interest income (81,381) (131,393) (125,029) (248,408) Interest expense 4,361,836-8,705,148 - Revaluation of derivative (10,714) - 17,793 - Foreign exchange loss (gain) (345,474) 18,612 156,575 171,191 Net Income (Loss) before income taxes (3,174,629) 6,122,656 (7,723,639) 9,699,239 Income tax expense (recovery) (479,759) - (1,617,012) - Net Income (Loss) for the period (2,694,870) 6,122,656 (6,106,627) 9,699,239 Note: Employee wages and benefits have been allocated to the functions to which they relate in the amounts above. Page 23