Management s Discussion and Analysis For the three months ended November 30 th, 2015 January 13 th, 2016
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 ( SXM, we, us, our or the Company ). This MD&A is current as of January 13, 2016, should be read in conjunction with the Company s unaudited interim consolidated financial statements dated November 30, 2015 and annual audited consolidated financial statements for the year ended August 31, 2015 and notes attached thereto, the August 31, 2015 MD&A, and other recent securities filings available on SEDAR at sedar.com. The financial information presented herein has been prepared on the basis of IFRS and is expressed in Canadian dollars unless otherwise noted. The Class A Subordinate Voting Shares of SXM trade on the Toronto Stock Exchange (TSX) under the stock symbol XSR. 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 amount and timing of dividend payments, growth, results of operations, performance, business prospects and opportunities of the Company on a consolidated basis. In some cases, forward-looking 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, dividends, 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 forward-looking statements are: The Company s reliance on its exclusive relationship with Sirius XM Radio Inc. ( Sirius XM ); The Company s competitive position versus other forms of audio and video entertainment; The Company s ability to manage customer attrition and average monthly subscription revenue per subscriber; The Company s reliance on automakers and automobile industry sales in Canada; General economic conditions in Canada; The impact of any application of or changes to governmental regulations, including any copyright legislation; 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 most recent Annual Information Form ( AIF ). 1
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 most recent Annual Information Form available on SEDAR at www.sedar.com. 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 1 Overview 3 Developments during the Quarter 3 Financial and Operational Highlights 4 Summary and Discussion of Financial and Operating Results 5 Financial Position 11 Liquidity and Capital Resources 12 Off-Balance Sheet Arrangements 15 Relationships and Transactions with Related Parties 15 Critical Accounting Estimates and Judgments 16 International Financial Reporting Standards ("IFRS") 17 Risks and Uncertainties 17 Outstanding Share Data and Other Information 17 Definition of Industry Terminology 18 Definition of Non-GAAP Measures 19 2
OVERVIEW Our Business Through licensing agreements with Sirius XM, we provide audio entertainment on a subscription basis and broadcast approximately 130 channels, including commercial-free music, news, talk, sports, comedy and children s programming over a satellite and terrestrial repeater network. We also provide our content over the internet whereby subscribers can access on-demand and personalization features, in addition to providing ancillary services including traffic, data and weather. SXM is one of the largest Canadian subscription based media companies as measured by total number of subscribers with more than 2.7 million of which 1.9 million are Self-Paying subscribers and 0.8 million are Paid and Non-Paid Promotional subscribers. We have agreements with all major automobile manufacturers ( OEMs ) in Canada to install satellite radios in new vehicles and provide promotional subscriptions with the sale or lease of their vehicles. Currently, over 70% of the new cars sold in Canada come equipped with satellite radio. In certain instances we receive subscription payments from OEMs in advance of our service being activated. In addition, we have agreements with over 2,600 auto dealers to provide promotional subscriptions with the sale or lease of used vehicles. The length of these subscriptions provided by OEMs and auto dealers vary from three to twelve months. After-market satellite radio receivers are available at more than 2,500 leading retailers across Canada such as Best Buy, Canadian Tire, Costco, The Source, Wal-Mart, Amazon.ca, other national, regional and independent retailers and directly through our online portal. Our primary source of revenue is subscription fees with our customers subscribing to multi-year, annual, semi-annual, quarterly, or monthly plans and paid promotional trials. Other sources of revenue include: the Music Royalty and Regulatory Fee ("MRF"), activation fees, advertising revenues, and the direct sale of satellite radios and accessories through our call centers and website. We have four significant shareholders including, Sirius XM Radio Inc. ( Sirius XM ), Canadian Broadcasting Corporation ( CBC ), Slaight Communications Inc. ( Slaight ), and Obelysk Media Inc. ( Obelysk ) with a combined equity interest in SXM of approximately 69%. DEVELOPMENTS DURING THE QUARTER Quarterly Dividends Declared and Paid On October 29, 2015, the Board of Directors declared a cash dividend of $0.105 per Class A Share and Class C Share and $0.035 per Class B Share, which was paid on December 4, 2015 to the shareholders of record at the close of business on November 20, 2015. Programming Highlights During the quarter, the Company announced that Grammy Award -winning singer-songwriter and rock legend Tom Petty will launch his own Sirius XM channel. The new and exclusive channel will be curated by Petty himself, and will feature music from his legendary career. The Company also announced the comprehensive coverage of the National Hockey League ("NHL") and National Football League seasons as well as an extensive holiday music lineup featuring 10 commercial-free channels celebrating the festive season. 3
Subsequent to the quarter end, on December 15, 2015, the Company announced an agreement under which legendary broadcaster Howard Stern will continue to produce and host "The Howard Stern Show" on Sirius XM for the next 5 years. The deal includes plans for Sirius XM to launch its first venture into video programming with Stern. FINANCIAL AND OPERATIONAL HIGHLIGHTS The following are the highlights for the three months ( Q1, "First quarter") ended November 30, 2015 in comparison to the three months ended November 30, 2014. Three months ended November 30, 2015 Revenue increased by 5.7% to $83.5 million from $79.0 million; an improvement of $4.5 million; Adjusted EBITDA 1 increased by 2.7% to $23.5 million from $22.9 million; an increase of $0.6 million; EBITDA 1 increased by 7.2% to $23.2 million from $21.6 million; an increase of $1.6 million; Operating income increased by 20.4% to $17.6 million from $14.7 million; an increase of $2.9 million; Net income increased by 25.6% to $10.1 million from $8.0 million; an increase of $2.1 million; Earnings per share ("EPS") 2 of $0.08 compared to an EPS of $0.06, an increase of $0.02 per share; Cash from operations decreased by 0.8% to $17.2 million from $17.3 million; a decrease of $0.1 million; Free Cash Flow 1 decreased by 25.2% to $10.2 million from $13.7 million; a decrease of $3.5 million; Ending Self-Paying and Total Subscribers of 1,938,819 and 2,713,305 respectively, an addition of 13,661 Self- Pay and a loss of 12,340 Total Subscribers in the first quarter of fiscal 2016. 1 Non-GAAP measure. See definition in the section entitled Definition of Non-GAAP Measures. 2 EPS is based on a basic and fully diluted earnings per share basis. Note: Percentage variances/changes are calculated based on the exact numbers, therefore, amounts may not sum as a result of rounding in certain instances. 4
SUMMARY AND DISCUSSION OF FINANCIAL AND OPERATING RESULTS The following tables present the Company s summarized financial results and operating metrics used to help measure the performance of the operations for the three months ended November 30, 2015 in comparison to the three months ended November 30, 2014. Please refer to the section "Definition of Industry Terminology" and "Definition of Non- GAAP Measures" at the end of this MD&A for an overview of the metrics noted below. Three months ended Summarized Financial Results Nov 30, 2015 Nov 30, 2014 (in $ 000's, except as indicated) Q1 2016 Q1 2015 Revenue 83,517 78,985 Operating expenses Operating costs 60,367 57,387 Depreciation and amortization 5,503 6,942 Operating income 17,647 14,656 Finance costs, net Interest income 60 90 Interest expense (3,375) (3,117) Foreign exchange loss (316) (64) Finance costs, net (3,631) (3,091) Net income before income tax 14,016 11,565 Income tax expense (3,941) (3,541) Net income and comprehensive income 10,075 8,024 Earnings per share - basic and diluted 0.08 0.06 EBITDA 23,150 21,598 EBITDA margin (in %) 27.7 % 27.3 % Adjusted EBITDA 23,518 22,906 Adjusted EBITDA margin (in %) 28.2 % 29.0 % Cash and short term investments 36,391 37,658 Free cash flow 10,229 13,679 Net debt 159,791 157,946 Net debt to Adjusted EBITDA (times) * 2.00 1.92 * Net debt to Adjusted EBITDA ratio for the period is based on last 4 quarters of reported Adjusted EBITDA 5
Three months ended Summarized Operating Metrics Nov 30, 2015 Nov 30, 2014 Beginning subscribers 2,725,645 2,611,679 Net additions (12,340 ) (8,257 ) Ending subscribers 2,713,305 2,603,422 Self-Paying subscribers 1,938,819 1,847,355 Paid-Promotional subscribers 609,974 608,196 Non-Paid Promotional subscribers 164,512 147,871 Ending subscribers 2,713,305 2,603,422 Self-Pay net change 13,661 (4,389 ) Paid/Non-Paid net change (26,001 ) (3,868 ) Net additions (12,340 ) (8,257 ) Average Self Pay Churn 1.93 % 2.33 % Self-Pay ARPU $12.57 $12.38 SAC $40 $39 The following section discusses the comparison of the results of operations for the three months ended November 30, 2015 to the results of operations for the three months ended November 30, 2014. Subscribers Ending Self-Paying subscribers increased 5.0% versus the first quarter of fiscal 2015, driven largely by growth in the number of OEM additions on account of growth in new and pre-owned car sales during the period. During the first quarter, Self-Paying subscribers increased by 13,661, compared to a decrease of 4,389 in the first quarter of fiscal 2015. The increase in Self-Paying net additions compared to the same period in fiscal 2015 was driven by the increase in year-over-year sales coupled with lower deactivations as a result of improved retention performance. Self-Paying subscribers decreased in the first quarter of fiscal 2015, primarily as a result of the increase in the MRF in August 2014 and transition of one of our call centres. Ending Paid Promotional subscribers and Non-Paid Promotional subscribers increased by 2.4% compared to the first quarter of fiscal 2015 due to increases in both vehicle sales and the penetration rate. Paid and Non-Paid Promotional subscribers decreased by 26,001, compared to a decrease of 3,868 in the comparative quarter of fiscal 2015 due to a higher number of expired trials in the first quarter of fiscal 2016. Self-Pay Churn For the first quarter of fiscal 2016 and 2015, Self-Pay churn was 1.93% and 2.33% respectively as the Company retained more subscribers on account of improved retention performance. Churn in the first quarter of fiscal 2015 was negatively impacted by the increase in the MRF in August 2014 and the transition of one of the third party call centres. Self-Pay ARPU For the first quarter of fiscal 2016 and 2015, Self-Pay ARPU was $12.57 and $12.38 respectively, an increase of $0.19 or 1.5%, primarily due to the cumulative impact of the increased MRF on renewing subscribers which was rolled out in the last week of fiscal 2014, partly offset by increased subscription discounts provided to acquire and retain subscribers. 6
In the quarter, the Company updated the MRF from a flat rate of $2.27 per month to 14.2% of satellite radio subscription prices so that the MRF is applied proportionally across plans of differing prices. Revenue Revenue includes subscription fees, activation fees, MRF, sale of merchandise through direct fulfillment channels, advertising revenue from Canadian-produced channels and certain other revenues. For the first quarter of fiscal 2016 and 2015, revenue was $83.5 million and $79.0 million respectively, an increase of $4.5 million or 5.7%. The increase was primarily attributable to the growth in our Self-Paying subscriber base coupled with an increase in Self-Pay ARPU of 1.5%. Operating Expenses Three months ended Operating Expenses Nov 30, 2015 Nov 30, 2014 (in $000s) Q1 2016 % of Rev Q1 2015 % of Rev Revenue share and royalties 27,443 32.9 % 23,594 29.9 % Customer care & billing operations 4,999 6.0 % 5,190 6.6 % Cost of merchandise 1,111 1.3 % 1,158 1.5 % Programming and broadcast 2,761 3.3 % 2,975 3.8 % Total cost of revenue 36,314 43.5 % 32,917 41.7 % General and administrative 2,670 3.2 % 2,958 3.7 % Information technology 2,606 3.1 % 1,903 2.4 % Stock-based compensation 368 0.4 % 1,306 1.7 % Total overhead costs 5,644 6.8 % 6,167 7.8 % Marketing 8,428 10.1 % 8,427 10.7 % Subsidies and distribution 9,981 12.0 % 9,876 12.5 % Total marketing costs 18,409 22.0 % 18,303 23.2 % Total operating expenses 60,367 72.3 % 57,387 72.7 % Revenue share & royalties includes license payments to Sirius XM, revenue share payments to OEM partners, Canadian Radio and Telecommunications Commission ("CRTC") fees, CRTC mandated Canadian Content Development ("CCD") contributions, and copyright royalties payable to rights holders for public performances and reproduction of musical works, performers performances and sound recordings. For the first quarter of fiscal 2016 and 2015, revenue share and royalties were $27.4 million and $23.6 million respectively, an increase of $3.8 million or 16.3%. The increase was primarily due to the impact of higher revenues, higher royalty rates related to changes in copyright laws which took effect during October 2014, and timing of CCD initiatives. Revenue share & royalties will fluctuate seasonally with the timing of CCD initiatives as a significant portion of the CCD expenses are expected to occur in the third and fourth quarter of the fiscal year. Customer care & billing operations includes costs associated with the operation and management of onshore/offshore third party call centers, and billing and payment processing fees. 7
For the first quarter of fiscal 2016 and 2015, customer care and billing operations costs were $5.0 million and $5.2 million respectively, a decrease of $0.2 million or 3.7%, mainly due to lower billing and payment processing fees. The savings are a result of reduced rates associated with billing and payment processing. Cost of merchandise includes cost of equipment sold directly through our online store and call centers, as well as related fulfillment costs. For the first quarter of fiscal 2016 and 2015, cost of merchandise was $1.1 million and $1.2 million respectively a decrease of $0.1 million or 4.1%. The decrease was the result of efficiencies in distribution and the sale of lower cost products compared to the same quarter in fiscal 2015. Programming and broadcast includes acquired content, production of the Company s Canadian-produced channels, as well as the management and maintenance of the Company s studios and terrestrial repeater network. For the first quarter of fiscal 2016 and 2015, programming and broadcast expenses were $2.8 million and $3.0 million respectively, a decrease of $0.2 million or 7.2%, mainly due to reduced acquired content costs. General and administrative includes compensation, public company costs, office occupancy expenses and other corporate expenses. For the first quarter of fiscal 2016 and 2015, general and administrative expenses were $2.7 million and $3.0 million respectively, a decrease of $0.3 million or 9.7%. The decrease was primarily due to lower employee compensation expenses, partly offset by higher professional fees. Information technology includes costs related to the management and maintenance of our subscriber management system, data processing, communications cost, and network infrastructure costs. For the first quarter of fiscal 2016 and 2015, information technology expenses were $2.6 million and $1.9 million respectively, an increase of $0.7 million or 36.9%. The increase was primarily due to completion of the unified Subscriber Management System ("SMS") in the third quarter of fiscal 2015 which resulted in a reduced capitalization of internal resources compared to the same quarter in fiscal 2015. Stock-based compensation expenses are related to the issuance of stock options, Restricted Stock Units ( RSUs ) and Performance Stock Units ( PSUs ). For the first quarter of fiscal 2016 and 2015, stock-based compensation expense was $0.4 million and $1.3 million respectively, a decrease of $0.9 million, mainly due to forfeitures of unvested RSUs and PSUs, and amendments due to net settlement accounting. During the quarter, for the RSUs and PSUs that vested, some units were net settled, whereby the number of units to be received by an employee was reduced to cover the employee's statutory tax requirements. At the discretion of the Company's Board of Director's, the Company may net settle all outstanding PSUs and RSUs. As such, the Company has booked a liability to reflect the value of the portion of units that would be used to settle the employee's tax requirements. The liability is revalued to the market value of a Class A Subordinate Voting Share of the Company at the reporting date, and any adjustment to the liability is reflected in stock-based compensation expense. On November 2, 2015, the Company granted stock options to the Board of Directors and senior management for 300,637 Class A Subordinate Voting Shares with an exercise price of $4.76. The options granted to the Board of Directors vest immediately, and the grants to the senior management vest over 4 years. The fair value of the options was estimated using the Black-Scholes option pricing model. 8
As a form of incentive compensation, during November 2015, with approval from the Company s Board of Directors, the Company granted to certain employees 225,060 RSUs and 450,120 PSUs. The vesting of the PSUs granted is conditional on the achievement of specified non-market performance targets. Each of the RSU and PSU grants include an additional grant of a dividend equivalency to accrue upon each future quarterly or special dividend declaration during the vesting term which can be settled in cash or shares upon vesting, at the discretion of the Board. The weighted average fair value for both RSUs and PSUs granted is $4.70 per unit. The RSUs vest from one to three years and PSUs cliff vest in three years, and can be settled in cash or shares at the discretion of the Company s Board of Directors. As at November 30, 2015, the number of non-vested RSUs is 269,185 units and the range of PSUs that may vest is from a minimum of nil to a maximum of 937,852 units depending on achievement of specified non-market performance targets. The number of PSUs that may vest based on conditions existing at the balance sheet date is 587,028 units. As at November 30, 2015, the Company had the following stock options outstanding: Stock Options Outstanding (in $000 except for exercise price) Weighted Average Remaining Contractual Life (years) Weighted Average Exercise Price Total Vested Unvested At September 1, 2015 4.7 $5.25 2,597 925 1,672 Granted $4.76 301 201 100 Vested 418 (418) Exercised $3.32 (10) (10) Forfeited $4.96 (244) (244) Balance, November 30, 2015 4.7 $5.23 2,644 1,534 1,110 Marketing includes direct marketing efforts to convert and retain subscribers, advertising, co-operative advertising with distribution partners, sponsorships, and market research. It also includes staffing costs directly associated with marketing activities. For the first quarter of fiscal 2016 and 2015, marketing remained flat at $8.4 million and $8.4 million respectively. Higher communication volumes resulting from an increase in trial starts were offset by expired advertising commitments and lower compensation expense. Subsidies and distribution includes the subsidization of radios, commissions paid to partners for the sale and activation of radios, warranty costs and certain promotional costs. For the first quarter of fiscal 2016 and 2015, subsidy costs were $10.0 million and $9.9 million respectively, an increase of $0.1 million or 1.1%. The costs increased mainly due to higher purchases in the Aftermarket segment and foreign exchange rates, partly offset by lower average OEM subsidy rates compared to the same quarter in fiscal 2015. SAC For the first quarter of fiscal 2016 and 2015, SAC was $40 and $39 respectively, an increase of $1 or 2.6%. SAC increased marginally relative to the same quarter in fiscal 2015 due to higher subsidies and distribution costs. 9
EBITDA The Company uses EBITDA and its variants such as Adjusted EBITDA, as described in the "Definition of Non-GAAP Measures" section, to gauge the performance of the business. The table below is a reconciliation of income before income tax to EBITDA and Adjusted EBITDA. Adjusted EBITDA: Reconciliation Three months ended in ($ 000 s) Nov 30, 2015 Nov 30, 2014 Net income and comprehensive income before income tax 14,016 11,565 Interest expense & income, (net) 3,315 3,027 Foreign exchange loss 316 64 Depreciation and amortization 5,503 6,942 EBITDA 23,150 21,598 Stock-based compensation 368 1,306 Fair value adjustments * 3 Adjusted EBITDA 23,518 22,906 * Fair value adjustment relates to a reduction in revenue due to the valuation of deferred revenue under purchase price accounting. For the first quarter of fiscal 2016, EBITDA increased by $1.6 million or 7.2% to $23.2 million from $21.6 million in the first quarter of fiscal 2015. EBITDA increased in the current quarter compared to the same period last year as an increase in revenue was partly offset by an increase in the company s copyright fees and royalties related to higher revenues. EBITDA was also favourably impacted by lower stock-based compensation in the first quarter of fiscal 2016. As a percentage of revenue, EBITDA margin increased to 27.7% in the first quarter of fiscal 2016 from 27.3% in the first quarter of fiscal 2015. EBITDA margins will fluctuate with the timing of CCD initiatives as a significant portion of the CCD expenses are expected to occur in the third and fourth quarter of the year. Adjusted EBITDA For the first quarter of fiscal 2016, Adjusted EBITDA increased by $0.6 million or 2.7% to $23.5 million from $22.9 million in the first quarter of 2015. Adjusted EBITDA increased in the current quarter as an increase in revenue was partly offset by an increase in the company s copyright fees and royalties related to higher revenues. As a percentage of revenue, Adjusted EBITDA margin decreased to 28.2% in the first quarter of fiscal 2016 from 29.0% in the first quarter of fiscal 2015 due to the increase in copyright expenses as the Company incurred a full quarter of copyright expenses compared to only a partial quarter of increased copyright expenses realized in the same quarter in fiscal 2015. Adjusted EBITDA margins will fluctuate with the timing of CCD initiatives as a significant portion of the CCD expenses are expected to occur in the third and fourth quarter of the year. Depreciation and amortization For the first quarter of fiscal 2016 and 2015, depreciation and amortization expense was $5.5 million and $6.9 million respectively, a decrease of $1.4 million or 20.7%. Depreciation and amortization expense decreased as some intangible assets associated with OEM contracts and subscriber relationships that were in effect last year have now been fully amortized, partly offset by an increase in depreciation and amortization as a result of higher activation fees and completion of the unified SMS. Finance costs include interest expense, interest income from our cash and cash equivalent balances, and foreign exchange losses associated with valuation of US dollar balances and payments. 10
For the first quarter of fiscal 2016 and 2015, finance costs were $3.6 million and $3.1 million respectively, an increase of $0.5 million or 17.5%. The increase was primarily due to higher foreign exchange losses due to strengthening of the US dollar relative to the Canadian dollar, higher interest expenses primarily due to the issuance of a letter of credit utilizing the Company's Credit Facility (see the section Liquidity and Capital Resources), and lower interest income due to a lower average cash and cash equivalents balance in the first quarter of fiscal 2016 compared to the same quarter of fiscal 2015. Income tax expense For the first quarter of fiscal 2016 and 2015, income tax expense was $3.9 million and $3.5 million respectively, an increase of $0.4 or 11.3%, primarily due to higher operating income in first quarter of fiscal 2016 compared to the same period in fiscal 2015. As was discussed in the August 31, 2015 audited consolidated financial statements and fiscal 2015 MD&A, the Company received notice of reassessments whereby the Canada Revenue Agency ("CRA") denied the deductions related to share issuance costs that were claimed in its August 31, 2006 tax return. The Company was assessed for withholding taxes including interest and penalties of $15,887, which were due immediately. During fiscal 2016, the Company filed a notice of appeal in respect of the withholding taxes, interest and penalties assessed. The Company remains confident in its filings and will continue to vigorously defend its position. Net income and earnings per share For the first quarter of fiscal 2016 and 2015, the net income attributable to the shareholders was $10.1 million ($0.08 per share) and $8.0 million ($0.06 per share) respectively, an increase of $2.1 million or 25.6%. The increase in net income was driven by better operational performance and lower depreciation and amortization charges in the current quarter compared to the same quarter in fiscal 2015. FINANCIAL POSITION The following discussion outlines the significant changes in the consolidated statements of financial position since August 31, 2015. Assets Cash and cash equivalents increased by $10.3 million. See the section Liquidity and Capital Resources. Accounts receivables increased by $1.2 million, mainly due to the result of timing of receipts. The company reviews outstanding accounts receivables on a regular basis. Prepaid expenses decreased by $2.0 million, mainly due to the result of pre-payments for dual band repeaters at the end of August 31, 2015 which were deployed and transferred to property and equipment in the quarter. Property and equipment increased by $3.0 million as the Company updates and expands its network of terrestrial repeaters, partly offset by reduced depreciation expense for the quarter. Intangible assets increased by $9.5 million, primarily due to the recognition of the NHL trademark rights associated with the Company s NHL license renewal extension through the 2021-22 NHL season, XM activation fees, and computer software, partly offset by amortization expense for the quarter. Deferred tax assets decreased by $3.9 million, see Income tax expense in Operating expenses section. 11
Liabilities Trade and other payables increased by $5.2 million, mainly due to the timing of trade payable payments. Due to related parties decreased by $2.9 million, mainly due to the timing of payments to Sirius XM. Interest payable decreased by $2.8 million, mainly due to the interest payment in the quarter for the 2021 Senior notes. The Company pays interest semi-annually in October and April. Dividend payable increased by $13.5 million, as a result of the dividend declared on October 29, 2015 for shareholders of record November 20, 2015. The dividend was subsequently paid December 4, 2015. Deferred revenue decreased by $1.2 million, mainly due to the seasonality of subscriber billing cycles. Other long-term liabilities increased by $9.8 million, mainly due to the NHL trademark rights associated with the Company s NHL license renewal extension through the 2021-22 NHL season. Shareholders' deficiency Shareholders deficiency increased by $3.7 million, mainly due to the dividend declaration on October 29, 2015, partly offset by net income for the quarter. LIQUIDITY AND CAPITAL RESOURCES The Company s cash flows from operating, investing and financing activities are summarized in the following table: Cash Flow Data Three months ended (in $ 000's) Nov 30, 2015 Nov 30, 2014 Cash flow provided by operating activities 17,206 17,343 Cash flow used in investing activities (6,977 ) (3,664 ) Cash flow provided by financing activities 34 111 Net change in cash and cash equivalents 10,263 13,790 Cash and cash equivalents, beginning of the period 26,128 23,868 Cash and cash equivalents, end of the period 36,391 37,658 Operating activities - For the first quarter of fiscal 2016 and 2015, operating activities were $17.2 million and $17.3 million respectively, a decrease of $0.1 million or 0.8%, mainly due to increased finance costs and a decrease in operating working capital, partially offset by increased adjusted EBITDA. Investing activities - For the first quarter of fiscal 2016 and 2015, investing activities were $7.0 million and $3.7 million respectively, an increase of $3.3 million or 81.9%, mainly due to the Company updating and expanding its network of terrestrial repeaters, and increased XM activation fees. Financing activities - For the first quarter of fiscal 2016 and 2015, financing activities were $0.0 million and $0.1 million respectively, a decrease of $0.1 million, mainly due to lower stock option exercises. 12
Free Cash Flow Data Three months ended (in $ 000's) Nov 30, 2015 Nov 30, 2014 Cash flow provided by operating activities 17,206 17,343 Purchase of property and equipment (1,425) (205) Purchase of intangible assets (5,552) (3,459) Free Cash Flow 10,229 13,679 Free Cash Flow - The Company generated free cash flow of $10.2 million during the first quarter of fiscal 2016 compared to $13.7 million in the same quarter last year, a decrease of $3.5 million or 25.2%. The decrease in free cash flow on a comparative basis is due primarily to an increase in capital expenditures. Long-term Debt Debt As at (in $ 000's) Nov 30, 2015 Aug 31, 2015 Senior Notes 196,182 196,036 Total debt 196,182 196,036 2021 Senior Notes In 2014, the Company refinanced its high yield debt through issuance of new senior unsecured notes in the aggregate amount of $200 million due April 23, 2021, at 5.625% ("2021 Senior Notes"). Interest payments on the 2021 Senior Notes are due semi-annually on April 23 and October 23 of each year commencing on October 23, 2014. The 2021 Senior Notes are redeemable at the option of the Company. At any time prior to April 23, 2017, the Company may on any one or more occasions redeem up to 35% of the aggregate principal amount of the 2021 Senior Notes at a maximum redemption price of 105.625% of the principal amount. The premium on early redemption will vary based on the date of redemption. The 2021 Senior Notes contain a financial covenant requiring the Company to meet a maximum leverage ratio test of 6.0:1.0, with a provision allowing for the enactment of certain restrictions if the leverage ratio test exceeds a threshold of 3.75:1.0. The Company remains in compliance with both leverage ratio test thresholds. Credit Facility On March 24, 2015, the Company renewed its Credit Facility with a syndicate of banks in the amount of $50.0 million for a two-year term due May 23, 2017. The Credit Facility, as generally required, contains financial covenants requiring the Company to meet a maximum drawn Credit Facility debt to EBITDA ratio of 2.0:1.0 and a minimum fixed charge coverage ratio of 2.5:1.0. The interest rate on the Credit Facility fluctuates with Canadian prime rate, Canadian bankers acceptance rate, US base rate and/or London Inter-Bank Offered Rate plus an applicable margin. As at November 30, 2015, an irrevocable letter of credit in the amount of $17.1 million has been issued under the Credit Facility to the CRA as security related to the withholding taxes for a 2006 tax issue with the CRA. The current effective rate on the letter of credit is 2.5%. No other advances have been made from the Credit Facility. As at November 30, 2015, the Company was in compliance with all financial covenants, financial ratios and all of the terms and conditions of our 2021 Senior Notes and Credit Facility agreements. 13
Liquidity As at November 30, 2015 the Company had $36.4 million in cash and cash equivalents and $32.9 million available under our credit facility for a total of $69.3 million. We believe that the cash on hand, undrawn Credit Facility and cash flow from operations will provide sufficient liquidity to fund operations and discharge financial obligations going forward. Net debt to Adjusted EBITDA increased to 2.00 from 1.92 times in the comparative quarter last year primarily due to a lower cash balance and lower reported cumulative Adjusted EBITDA for the trailing four quarters. The Company regularly assesses ways to allocate capital in order to maximize shareholder value and believes that it can sustain its dividend. The amount and timing of any dividend however is within the discretion of the Board of Directors and will depend on the Company's financial condition, compliance with terms and conditions of the Company's credit and contractual arrangements on an on-going basis, general business conditions, and other factors that the Board of Directors considers to be relevant. Dividend A dividend of $0.105 per Class A and Class C Shares, and $0.035 per Class B Shares was declared on October 29, 2015 for shareholders of record November 20, 2015. The dividend was subsequently paid December 4, 2015. Contractual Commitments The Company has entered into a number of leases and other contractual commitments. The following table summarizes its outstanding contractual commitments as at November 30, 2015: As at November 30, 2015 Contracts and Commitments (1) Consolidated Total Less than 1 Yr. 1-3 Yrs. 4-5 Yrs. More than 5 Yrs. (in $ 000's) Operating leases 11,313 1,946 3,590 3,405 2,372 Principal on 2021 Senior Note 200,000 200,000 Interest on 2021 Senior Note 61,875 11,250 22,500 22,500 5,625 Service provider agreements Programming, Advertising and marketing (2) 42,380 10,053 12,298 10,682 9,347 CBC 14,175 2,100 4,200 4,200 3,675 Sirius XM 855 513 342 Others 18,996 16,690 2,244 62 Total 349,594 42,552 45,174 40,849 221,019 Notes: (1) The Company must pay certain royalties for the use of music under Canadian copyright laws outlined in tariffs certified by the Copyright Board of Canada or by agreement. The Company also pays license royalties to Sirius XM and fees to certain OEMs. These arrangements have not been included in the table above because the specific amounts payable are contingent on the Company s revenue and/or subscriber levels, which themselves are subject to various economic assumptions and future results and cannot be estimated. (2) Some balances are denominated in US dollars and converted to Canadian dollars and are subject to foreign exchange fluctuations. 14
OFF-BALANCE SHEET ARRANGEMENTS The Company has no off-balance sheet arrangements. RELATIONSHIPS AND TRANSACTIONS WITH RELATED PARTIES Our contracts with related parties are reviewed with the Corporate Governance Committee comprised of independent directors and approved by the Board of Directors. The Company transacts business under these contracts in the normal course with Sirius XM, CBC, and Obelysk who are significant shareholders of the Company and who exercise significant influence. Transactions with CBC - In consideration for the costs incurred, the Company receives broadcasting rights for six CBC channels which are broadcasted on the Sirius and XM networks, use of rooftop space for the placement of some of the Company s repeaters and advertising on certain CBC media properties. Transactions with Sirius XM - In consideration for the costs incurred, the Company receives: the right to distribute within Canada the Sirius and XM network channels owned or licensed by Sirius XM, the right to distribute within Canada other data services owned or licensed by Sirius XM, provisioning access to activate radios on the XM network, and monitoring and support services related to managing the Company s repeater network. The Company partners with and financially supports the development of new products and services. The Company also reimburses Sirius XM for costs incurred which are directly related to products and services delivered in Canada. Transactions with Obelysk and its affiliates - In consideration for the costs incurred the Company receives media advertising and sundry purchases, for which the Company reimburses Obelysk. The balances outstanding and transactions with the related parties are set out in Note 5 of the Company s unaudited interim condensed consolidated financial statements and are summarized below: Three months ended (in $ 000's) Nov 30, 2015 Nov 30, 2014 Change (%) CBC license agreement and support 547 603 9.3 % Sirius XM agreements 13,783 12,212 12.9 % Non-interest bearing promissory notes 1,208 1,208 % Amounts capitalized 2,524 896 181.7 % Amounts capitalized relate to intangibles assets (XM activation fees and computer software) that are presented net of amortization on the balance sheet. The actual cash payment made in the quarter to Sirius XM relating to these intangibles assets is $3.8 million for the first quarter of fiscal 2016 and $1.3 million for first quarter of fiscal 2015. 15
CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS Please see our 2015 annual MD&A and our 2015 annual audited consolidated financial statements and notes thereto for a discussion of the accounting policies and estimates that are critical to the understanding of our business operations and the results of our operations. Except as indicated below, there were no changes to these policies and estimates this quarter. Stock-based compensation Restricted Stock Units ( RSUs ) and Performance Stock Units ( PSUs ) The Company grants RSUs and PSUs to certain employees, directors and senior officers. The RSUs and PSUs are settled in cash or equity at the discretion of the Company's Board of Directors. Certain grants include an additional grant of a dividend equivalency for each future quarterly or special dividend declaration during the vesting term of the RSU and PSU, and can also be settled in cash or shares at the discretion of the Company's Board of Directors. RSUs vest from one to three years, PSUs cliff vest in three years, and the number of PSUs that will vest vary depending on the Company meeting minimum specified performance targets attached to the award. During the quarter, for some of the units that vested, the Company net settled the RSUs and PSUs, whereby the number of RSUs and PSUs obtained by the employee were reduced by the value of the RSUs and PSUs required to settle the employee's statutory income tax requirements. The taxes owed will be paid by the Company on behalf of the employee. As a result, all new and outstanding RSU and PSU awards will include an equity component and a liability component for the tax portion. At the time of grant, the Company determines the employee's tax obligation (liability component) and the equity component of the grants. For each RSU and PSU granted, the Company recognizes a liability and stock-based compensation expense equal to the market value of a Class A Subordinate Voting Share of the Company at the date of grant based on the number of RSUs and PSUs expected to vest, which includes dividend equivalent units where applicable, recognized over the term of the vesting period, as well as an adjustment to contributed surplus for equity settled RSUs and PSUs. At each reporting period, the liability component is adjusted to the market value of the Company's Class A Subordinate Voting Shares along with a corresponding adjustment to stock-based compensation expense. Stock-based compensation expense is also adjusted for subsequent changes in management s estimate of the number of RSUs and PSUs that are expected to vest. The effect of these changes is recognized as operating costs in the period of change. Upon settlement of equity settled RSUs and PSUs, any difference between the cost of the shares purchased on the open market and the amount credited to contributed surplus is reflected in accumulated deficit. Disclosure controls and procedures Management has designed disclosure controls and procedures to provide reasonable assurance that material information relating to the Company is made known to it by others. As at November 30, 2015, the Chief Executive Officer and the Chief Financial Officer, with participation of the Company s management, have concluded that the design and operation of the Company s disclosure controls and procedures were effective to provide that information required to be disclosed by the Company in reports that it files or submits under the applicable Canadian securities laws is (i) recorded, processed, summarized and reported within the time periods specified in applicable rules and forms and (ii) accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. Due to the inherent limitations in control systems and procedures, their evaluation can provide only reasonable, not absolute, assurance that such disclosure 16
controls and procedures are operating effectively. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Changes in internal control over financial reporting During the three months ended November 30, 2015, there were no changes in the Company s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company s internal control over financial reporting. INTERNATIONAL FINANCIAL REPORTING STANDARDS ("IFRS") Accounting standards issued but not yet effective A listing of the recent accounting pronouncements promulgated by the International Accounting Standards Board and not yet adopted by the Company are listed in Note 2 of our 2015 annual audited financial statements and also in our 2015 annual MD&A. A listing of these accounting pronouncements issued but not yet adopted by the Company are summarized below: IAS 1, Presentation of Financial Statements (effective January 1, 2016) IFRS 9, Financial Instruments (effective January 1, 2018) IFRS 15, Revenue from Contracts with Customers (effective January 1, 2018) RISKS AND UNCERTAINTIES For a detailed description of certain risk factors that could affect our business, financial condition and results of operations, and which should be considered in connection with any forward looking statements in this document, readers are advised to review the Risk Factors section of the Company s most recent AIF available on SEDAR at www.sedar.com. OUTSTANDING SHARE DATA AND OTHER INFORMATION The Company is authorized to issue an unlimited number of Class A Shares, an unlimited number of Class B Shares and an unlimited number of Class C Shares. As at January 13, 2016, there were 104,731,168 fully paid and nonassessable Class A Shares, and 30,729,510 fully paid and non-assessable Class B Shares and 13,638,527 fully paid and non-assessable Class C Shares outstanding. As at January 13, 2016, a total of 2,637,670 stock options were outstanding under the Company s stock option plan, and the number of non-vested RSUs and PSUs were 267,481 and 929,964 respectively. Additional information concerning the Company, including our AIF for the year ended August 31, 2015, is available on SEDAR at www.sedar.com. Assuming conversion of the Class B Shares, which are convertible into Class A Shares on a 3 to 1 basis, and the conversion of Class C Shares, which are convertible into Class A Shares on a 1 to 1 basis, the total number of Class A Shares outstanding would be 128,612,865. 17
DEFINITION OF INDUSTRY TERMINOLOGY METRIC Aftermarket Average Monthly Subscription Revenue Per Self-Pay subscriber (Self-Pay ARPU) Original Equipment Manufacturer (OEM) Self-pay churn Subscribers Subscriber Acquisition Costs (SAC) Subscription Revenue DEFINITION Non-OEM channels, which include Retail, Direct to Consumer and Special Markets Total of earned subscription revenue from Self-Pay subscribers, music royalty fee, and activation fees divided by monthly weighted average number of Self-Paying subscribers - Self-Pay ARPU is a measure of operational performance and not a measure of financial performance under IFRS. We believe Self-Pay ARPU is a useful measure of our operating performance and is a significant basis used by management to measure the operating performance of our business Includes automotive manufacturers with which the Company has a contractual agreement in place to factory install satellite radios in certain manufacturers vehicles Self-Pay subscriber deactivations for the period divided by the average number of Self-Pay subscribers for the period divided by the number of months in the period - Self-Paying subscribers: customers who are receiving and have paid or agreed to pay for our satellite radio service by credit card, prepaid card or invoice - Paid-Promotional subscribers: customers currently in a trial period and vehicles factoryactivated with one of the SXM services, whereby automakers have agreed to pay for all or a portion of the trial period service - Non-Paid Promotional subscribers: customers currently in a trial period and vehicles factoryactivated with one of the SXM services, whereby the Company has agreed to compensate certain automakers to install satellite radios and the automakers have agreed to promote the trial period service to the consumer. (Automakers are not paying for any portion of the trial period service) Subsidies cost and net costs related to equipment sold directly to consumers divided by total gross additions (excluding Non-Paid Promotional subscribers for the period) - Management believes SAC is a useful measure of the operating performance of the business. In our financial statements, most of our Subscriber Acquisition Costs are captured in the marketing section Consists primarily of monthly subscription fees (including Music Royalty Fee) for our satellite radio service charged to consumers, commercial establishments and businesses that purchase or lease vehicles for use in their business and is recognized as the service is provided. - Promotions and discounts are treated as a reduction to revenue over the term of the plan purchased by the subscriber - Subscription revenue growth is predominantly driven by growth in our subscriber base but is also affected by fluctuations in the percentage of subscribers in our various discount plans, family plans as well as changes in our subscription rates 18
DEFINITION OF NON-GAAP MEASURES In addition to our results reported in accordance with IFRS, we use certain non-gaap financial indicators, including non-gaap information and operating measures for internal planning purposes and as a basis for investors and analysts to evaluate and compare the periodic operating performances and value similar companies in our industry, although our metrics may not be comparable to similarly titled metrics of other companies. These non-gaap measures should be used in addition to, but not as a substitute for, the analysis provided in our financial statements. Provided below are the definitions of metrics. NON-GAAP MEASURE HOW IT IS CALCULATED WHY WE USE IT EBITDA Adjusted EBITDA Fixed Charge Coverage Ratio Free Cash Flow Cost of Revenue Net Debt to Adjusted EBITDA Earnings before Interest income and Interest expense, Income tax expense (recovery), Depreciation and amortization, Change in fair value of embedded derivative, and Foreign exchange loss EBITDA, adjusted for Withholding tax expense, Stock-based compensation, Fair value adjustments arising due to purchase price accounting Adjusted EBITDA divided by cash and payable interest expense for the last four consecutive quarters Cash provided by operating activities less capital expenditures for the purchase of property and equipment and purchase of intangible assets Includes Revenue share and royalties, Customer care & billing operations, Cost of merchandise, and Programming and broadcast Total debt (2021 Senior Notes) less cash, cash equivalents and short term investments at the end of the period divided by four quarters of trailing Adjusted EBITDA - Important indicator of the Company s ability to: - generate liquidity through operating cash flow to fund future working capital needs - service outstanding debt - fund future capital expenditures and pay dividends - Provide additional useful information to investors and analysts (investors and analysts use this measure for the purpose of company valuation) - Important indicator of the Company s ability to: - generate liquidity through operating cash flow to fund future working capital needs - service outstanding debt - fund future capital expenditures and pay dividends - The exclusion of fair value adjustments, gain (loss) on revaluation of derivative and foreign exchange gains and losses eliminates the non-cash impact of these items - Provide additional useful information to investors and analysts (investors and analysts use this measure for the purpose of company valuation) - Required for our debt covenants - Measures the Company s ability to generate liquidity through operating cash flow to fund dividend payments and other significant strategic initiatives - Provide additional useful information to investors and analysts - Cost of Revenue is used to measure variable costs associated with revenue - Cost of Revenue as a percentage of total revenue is also used by management to gauge the Company s variable/fixed cost structure, which is a measure of operational leverage - Ratio used by investors as a measure of company-specific risk - Management believes this non-gaap measure is a key performance indicator to assess the Company s ability to meet short term and long term obligations through cash flow from operations - This measure is useful to investors as it indicates whether the Company s leverage has changed compared to the corresponding prior year period 19