Barrington analyst James Goss issue a report on XM's Q4 and full year operations.

REPORT EXCERPTS

XM Satellite Radio Holdings Inc. (XMSR-NASDAQ )

Q4/07 and Full Year 2007 Results Slightly Lag Expectations

Investment Highlights

• XM reported fourth quarter and full year results that lagged our expectations including subscriber counts and earnings measures. EPS of $(2.23) for the year compared unfavorably with our estimate of $(2.10) and the consensus mean of $(2.07). The quarterly EPS figure was $(0.78), a larger loss than our $(0.65) estimate and the $(0.63) mean. The year closed with a subscriber count of 9,027,000, somewhat below our estimate of 9,077,000. The full year net additions were 1,398,000 including 460,000 in the fourth quarter. Our estimates had been 1,448,000 for the year and 510,000 for the final period.

• The shift to an OEM subscriber focus remains at the forefront. OEM net subscriber additions totaled 1,213,000 in 2007 on gross additions of 2,622,000. By contrast, retail net additions totaled only 185,000 on gross additions of 1,269,000. XM is essentially running in place on the retail side, with substantial retail gross additions required to offset churn in this subscriber category, and generated modest growth. One year ago, the net additions were fairly comparable between these major categories, with 884,000 net OEM subscriber additions and 812,000 net retail subscriber additions during 2006.

• As was the case with Sirius, the increased royalty rates agreed to by the satellite radio companies caused the revenue share and royalties expense line to jump in the quarter, reflecting not only the fourth quarter’s share of the impact but a retroactive adjustment for the first three quarters as well. XM also experienced added expenses totaling roughly $77 million in the year for merger costs, legal expenses and other one-time items, in addition to a $22 million non-cash charge to terminate the Starbucks agreement.

• We are maintaining our MARKET PERFORM rating on XMSR. We remain cautious about the relatively soft subscriber momentum that should form the underpinning of any substantial improvement in earnings trends. The key investment plus will likely be news that the merger can take place and, while we feel the odds still favor this scenario, it remains uncertain.

Quarterly Highlights

XM Satellite Radio Holdings Inc. announced financial results for Q4/07 and FY/07 that were below our expectations. In the quarter, revenues were up 20% to $308 million, unadjusted operating loss increased by approximately 45% to $(202) million and net loss decreased 9% to $(239) million, leading to diluted EPS of $(0.78) versus $(0.90) in the year-ago quarter. We had expected diluted EPS of $(0.65) on revenues of $305.1 million. The consensus mean estimate called for diluted EPS of $(0.63) on revenues of $303.8 million.

Revenue growth in the quarter was primarily driven by a $46 million year-over-year increase in subscription revenues, bringing total subscription revenues in the quarter to $266.5 million. This increase reflects gross subscriber additions of 1.13 million and net subscriber additions of 460,000 in Q4/07. Much like the data reported by Sirius on February 26, XM is seeing a marked shift in subscriber growth, away from retail and more focused on automotive OEM customers. We believe XM data services like XM NavTraffic and XM NavWeather are helping to promote growth in the OEM markets. To further emphasize this shift toward an OEM-centric approach, when compared with Q4/06, OEM net subscriber additions in the quarter were up 110% (361,000 versus 172,000), while retail net subscriber additions fell 63% (99,000 versus 271,000).

At the end of the quarter, OEM subscribers totaled 3.59 million and retail subscribers totaled 4.55 million, bringing the year-end subscriber total (which includes subscribers in OEM promotional periods, rental car subscribers and data service subscribers) to 9.03 million. Also on the positive side was a reported year-over-year increase of 150 basis points (increasing to 53.9%) in the conversion rate. Management noted that this was aided by some OEM partners’ decision to bundle 1-3 year subscriptions into the purchase of a vehicle. This also helped contribute to a modest decline in the quarter’s monthly churn rate (1.72% versus 1.79% in Q4/06). Management also observed that XM and Sirius use different treatments for OEM equipped cars. While there are arguments in support of each method, the current subscriber count advantage in favor of XM is likely larger on a comparable basis than is implied by the raw numbers.

While many of the trends regarding growth in the revenue and subscriber base were positive, the cost side of the company’s results was more negative. However, to be fair, many of the costs incurred in both the full-year and the quarter are non-recurring and should not be present in 2008. For instance, the operating loss of $(202) million included $58 million in costs associated with the proposed merger with Sirius, $13 million in settlement expenses for recording label lawsuits and $37 million in retroactive royalty fees, due to a royalty rate increase at the end of the year. Increases in G& A and marketing costs also added to the higher operating loss. SAC rose to $87 from $74 in Q4/06 and CPGA rose to $140 from $128 over the same period.

Annual Highlights

Full-year revenues in 2007 were up 22% to $1.14 billion. Unadjusted operating loss rose 27% to $(511) million, while net loss fell 7% to $(682) million. Diluted EPS for the full year was $(2.22), compared to $(2.70) in 2006. Our estimates called for diluted EPS of $(2.10) on revenues of $1.13 billion, while the consensus mean estimate calls for diluted EPS of $(2.07) on revenues of $1.13 billion.

Gross subscriber additions for the year were 3.89 million, with 2.62 million coming from the automotive OEM market and 1.27 million coming from retail. XM added 1.40 million net subscribers in 2007, compared to 1.70 million in 2006. Of the 1.40 million, 1.21 million came from the automotive OEM market and 185,000 came from retail. Additionally, the monthly churn rate for 2007 dropped to 1.75% from 1.77% in 2006, but the conversion rate slid modestly to 52.7% from 53.3% last year.

The annual increase in operating loss was exacerbated by the presence of a variety of non-recurring charges, some of which we discussed above. Management pointed out on the conference call that, over the entire course of 2007, the company incurred $177 million of charges that will not recur in 2008. Also of interest was management’s discussion of significant reductions in capital expenditures in 2008 and beyond. The XM3 and XM4 satellites are now online and should be able to provide XM with 15 years of service. Additionally, the XM5 satellite is nearing completion, providing a ground spare that will also cover Sirius’ spectrum, providing a potential plus assuming the merger closes. Now that XM’s infrastructure is largely in place and the nearly $700 million that was spent in putting up this new fleet of satellites is all but accounted for (with the exception of $63 million left for finishing up work on the spare XM5 satellite), free cash flow should have a chance to see improvement over the next few years.

Estimate Updates

We have made some changes to our estimates in the wake of the new earnings report. Our assumptions for 2008 are detailed following the text of this report. Our new EPS estimates are $(2.00) for 2008, $(1.50) for 2009, $(1.10) for 2010 and $(0.75) for 2011. We have not changed our subscriber growth assumptions that call for an increase to roughly 15 million by year-end 2011. Our Sirius figure for that time is a similar number, indicating a combined sub count of roughly 30 million over the next several years, contributed in fairly equal parts by these two competitors. Sirius will benefit from the absence of certain costs, as detailed above, but with added allocations for the new royalty structure.

Opinion

We are maintaining our MARKET PERFORM rating on XMSR. We remain cautious about the relatively soft subscriber momentum that should form the underpinning of any substantial improvement in earnings trends. The key investment plus will likely be news that the merger can take place and, while we feel the odds still favor this scenario, it remains uncertain.

Tyler Savery Position - Long Sirius, Long XM