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Sirius Satellite Radio (SIRI)

Q2 2006 Earnings Conference Call

August 1, 2006 8:00 am ET

Executives

Michelle McKinnon - IR

Mel Karmazin - CEO

Jim Meyer - President, Sales and Operations

Scott Greenstein - President, Entertainment and Sports

David Frear - EVP and CFO

Analysts

Ben Swinburne - Morgan Stanley

Bob Peck - Bear Stearns

Bryan Kraft - Credit Suisse

Laraine Mancini - Merrill Lynch

James Ratcliffe - Lehman Brothers

Eileen Furukawa - Citigroup

James Dix - Deutsche Bank

Lucas Binder - UBS

Barton Crockett – JP Morgan

Presentation

Operator

Good day, everyone, and welcome to the Sirius Satellite Radio second quarter 2006 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Michelle McKinnon, Senior Director of IR. Ms. McKinnon, please go ahead.

Michelle McKinnon

Good morning, everyone and thank you for your participation today. This morning Mel Karmazin, our CEO; joined by Jim Meyer, President of Operations and Sales; and Scott Greenstein, President of Entertainment and Sports will review our second quarter operations and current business outlook. David Frear, our CFO, will then discuss our financial results for the second quarter and our updated full year guidance. At the conclusion of our prepared remarks, management will take your questions.

I would like to remind everyone that certain statements made during this call might be forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These and all forward-looking statements are based management's current beliefs and expectations and necessarily depend on assumptions, data or methods that may be incorrect or imprecise.

Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. More information about those risks and uncertainties is contained in Sirius’ SEC filings. We caution listeners not to rely unduly on forward-looking statements and disclaim any intent or obligation to update them. I will now hand the call over to Mel Karmazin for his opening remarks.

Mel Karmazin

Thanks, Michelle. Thank you all for joining us this morning. I won't take a lot of time talking about the last quarter, as we believe our operating performance and execution speaks for itself. David, Jim and Scott will give you the specifics you need, but I just want to make few points.

We ended the quarter with 158% more subscribers than we had at the end of Q2 '05. OEM grew 217% and retail grew 142%. We delivered 64% net subscriber growth this quarter over last Q2. According to NPD, our market share in 2Q05 was 47% and this year it increased to 57%, with the most recent month of June being 61% versus 52% a year ago. For the year-to-date, we have 58% market share of the fast-growing satellite radio market, according to NPD.

Since September '05, we have been the market share leader every single month and July will be no exception. Remember, we told you to expect parity, not the pre-eminent position we now hold. We fully expect to get the majority of retail net adds going forward in this very important distribution channel. Where the customer has the choice, they continue to prefer Sirius.

We are also on target to deliver the growth in OEM that we committed to. We will double the number of OEM subs this year from the level we had going into '06.

Our record revenue in the quarter was $150 million versus $52 million last year. We call that dramatic growth. Our ARPU increased in the quarter to $11.16 from $10.50 last year. Our advertising ARPU was $0.62 versus $0.22 last year, reflecting advertising growth even greater than subscriber growth.

On the cost side, very importantly, our SAC per gross add for the year-to-date has dropped from $173 to $122, which is on track to deliver the approximate $110 we had given you as guidance for the full year '06.

Looking forward, our unparalleled world-class content, industry-leading unaided awareness, brand strength and consumer satisfaction continue, and contribute to our very bullish feelings about satellite radio, and specifically Sirius. We just concluded a wave of consumer satisfaction research which was in the field the end of June through the first week in July -- so the data is obviously very current -- and the results showed that 94% of our subscribers are satisfied. That number is up from 92%. When asked, 90% said they would recommend Sirius to a friend, up from 86%. This satisfaction is driving our low churn, which is driving our very strong net adds.

When you look at the exciting growth of satellite radio, which added approximately 1 million net subscribers in the second quarter, it is very important to remember that the satellite penetration remains low and there is big growth ahead for many, many years to come. By the end of this year, if you relate the number of satellite radio subscribers from us and our competitor to just the number of households in the United States -- approximately 109 million households, and that doesn't include the 216 million cars on the road -- the penetration is still less than 15%. We have accomplished a lot in a few years, but the growth, and the big growth, really lies ahead.

Our video initiative is well underway and we are close to signing deals to offer the best video programming for kids as part of our OEM offering in the second half of the year.

In Canada, Sirius’ growth is explosive and we are by far the satellite leader in this market. Since launch in Canada, where unlike the United States, both companies began at the same time, Sirius has well over 60% of the market. Our personal live satellite radio product, Stiletto, is great. We have been beta testing it for a few weeks and we will have it available to consumers by the end of the summer.

We continue to develop our important second stream of revenue in advertising. We have approximately $22 million on the books this morning. That compares to finishing all of last year at slightly over $6 million. Another demonstration of the great acceptance of our programming is that our advertising ARPU of $0.63 for the year-to-date is 58% greater than that of our competitor.

Most important is that each quarter that passes we put ourselves closer to delivering what we really believe is most relevant for our investors; and that is to deliver on our financial plan. We reiterate today that we believe we will be free cash flow positive -- and that is after CapEx -- for the full year '07 and subsequent years; and, could be free cash flow positive in the fourth quarter of this year, which will begin in just a few weeks.

We are also pleased to be able to once again be in a position to raise our year end guidance and also our revenue estimate for '06. Also most important is that we continue to deliver on all of the commitments we have made to investors. We are very well positioned for growth. We have the best radio on radio, a very superior management team in place, a track record for delivering, not making excuses, and a business plan that will create great wealth for investors. Our entire organization is committed to deliver the results that investors expect and deserve.

Now I would like to turn the call over to Jim, who will give you some more detail.

Jim Meyer

Thanks, Mel. I'll start with comments on the retail sector. Industry retail sales in the second quarter were 466,000 units, according to NPD, up about 4% from the second quarter 2005. When faster growing non-NPD reporting distribution channels such as Wal-Mart and Costco are included in the mix, industry growth has been roughly in line with our expectations year-to-date, although our market share has been greater than we had expected.

Sirius added 276,000 retail net additions during the second quarter, representing approximately 13% growth in retail units and a 62% actual retail share for the second quarter. For those of you who follow NPD data, it is important to note that Sirius’ actual market share results are continuing to exceed NPD data as a result of better performance across the non-NPD channels. For instance, note Wal-Mart's growing share of industry sales as well as Sirius’ growing market share within Wal-Mart.

During the quarter, we introduced the new Sportster 4. It is ultra sleek in design, uses a gen 3 chipset for lower cost, and incorporates our new universal connector, which allows for expanded accessory options. As Mel mentioned earlier, we are on target to launch Stiletto later this month, our first live wearable with a number of exciting new features. With the introduction of the new Sportster 4 as well as a new line of wearables, we believe our hardware is more than competitive.

In addition, given the new functionality and enhanced usability of these new products, the combination of these products with our strong programming line-up will be competitive, we believe, within a larger universe. We have made extraordinary progress in the design and development and cost of our products over the past 18 months.

It is also, I believe, very important to note that major retailers continue to expand both advertising lineage and in-store square footage for the satellite radio category.

Now let me turn to the OEM world. In the second quarter, Sirius added approximately 325,000 net subscribers from our OEM channel. This is 167% more than the second quarter of '05 net subscriber additions of approximately 122,000. Factory programs are gaining momentum. Economics continue to improve and our overall penetration rate is poised to continue to increase.

Let me now comment on each of our OEM partners, beginning with DaimlerChrysler. Factory installations continue at high volume across virtually all DCC vehicle lines and now include the new 2007 model year Dodge Caliber and Jeep Compass. Sirius is now available on virtually every DCC model as a factory option; and, Chrysler exceeded 30% penetration of Sirius factory installations on an aggregate basis during the '06 model year.

Mercedes. Mercedes continues to a target approximately 50% of production with Sirius over the next two years. We continue to be standard on 2007 model year SL class, CL class, AMG, and 600 model vehicles. Sirius is also included in the P1 package across the majority of Mercedes-Benz vehicles, including the new, highly acclaimed S class, which has a penetration rate of over 90%.

Ford. You may have seen the recent Ford announcement that they are targeting to quadruple the number of cars with Sirius Satellite Radio. Sirius has now expanded factory availability into 11 models including the F-150, Explorer, the all-new Mustang, and the Mercury Mountaineer, amongst others. Ford is planning on introducing eight additional models with Sirius by the end the calendar year.

During the quarter, Mercury rolled out a nationwide campaign including an extensive TV presence featuring Sirius with a three-year bundled subscription in the Mountaineer. Mercury has deemed the promotion a success, and we believe that satellite radio is becoming a key recognizable and requested feature.

Bottom line: customers are increasingly asking car dealers about satellite radio and OEMs are beginning to see satellite radio as imperative in certain models.

Toyota. Sirius continues to be an important part of Toyota's port and dealer accessory program. We will continue to expand our availability as Toyota launches new vehicles with satellite radio capability. We recently became available on the new Toyota Forerunner. To date, Sirius has been introduced on a total of 12 Toyota, Lexus and Scion models.

VW and Audi. Beginning this month, our exclusive agreement to offer Sirius service in the 2007 models has started. The stated goal is to reach 80% penetration rate of the 2007 model year production. The latest vehicle with Sirius from Audi is their all-new Q7.

Peterbilt. Peterbilt Motors announced that they will include Sirius radios with its new truck models equipped with platinum level Unibuilt sleepers. Additionally, Sirius radios will continue to be available as a factory-installed option on all other Class A Peterbilt trucks.

Last but not least, yesterday we announced a new agreement with Mitsubishi to make Sirius a standard or factory option in 2007.

Now let me comment on a few other areas. In Canada, as Mel indicated earlier, Sirius is dominating the satellite radio market and now has in excess of 60% market share. In addition, Ford of Canada and Sirius of Canada also recently announced an exclusive long-term agreement to make Sirius receivers standard factory-installed equipment in virtually all Ford vehicles in Canada by 2008.

I would also like to briefly comment regarding our retail pricing philosophy. As we have said in the past, it is not Sirius’ intention to be the low price leader in the marketplace; but instead, to only react to lower prices if we need to, to remain competitive. Therefore what you see in the marketplace will always represents our philosophy, but may, from time to time, reflect additional contributions from individual retailers who choose to address their own competitive position.

Satellite launch. We recently announced that in late 2008 we will launch a new and powerful Sirius FM 5, our fourth satellite, into a geostationary orbit joining our existing satellites to create a hybrid constellation. We expect several major benefits from this permanent hybrid configuration, such as: improved robust service, signal diversity, and network redundancy. Sirius FM 5 should extend the useful lives of our existing satellites and serve as an in orbit spare in the event of a major failure, reducing a small element of risk to our customers and shareholders. Our minimum look angles will improve, while we simultaneously retain the benefit of the high look angle HEO birds.

Bottom line: without getting too technical, we will be taking an unparalleled user experience and making it even better, particularly with improvements for fixed location receivers, wearable devices, and mobile users.

Finally I would like to comment on the FM modulator issue. We continue to cooperate with the FCC on the FM modulator inquiry and we continue to believe that we have enough supply in the marketplace to meet near-term demand. We expect to have greater clarity from the FCC shortly and to resolve this issue expeditiously.

In addition, I can assure you that cost-effective engineering solutions are available and being evaluated, which can address both the regulatory and service quality issues related to the FM modulators in the near term. Now let me turn it over to Scott Greenstein.

Scott Greenstein

Thanks, Jim. In the second quarter, Sirius continued to fulfill our mission of being the best radio on radio. We feel our line-up is strong, and in the second quarter became even stronger from the passionate response we've seen to our women's, family and niche programming, to the continued strength of our tent pole assets like the NFL and Howard Stern. Going forward, we will add content judiciously as it makes sense for the audiences we serve, with a focus on the Company's overall goal of reaching cash flow positive in late 2006, early 2007.

In programming, the momentum created by Howard Stern has continued well into 2006 and, more importantly, continues to date. Most recently, with the buzz surrounding his acquisition of The Tapes, the uncensored recordings of every show he did from the last 20 years. With the innovative content he and his staff have made here and with the tapes now as well, the Howard Stern show and his channels will continue to work very hard for Sirius subscribers, but also for the acquisition of new subscribers, ad sales, public relations and interactive.

Additionally, on Father's Day weekend, Sirius began streaming Howard 24/7 online, creating a tremendous added value from the car to the home to the office, now making Howard easily available at any time to our subscribers.

We have also seen a strong response to our newer programming initiatives with Playboy, Barbara Walters, Deepak Chopra, and the Catholic Church, all have ramped up Sirius's already existing content line-up and made it even stronger. Finally, we've also ramped up Sirius's auto racing channel with all-star guests and interviews as we prepare for the eagerly anticipated exclusive satellite launch of NASCAR on Sirius in January 2007.

These programming assets provide Sirius with unique environments to be sold by ad sales, driving interest and commitments from blue chip companies such as Procter & Gamble, Heineken, Verizon and HBO, resulting in ad sales of $15.4 million through the second quarter. As Mel mentioned earlier, currently almost $22 million and counting. The department continues to carefully ramp up its staffing as we progress towards our long-term goal of having ad sales approach 10% of our overall revenue.

To capitalize on Sirius' momentum and succinctly package our diverse offering of premier programming, we have also unveiled a new brand campaign in the second quarter that was selected, developed and launched to own the identity our programming has earned us among consumers and reviewers. The campaign is simply known as “The Best Radio on Radio” and we will direct our various marketing initiatives from TV to newspaper and the Internet with a message that remains consistent for all our programming -- whether talking about the NFL, Martha, the Catholic Church Channel -- that with Sirius you can always hear exactly what you want. What everybody wants is simply the best radio on radio.

In the second quarter, we efficiently ran newspaper, cable, and network TV in support of this campaign and garnered an overall brand awareness of 73%. In tandem with the launch of our marketing campaign, Sirius launched a new home page design and navigation system at Sirius.com with the goal highlighting our exclusive assets, encouraging subscriber community, and driving visitors to DTC. Since the launch, site traffic has increased to an all-time high and repeat visitation rates place this site on par with other popular music sites whose primary business is conducted on the Internet.

Our programming has also continued to drive PR for Sirius. The diversity, quality, and exclusivity of our content secure its features in a wide variety of print, TV, and web outlets, adding to millions of impressions already generated across the country in previous quarters, which has now built the foundation of awareness and continues to do so on a daily basis. From national TV exposure to local newspaper features, this media coverage reinforces our marketing efforts and continues to spread the message about Sirius.

In the third and fourth quarters, we will continue to offer the best radio on radio, remaining opportunistic with respect to particular talents, brands and market segments, and we will continue to market and promote the best radio on radio through traditional media, a strong presence online, and in the press.

Between back-to-school sales, the launch of new car models, and of course the holiday season, we are entering our busiest time of the year. We're confident that our premier programming line-up, which has the best content assets in all of radio and is once again ignited in the second half by our sports properties with the NFL, the NBA, college sports and coming in January, NASCAR, has us well-positioned for a strong second half.

With that, I thank you and I turn the call over to David Frear.

David Frear

Thanks, John. My comments today will follow the condensed income statement in our press release, which excludes the effect of equity expenses on the individual line items. In early July we announced that Sirius added over 600,000 net new subscribers in the quarter, beating every single published Street forecast. Given our leading market share and strong year-to-date performance, we are raising year end subscriber guidance to 6.3 million subs.

Second quarter net sub additions grew 64%, driven by strong growth from our OEM channel, and as you have heard, continued exceptional performance at our retail channel. We added almost 325,000 net OEM subs during the quarter, a record for Sirius.

Chrysler exceeded 30% penetration on an aggregate basis during the '06 model year, and Ford's penetration rate is over 30% in most of the 11 model lines that currently install Sirius at the factory. We expect Ford to end 2006 offering Sirius as a factory option in 19 Ford and Lincoln Mercury model lines.

Our second quarter churn was in line with guidance at 1.8% per month and we are maintaining our monthly churn guidance of approximately 1.8% for 2006. Total ARPU for the quarter was $11.16, up from $10.50 a year ago, driven by stellar ad sales which for the second quarter alone exceeded all of 2005.

At the end of the second quarter, approximately two-thirds of our subscribers were on year or longer subscription plans and approximately 13% were paying $6.99 per month under a multi-unit subscriber plan. Total revenue almost tripled year-over-year to over $150 million as our subscriber base grew 158% to approximately 4.7 million subs from 1.8 million just a year ago.

In line with our strong first half performance and increased subscriber guidance, we are also increasing our revenue guidance to $615 million for 2006.

Our SAC per gross add was $131 for the quarter, 18% lower than the year ago period. As we predicted on our first-quarter conference call, SAC per gross add increased sequentially, given strong inventories sell-through in the first quarter of this year. We are reiterating our previous guidance for SAC per gross add to approach $110 for the full year.

Customer service and billing expenses per average sub declined 34% to $1.05 per sub, per month in the second quarter, from $1.60 in the year ago quarter and $1.40 in the first quarter of this year. Sales and marketing expense increased 65% to $57 million from $34 million in the second quarter of 2005, primarily due to higher residuals in OEM revenue share on our larger subscriber base, as well as increased cooperative marketing spend with our channel partners and costs for our new “Best Radio on Radio” advertising and branding campaign. This compares to a lighter advertising spend in the prior year quarter as we concentrated 2005 spending in Q4 to support the launch of Howard Stern.

G&A increased 53% or $7.6 million to $22 million in the second quarter, primarily due to additional legal fees, employment related costs, and bad debt expense to support the growth of the business.

We are clearly seeing the operating leverage that comes from great top line growth and smart spending. Pre-SAC adjusted loss from operations improved sequentially from Q1, and by 56% on a year-over-year basis to a loss of only $17.5 million in the second quarter of '06. Our adjusted loss from operations improved sequentially from the first quarter of this year and widened by only $18 million over last year, despite the $40 million increase in SAC required to support 92% higher gross adds.

Our 2006 guidance for adjusted loss from operations remains unchanged at $565 million, while we expect to generate a pre-SAC adjusted loss from operations of approximately $130 million for the year; a $10 million improvement over previous guidance.

As Jim mentioned, during the second quarter Sirius announced an agreement with Space Systems Loral for the design and construction of a new satellite. We expect construction to be completed in the fourth quarter of '08 and a launch shortly thereafter. The aggregate cost to design, build, launch the satellite and insure its launch will be approximately $260 million. We expect the bulk of these payments to be made in 2008, in line with key contractual milestones.

Following our decision to build the next generation satellite, Sirius recorded a $10.9 million impairment charge in satellite and transmission expense this quarter, to write off certain satellite spare parts we purchased in 1999 and no longer expect to use.

For 2006, we expect our free cash flow loss to widen from approximately $480 million previously to approximately $500 million, reflecting this new satellite contract as well as modifications to our working capital assumptions. Sirius ended the quarter with approximately $584 million in cash, cash equivalents and marketable securities, and we remain fully funded. We continue to expect to be free cash flow positive after capital expenditures as early as the fourth quarter of this year, and for the full year 2007.

With that, operator, let’s open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ben Swinburne - Morgan Stanley.

Ben Swinburne - Morgan Stanley

Good morning and thanks for taking the call. I have two questions. First if I could ask you to maybe give us a little more color on the FM modulator issue, which is I think on a lot of people's minds. You are clearly managing for this process successfully, have confidence to raise guidance. Can you give us a little bit of an idea of where we are with the FCC on your end in terms of communications? Are they changing their testing process? Are they changing the power limits? How do you guys see this playing out over the next couple months?

Then second on the Stiletto, have you made a decision about an agreement with the RIAA at all on that device? Where are we on that process as well? Thank you.

Scott Greenstein

Let me start. If anyone has anything to add, please jump in. So we mentioned to you that we were working closely and cooperating with the FCC. What that means is that we are visiting with them at the engineering level daily. We are working with their methods for testing. The NAB has been very aggressive in lobbying on this subject. We continue to see what their agenda is. Obviously, the NAB has been moving from an organization that used to play offense to playing defense and is looking to try to muddy waters.

We have stated that we believe that the products that we are currently manufacturing are all in compliance. We and our manufacturers are working with the FCC. We have said that there is certainly no health or safety issues. There have been very few complaints from the part of the consumer on interference, but it is an issue and one that our engineering people are working their way through.

And again, based on everything that we know this morning is that we are confident that we have enough product in the pipeline so that there wouldn't be any shortage. We are hopeful that short-term, the FCC will give us the guidance that we need in order to continue to manufacture the products in a way that is going to be very rewarding for the consumers, as well as being in compliance for the FCC.

Regarding our Stiletto product, I think you heard from us all you are going to hear from us until we're ready to show you the product.

Ben Swinburne - Morgan Stanley

Great. Thank you.

Operator

Our next question comes from Bob Peck - Bear Stearns.

Bob Peck - Bear Stearns

Hi, thanks for taking my call. Congratulations. Mel, I wanted to ask you a couple questions first and then move to David. I think one of the questions in this industry has been the long-term demand curve. Could you talk to us a little bit about why you feel comfortable about the long-term demand and what it is specifically you are looking at that gets you comfortable in the demand for satellite radio and in particular for Sirius?

Also in your press release you talk about reiterating long-term guidance. Just to be clear, are you reiterating guidance of $3 billion in revs and $1 billion of free cash flow for 2010?

Mel Karmazin

Great. We feel based on all of the research that we have on the fact that the people's satisfaction, looking at our churn level, looking at what is going to happen with the number of cars that are going to be made every single year in the future that are going to have satellite radio, is that everything we have is saying that this is going to be a category that is going to be larger than most of the forecasters have predicted, based on the information that we are seeing. 92% satisfaction level is a very high level to have people with.

We think that we have only been around for five or six years, so we have accomplished an amazing growth in that relatively short period of time. So we have no reason to believe, there's nothing out there -- we currently are looking at fielding more research to find out what are the issues that exist on why people may not want satellite radio at any point.

We believe that if radio is important to you -- particularly if you are a commuter and if you spend a significant amount of time in the car -- that radio is very important to you and our very attractive price makes it very affordable there. Again, there's no signs that we are seeing, including our growth that we are seeing each quarter, that is making us not believe in our long-term belief.

To your second point, are we reiterating guidance on our $1 billion of revenue in 2007 and our $3 billion in revenue in 2010 and that $1 billion of free cash flow in 2007? Yes, we are. David talked about the 2008 --

David Frear

$1 billion free cash flow in 2010.

Mel Karmazin

2010, I'm sorry. The $1 billion of free cash flow when we have that $3 billion of revenue. David talked about the majority of the satellite expense will be in 2008, and obviously we will have free cash flow in 2008 after dealing with those additional costs.

Bob Peck - Bear Stearns

Thanks, Mel. David, I was wondering if you could give us a little more color around the SAC efficiency of Sirius versus your competitor. Are you able to give us any sort of color or maybe any sort of breakout of OEM versus retail?

Just lastly, could you talk about if there is anything significant in your working capital assumption changes? Thanks.

David Frear

Taking the last first, nothing significant in working capital changes. It really just reflects more timing of when the subscribers come. They've come a little bit earlier in the year than we had thought, and you know how the model works. If we build the product in the fourth quarter, the payments on it tend to get made in the first quarter, but the subscriber pays us in December. So when the sub comes a little bit earlier in the year, you end up with SAC in it at the same time. So just a slight modification.

It is difficult for me to comment on our SAC relative to XM’s because I don't really know what is in their SAC. What I can tell you is that as you know, we have two different levels of SAC. One that we have for our retail products where we can turn out new generations of products and introduce them into retail in the six to nine month timeframe, where we have a much longer cycle for introducing new products in OEM. So as we have talked before, OEM is a couple generations behind retail in terms of the products that are in the cars, meaning that the costs in those are higher.

So as you look at our SAC guidance for the year of $110, what you can safely assume is that the SAC associated with our retail products is substantially less than $110 and the SAC associated with our OEM products is higher.

Bob Peck - Bear Stearns

Thanks, David.

Operator

Our next question comes from Bryan Kraft - Credit Suisse.

Bryan Kraft - Credit Suisse

Thank you. Can you talk about what you are seeing with OEMs that currently offer both your service and XM? So specifically Toyota and Nissan? Just trying to understand what kind of volumes you're getting from these manufacturers and what your share is versus XM with those OEMs?

Jim Meyer

This is Jim. I think that we actually try to track that pretty closely. In both cases, I think the share today is parity and in some cases actually reflects a little more what you see at retail. The growth in either of those companies today is certainly not at the rate of where you see factory implementation and all the things that come with a factory experience.

I think we can only estimate these market shares. We don't get them from the car companies. So we kind of go out and do some surveys, but I think it is fair to say that where the consumer has a choice, we believe that they are going to pick Sirius more than 50% of the time.

Bryan Kraft - Credit Suisse

Okay, thank you.

Operator

Our next question comes from Laraine Mancini - Merrill Lynch.

Laraine Mancini - Merrill Lynch

Two questions. First you mentioned that Costco and Wal-Mart growth rates are greater than what you're seeing in retail and NPD. Can you discuss what type of level you are seeing there?

Also this morning I saw some stuff saying the NAB is now requesting a recall of products that are on the shelf not sold yet for the FM modulation issue. Is there any precedent that the FCC has done anything like this before? Do you think there is a risk of that happening?

Mel Karmazin

So let me answer the second question. I mentioned a little bit about the NAB before. There have really been no history of any recalls in that area. As I also mentioned to you, there are very few bona fide complaints regarding any of the interference. It is also our belief that a recall would not be in the public interest at all, especially when we have a variety of other solutions which can be implemented more quickly and without consumer disruption.

So we again think the NAB is rattling its saber, but we continue to believe that there would been nothing served if in fact there was any sort of a recall and we have not heard any of that out of the SAC. The only place we have seen it is really from the NAB. Jim, do you want to talk about Wal-Mart?

Jim Meyer

Sure. I have spent 25 years in the consumer electronics industry and I think satellite radio is following a very similar curve to other high, mass market consumer electronics kind of products. That is, after the first two or three years of introduction and when awareness gets high enough, Wal-Mart tends to get a bigger and bigger share as those products continue to move down the product maturity scale. You are clearly seeing that today. Now Wal-Mart does not report, nor will I, what their satellite radio business is. I can only approximate what we think their impact on the industry is, as well as Costco and Sam's.

If you factor in that growth in the industry, I think it is safe to say that the industry is growing at a double-digit rate versus last year. I think the NPD growth of flat is a little bit misleading as to what is really going on at retail. That is I think the most I can say about it.

Laraine Mancini - Merrill Lynch

Great, and if I could have one follow-up. The Sportster 4 is still on the market, that is an FM modulated device. If it takes a long time for the FCC to approve your other devices, is there an opportunity to ramp up production of that to fill in any inventory holes you might have?

Jim Meyer

I can safely tell you that we have looked at a variety of “what ifs”. We have got them all listed and we have got a bunch of strategies. Certainly we can’t just flip overnight but I think what I said earlier is appropriate. We continue to cooperate with the FCC. We believe that we can get this problem solved expeditiously, and that is our intention.

Mel Karmazin

Just to reiterate what Jim said, we're working on two different levels. One level is obviously make sure that our products are compliant and that however the FCC decides that they want to test the products that we are in compliance. But equally important to us is working on making sure that the product is going to have a high degree of consumer satisfaction. We are spending an awful lot of time on all of these alternatives making sure that we also have a way of making them satisfy what the consumer expects when they subscribe to Sirius.

Jim Meyer

Can I just make one other comment? It is important to note by the way this is not only a satellite radio issue. There are literally thousands of devices out there that have the same type of issue in that many of the devices that iPods are attached to that use wireless FM modulation to be able to use for an in car radio experience.

So while there has been a lot written about satellite radio, it is a much bigger problem than that. I think it is safe to say there is quite a bit of effort going on in quite a bit of labs around the world on trying to recalibrate and deal with this.

Operator

Our next question comes from James Ratcliffe- Lehman Brothers.

James Ratcliffe- Lehman Brothers

Now that you folks have had about a year-and-a-half plus or more in the auto OEM space and a number of customers starting to reach the end of their bundled subscriptions, what sort of re-signup rates are you seeing from those customers? Are you seeing those vary by car models/price or by OEM? Thanks.

David Frear

As we've said on many previous calls that we don't think we will be in a position to talk about the conversion rates until next year. As you work your way through it, it gets pretty simple. We still have, if you roll the clock back, relatively small volumes of cars that are coming from underneath their original bundled subscription period. So until we build up a body of data that we believe has some statistical consistency to it, we actually don't believe it is helpful to investors to talk about too much.

That being said, we do see variations between model lines, between price points. I would say there are not any firm conclusions to be drawn from it yet, which is exactly why we think it makes sense to wait until next year to begin discussing those rates.

James Ratcliffe- Lehman Brothers

All right, thank you.

Operator

Our next question comes from Eileen Furukawa- Citigroup.

Eileen Furukawa- Citigroup

I have a couple of questions. First, regarding your raised sub guidance, is this upside coming primarily from better than expected strength in your retail or your OEM channel? Is this also partly because you are now expecting greater market share gains from XM related to inventory issues that they are having to deal with, with the FCC emissions issue?

Mel Karmazin

I think that our subscriber number comes from our performance for the first seven months of the year, as well as our read both from OEM and retail for the rest of this year. And no, it is not being raised with any reason of an FM modulator viewpoint, that XM has an issue at retail and we don't. As a matter of fact, we get retail inventory numbers on a regular basis and we see that there is not a whole lot of difference in the last retail numbers we have seen from ourselves and XM at retail.

So it just is a function of our believing that our gross adds, when factored in with our churn, will get us net adds to where we feel confident in being able to tell you for the second time this year that we're raising guidance to that 6.3 number.

Eileen Furukawa- Citigroup

Just a follow-up question. You showed pretty strong retail market share gains in the quarter and I am just trying to understand what you think were the primary reasons for this success? Do you think that inventory issues at XM played a big role at all in this quarter? Or was it continued demand from Stern heightened by the Internet launch? Or was there something else you think was a primary driver to large market share gains at retail?

Mel Karmazin

I think you can make your own judgments by going into Best Buy and Circuit City and taking a look. Every time that we go in there, we see our competitors product there. We believe that the reason for our share is what we have been saying for some time, and that is that our high level of consumer awareness, high level of this unaided awareness, having the best content on radio largely driven by Howard Stern.

Again, the time that people spend mostly listening to the radio is when they are in that car and in morning drive time. The fact that we have attracted the number one radio personality in the history of radio to Sirius on an exclusive basis where he is not available anywhere else and where they can listen to him driving to work and driving home from work is going to be a big deal each quarter.

We don't think that, like many analysts have said, there is a Stern effect for one quarter or maybe two quarters. We believe that Howard and the rest of our content is going to have an impact on our subscriber growth forever, as long as it is there.

Remember, we had talked about parity, right? We said last year you guys all would have thought it was a big deal if in fact we achieve parity because we had less than 50% market share and we knew that we had made investments in programming and marketing that was going to get us to have greater than parity at retail. That is where we are and that is where we fully expect to continue to be.

Eileen Furukawa- Citigroup

Okay, thank you very much.

Operator

Our next question comes from James Dix - Deutsche Bank.

James Dix - Deutsche Bank

Good morning, everybody. Just two questions. First, the OEM growth you have in the second quarter was better than we were expecting. If you look at the numbers, it looks like if you were only going to double your subs from that channel this year, you would already have gotten over 65% of that. Is there any type of seasonal dip we should be expecting, or are you just being conservative in terms of the expectations you are setting for that channel for the year?

Then secondly Mel, it goes back to your point on the retail market share. In the fourth quarter, are you assuming a better than parity share this quarter? One follow-up on that would be your competitor certainly expected an impact last fourth quarter from your launch of Howard Stern. What impact do you expect from their launch of Oprah in September?

Mel Karmazin

Yes, I'll try to get all of your points. Yes, we fully expect to have more than parity share at retail in the fourth quarter. By the way, we see no signs that that is not the case and that is not going to happen. We were particularly focused on looking at what happened in the second quarter because again, our competitor has baseball. If content were going to drive a subscriber, baseball in that second quarter -- much like the NFL in the fourth quarter -- would be a driver. So we see no reason to believe that we won't have better than parity, which means better than 50%.

Now that is not the game we are in. We are not at war with XM. That is really not what it is about. So conceivably there could be a month where we might drop below parity. We don't think so, but in general we're really pleased with fact that we are currently at 58% for the year-to-date going into, again, fourth quarter where we have a lot of strength.

On our OEM number, we have given you guidance. We don't believe that we are to be giving you guidance unless we believe we're going to be able to achieve it. It is not about just raising it. On the OEM side, we have a lot of latitude. We said that we would double where we were and there are summer periods where a number of the factories slow down. We know what is going on in Detroit by the difficulty that some of the automobile makers have.

Again, we pride ourselves on hitting or beating the numbers we give you and we just don't want to be too aggressive at this point. I think it is very logical and if you do some research and if you go into the stores and you talk to the people as we do, it's content that really is driving the subscribers. We again believe we have the best content in radio.

Jim Meyer

Just one thing to add on the content side in relation to Oprah. We feel, as Mel mentioned, not only is the programming strong but with women we have very strong exclusive women's programming that is on a consistent 24/7 basis, whether it is the Martha Stewart channels, the Cosmopolitan channel, now the launch of the Barbara Walters specials, Candace Bushnell's show mixed with other assets that are very significant to women, whether it is our music programming, Howard Stern, and other assets. So we feel we are very pleased with where we are versus that demo.

Secondly, our exclusivity as opposed to what you can and can't get on TV and other places is a factor that we feel confident with.

James Dix - Deutsche Bank

Okay, thank you.

Operator

Our next question comes from Lucas Binder - UBS.

Lucas Binder - UBS

Hi, thank you very much. Just real quick, you mentioned the Mercury Mountaineer as something that was heavily advertised for your service. Is this something we should see as a trend? It seems to me that this would lock in a lot more customers for a longer period of time. So is this something that we should see as a trend to see even longer-dated agreements with some of the other auto manufacturers?

Jim Meyer

I think two comments on the Mercury campaign. One, I think it was unprecedented kind of exposure for our brand and we were extremely happy with putting our marketing might along with what is extensive amount of marketing spend in the marketplace with a large OEM, to expand the presence for our brand. I think you'll see more of that.

I think as we work closer with our OEM partners and demand for the feature increases, I think there will be more and more opportunity in the next 12 to 18 months to do that.

In terms of what the actual offer will be and whether a longer bundle is the right answer, we don't know the answer to that. We continue to work. As David said earlier, this is a long game. The data is hard to understand and there are a lot of conclusions. I think a long way yet to be drawn, and so I don't know the answer to your question.

I do know that we're trying a variety of things. We're trying to build a database that lets us more intelligently answer that question. I don't think we're going to be able to answer that question for quite a bit of time still.

Operator

Ladies and gentlemen, due to time constraints, we'll take our last question from Barton Crockett – JP Morgan.

Barton Crockett - JP Morgan

Thank you very much for taking my question. I wanted to ask you a little bit about your retail outlook for the fourth quarter. In particular in the year ago period you guys had a very strong quarter with Howard Stern coming on and all the publicity surrounding that.

I know he remains popular at this point, but in your guidance, do you believe that your retail gross adds year-over-year in the fourth quarter will grow, or is there potential that we could see a bit of a decline there? And then as we look into the first quarter of next year similarly with the Howard Stern comps, do you expect you can grow retail gross adds or will that start to ease against the comps? Thank you.

Mel Karmazin

I think we have given you the only guidance that we are going to give you for this year, and that is that obviously we're going to double -- or at least double -- our OEM subs and that we're going to achieve at the end of the year 6.3 million subs, which means both OEM and retail are going to be working for us this year.

As it applies to 2007, all we have said at this point is that you should assume that we're going to generate $1 billion of revenue and be free cash flow positive. We have also said to you that we believe that we will have a market share at retail that will be better than parity.

So again, what the actual number is at retail, I can assure you that Howard Stern is mobilized for an aggressive campaign in the fourth quarter for Howard to bring on some of the fans that he had, that have not yet made the conversion to satellite radio. So unlike last year in the fourth quarter, we did not have Howard Stern officially selling for us. This year we will have Howard selling for us.

This will be the first holiday season, Christmas season where the best salesman on radio is going to be selling subscribers for us. So we are excited about what we add in the fourth quarter and the first quarter of '07.

Operator

Thank you. And at this time I'd like to turn the call back over to Ms. McKinnon for any further or concluding remarks.

Michelle McKinnon

Thanks very much everyone for your time. Investor Relations will be available today to answer your questions.

Operator

Thank you, ladies and gentlemen. That does conclude today's conference call and you may disconnect at this time.

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Source: Sirius Satellite Radio Q2 2006 Earnings Conference Call Transcript (SIRI)
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