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Sirius Satellite Radio (SIRI)

Q3 2006 Earnings Call

November 8, 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

Vijay Jayant – Lehman Brothers

Laraine Mancini - Merrill Lynch

Robert Peck - Bear Stearns

Eileen Furukawa - Citigroup

Tuna Amobi - Standard & Poor's

Jason Helfstein - CIBC World Markets

James Dix - Deutsche Bank

Presentation

Operator

Good day, everyone. Welcome to the Sirius Satellite Radio third quarter 2006 earnings conference call. Today's conference is being recorded. At this time I would like to turn the call over to Michelle McKinnon, Senior Director of Investor Relations. 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 discuss our third quarter operations and business outlook. David Frear, our Chief Financial Officer, will then review our financial results for the third quarter and our full year 2006 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 on 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 over the call to Mel for his opening remarks.

Mel Karmazin

Thank you, Michelle. Thank you all for joining us this morning. We once again had a great quarter. Our third quarter results delivered on all the commitments we have made. David, Jim and Scott will give you the specifics you need, but first I want to make a few points.

In the last 12 months, Sirius has added nearly 3 million new subscribers. Third quarter '06 was our fourth consecutive quarter where Sirius led the industry in terms of growth. Just to put this into perspective, last year in the third quarter of '05 we attracted 37% share of net additions and each quarter since then, Sirius has attracted the majority of net additions, with third quarter '06 reaching 61% total share of satellite radio net adds. That is a 24 percentage point increase in our market share in just 12 months.

Sirius retail share, as measured by the NPD group, was 57% for September '06, 57% for third quarter '06, and 58% year to date, significantly over-delivering on our commitment we made to investors over a year ago to have parity at retail. There's a lot of talk about NPD share, what it includes, and what it doesn't. But in fact, in the third quarter, Sirius' actual share of total retail net adds where the consumer has the choice was 75%.

Our revenue in the quarter was $167.1 million versus $66.8 million a year ago. That is an incremental $100 million of revenue in the last year and a growth rate of 150%. We call that dramatic growth and it puts us solidly on the path to generate $615 million of total revenue in '06 and $1 billion in revenue in 2007.

Also, next year we anticipate that there will only be two terrestrial radio companies that will have more revenue than Sirius. They are Clear Channel and CBS Radio. Importantly, these companies will have little or no growth and we believe our $1 billion revenue in '07 will grow to $3 billion in three years. Remember, we are where we are after only four years since we added our first sub. The other two terrestrial radio companies that will have higher revenue than Sirius in '07 have been in existence, in the case of Clear Channel, almost 35 years since they got their first listener; and in the case of CBS, KDKA got its first listener 80 years ago. We did it in four years. We are the fastest growing radio company in the U.S. Thanks to our dual revenue stream, I do not believe that in the history of radio a company will grow to $1 billion in revenue faster than Sirius.

We ended third quarter '06 with 135% more subscribers than we had at the end of Q3 '05. Net additions were up 23% over last year. We told you that we would double the number of OEM subs this year and I'm pleased to report that we have virtually accomplished that goal, after just nine months, with OEM subscribers up 95% year to date.

Our ARPU in the quarter was $11.17, with advertising ARPU contributing $0.49 versus $0.26 last year, reflecting advertising growth even greater than subscriber growth. Our advertising ARPU for the first nine months of the year is approximately 45 % greater than our competitor. We have almost $30 million on our books for '06 for advertising as compared to finishing '05 at approximately $6 million.

On the cost side, very importantly, our SAC per gross add for the third quarter was $114, down 23% from $149 in third quarter '05. We are on track to deliver the guidance we have previously given you.

I am also very pleased with the early reviews of the Stiletto and the worldwide launch of Sirius Internet Radio and the two-day free trial which took place last month. Scott will take you through the results of the free trial, but I am most impressed by the global demand for SIR. SIR is off to a great start toward becoming a major internet destination for music and entertainment, and this is all part of our strategy to make Sirius available wherever the consumer wants it, as long as they pay us $12.95 a month.

As evidenced by our nearly 3 million subscriber additions in the last 12 months and our solid cost control, Sirius has been running an excellent sprint, but let me remind you that satellite radio is also a marathon. In the OEM channel, our partners will continue to increase the penetration rates in new vehicles and we will have significantly more OEM adds in the fourth quarter than we had in the fourth quarter of last year. We continue to work with our exclusive OEM partners, those we share, as well as the dealer programs we have in place and in development to ensure that the greatest number of people have access to our world-class program.

We don't get nearly enough credit for what we are accomplishing with our OEM partners. In the third quarter, Sirius had 52% of total satellite radio OEM net adds; and for the last 12 months, that share was 55%. Most importantly for me is that Sirius continues to deliver on our business plan. We reiterate today that we will be free cash flow positive for the full year of '07 and could be free cash flow positive as early as this current quarter.

Sirius is well-positioned for growth. We have the best radio on radio and a demonstrated track record for delivering on our promises. Another example of how well Sirius is accepted is that we are, by a wide margin, the number one satellite radio company in Canada, where unlike the U.S., both satellite radio companies started signing up subscribers at the same time.

Lastly, let me address the fourth quarter. We are in the busiest time of the year for satellite radio. Last year Sirius added approximately 500,000 subscribers in the last ten days of the year, largely from retail. I can tell you that retail is expected to be strong, but does not have to necessarily exceed last year's levels for us to hit our numbers, in order for us to accomplish all of our goals. We will be strong in other channels.

So while we are targeting a strong fourth quarter, our full year subscriber and financial projections are just that; our best projections. We remain very bullish on continued strength in OEM, a surge in holiday sales for retail, we saw how well holiday sales were for Father's Day. We have no reason at this time to expect that there would not be that holiday surge again for Christmas.

Consumer awareness and consumer satisfaction with Sirius continue to be very positive. We remain focused on maintaining low churn and the preservation of excellent business economics. The fourth quarter selling season will feature new advertising from us, as well as our OEM and retail partners. We will have ample availability throughout the distribution channels of our best-ever products and accessories. We are expecting a big reaction from NASCAR fans, as we kickoff our five-year relationship to begin in January '07. You should also assume that we will do our best to marshal our over 5 million subscribers to give Sirius as holiday gifts.

Also for the first time, we will be participating in the live satellite wearable market this holiday season with Stiletto. As I sit here today, I have great confidence in these aggressive plans.

Lastly, it's worth repeating to say that Sirius will continue to pursue only those business strategies designed to produce long-term growth in shareholder value. We will stick to our plan and not overspend to gain subscribers or market share.

So now, I would like to turn it over to Jim.

Jim Meyer

Thanks, Mel. Let me start with some overall comments. As previously mentioned, Sirius’ total market share of net additions was 61% in the third quarter, up from 37% net add share a year ago. This is something that we and our investors should really be proud of.

Turning now to the retail sector, Sirius added 206,000 retail net additions during the third quarter, or roughly the same retail additions as last year's 210,000. Our actual share of retail net adds for the third quarter was 75%. Retail sales during the quarter and through October were impacted by a soft market for consumer electronics in general, as well as soft demand for satellite radio.

This lower demand was partly due to a limited ability to advertise or promote products due to spotty inventory as a result of the FM modulator issue. Fortunately, all of our products have now been recertified by the FCC and we now have an effective solution for FM modulation using a rather straightforward and easy to use passive radiator solution, otherwise known as a directional antenna. We expect this will provide the DIY an easy, cost-effective solution.

During the third quarter, as promised, we introduced Stiletto, our first live wearable, with a number of exciting new features, including open network WiFi access to Sirius Internet Radio. The Stiletto has been well received in the marketplace and most importantly, we are now producing and shipping sufficient quantities to meet the expected holiday demand.

In late October, we also introduced a second live wearable product, the SL-10, with less memory and $100 lower price point. Stiletto is just one example of the extraordinary progress we have made in the design and development of our products and accessories over the past 18 months. Our new line of wearables, as well as the updated StarMate and Sportster models gives us the best product lineup in the industry.

We've also accomplished another important product and technical milestone in October. We have now begun taking delivery of our fourth generation chipset. This innovative new chipset from ST Microelectronics allows for a significant reduction in both power requirements and in product costs. We will begin integrating the new gen-4 platform into products in the first quarter of 2007, and we are very excited about the product possibilities and lower costs that this new chipset will allow.

Now, let's turn to the OEM world. In the third quarter, Sirius added 236,500 net subscribers from our OEM partners. This is 51% more than the third quarter of '05 OEM net subscriber additions of 149,000. Factory programs continue to gain momentum. By year end, Sirius will have 132 individual vehicle model factory programs. OEM economics continue to improve and our penetration rates continue to increase, as I will discuss in a moment.

Sirius has nearly doubled its OEM subscriber base since the beginning of this year, reflecting increasing momentum from the company's exclusive OEM partners, which now number 21 individual automotive brands. Sirius is currently available as a factory-installed feature in virtually all Chrysler, Jeep, Dodge, Mercedes-Benz, BMW, Volkswagen, Audi, Rolls-Royce and Bentley vehicle lines. Most importantly, the Chrysler group is now targeting a 40% overall penetration rate for the 2007 model year with their Sirius factory programs, up from approximately 30% in the 2006 model year. In the coming days, look for some major advertising from the Chrysler Group that prominently features Sirius in association with Chrysler, Jeep and Dodge vehicles.

Ford is also on track to offer Sirius as factory-installed options in 21 vehicle lines by early calendar year 2007, up from four models at the beginning of 2006. Recent new Ford model launches with Sirius include the exciting new crossover vehicles, the Ford Edge and Lincoln MKX, as well as strong sellers such as the Ford Fusion, Lincoln MKZ and Mercury Milan. Momentum is building at Ford and our prospects for 2007 are strong.

Also during the third quarter, Audi and Volkswagen began their on-time launch of the previously announced exclusive factory program with Sirius. Audi VW is targeting at 80% installation rate in their 2007 vehicle lines. Mitsubishi announced that it would begin to offer Sirius as a standard feature or factory option on four models in the fall of '06 and throughout its entire line in the 2008 model year. In the third quarter, Volvo also announced that it will offer Sirius as a factory-installed option in the S-40, V-50, C-70 and all new S-80 vehicle lines. Mercedes Benz has previously stated that Sirius will be available in approximately 50% of their vehicles in '06 and '07. I am pleased to announce today that Mercedes Benz is currently installing Sirius radio in over two-thirds of all model year 2007 vehicles. Finally, last week we also announced an exclusive arrangement with Bentley to offer a lifetime subscription in each and every car that they sell.

Let's now discuss our focus on customer retention and how we are improving customer relation management activities. As we continue to experience dramatic growth in our business, we have to improve our ability to service our existing customers, keep customer hold times down and provide effective and efficient responses to customer questions as well as compelling offers, without excessive spending. Exceptional customer care only comes by having great data and systems, the best people, and excellent processes.

To date, we have posted industry-leading levels of customer satisfaction and retention, but we are focused on driving further improvements. As such, I'm pleased to announce that during the quarter we hired Vance LaVelle as our Chief Retention Officer. She comes to us with considerable expertise in delivering world-class customer retention. The message should be clear. We will use appropriate resources to maintain and improve customer retention programs and results.

Lastly, the obvious question is given the softness at retail in the last two months, what's going to happen in the fourth quarter? First and foremost, over the last three years, satellite radio has tended to be a great holiday gift, and I believe it will be again this year. A radio with a three-month subscription is now under $100. Even a full year subscription with a radio is under $200, making satellite radio a tremendous great gift opportunity. While near-term retail softness has clearly created concern, I believe that a significant holiday uplift will result from strong products, ample availability for the first time in three years during the holiday season, focused advertising, great customer awareness, and the best radio on radio, all contributing to a needed surge in fourth quarter demand. In my view, we now have the most compelling value proposition in the history of satellite radio.

Now I would like to hand it over to Scott.

Scott Greenstein

Thanks, Jim. In the third quarter, Sirius continued to deliver on our claim of being the best radio on radio, and when we launched Sirius Internet Radio this quarter, we became the best radio on the Internet. For example, we did a two-day worldwide trial that Mel referred to on October 25 and 26, where we wanted people to hear Howard Stern again and realize what they have been missing since he moved to Sirius Satellite Radio. Having two channels of Howard Stern programming, including the Howard Stern Show running 24/7 on Howard 100, what we did is exactly allow them to hear what they have been missing. We made Howard available worldwide for the first time ever.

In addition to Howard, visitors to Sirius.com those two days also had the opportunity to sample every one of the over75 channels available on Sirius Internet Radio. We experienced success well beyond internal expectations, with traffic to Sirius.com and HowardStern.com spiking during the week. For those who questioned Howard's draw, this should lay it to rest. We heard from servicemen on aircraft carriers and listeners from the four corners of the world calling into his show and other shows on Sirius that day.

Among the many accolades surrounding our no radio required internet offering, one prominent writer said within minutes, I remember just why and just how much I missed hearing Stern on my radio. As everyone knows, Howard made a huge impact for us last year, but it's important to note that Ad Age recently stated with regard to the free Howard trial, that traffic to Sirius.com was up 201% versus the same day a year ago.

During the trial, we also did what we do every day at Sirius. We delivered the most compelling radio anywhere in music, talk, sports, entertainment and the news. For example, the stars on those two days were voluminous. They included Eminem live, debuting tracks; John Legend performing in our studio; Tiki Barber; Joe Montana; Tom Brady on the sports side. Deepak Chopra, the First Lady of California Maria Shriver; the Who’s Roger Daltry and NASCAR driver, Tony Stewart, just to name a few who joined us those two days.

I'll go through some of the highlights for the third quarter on the programming side, but it reflects what we have always stated our priorities to be over the past year. We are unrelenting in meeting our goal of giving listeners the most inspiring, entertaining, informative and irresistible content anywhere on radio. We continue to add to our range of programming for family, women and niches of interest and we are adding content continually and weighing what our subscribers will enjoy, while never losing sight of Sirius’ overall goal of reaching cash flow positive.

In this quarter, we continued to work from a more refined programming strategy that focused on three of Sirius' core strength: reinforcing our core male programming, solidifying our position in innovative women's programming and remaining opportunistic about new initiatives across the platform.

For the core male audience, we strengthened our position as the programming leader with just a few select examples to highlight the point. Jerry Rice, the legendary Hall of Fame receiver debuted his regular show on Sirius NFL Radio. Soccer recently showing an increase in awareness and demand, we added Chelsea, the champion league soccer shows, and a regular soccer show for our fans. The Who channel debuted, and most importantly, the much anticipated Howard Stern Tapes and the Top Ten Moments of Howard’s past emerged and were put on the Howard Stern channels.

As for our emerging female audience, which continues to grow, we announced a deal with Jane Pratt, the founder of Jane magazine. We broadcast the California governor's women's conference hosted by Maria Shriver, which featured exclusive content, including a rare appearance by the Dali Lama. We have Sex and the City creator Candace Bushnell show debuting on Sirius Stars and is already drawing attention in the press and media. As you will recall from our announcement last quarter, we will be launching Barbara Walters, the Best of the Very Best this January and we are debuting Barbara's Ask Barbara Anything, her quarterly live call-in show this month to coincide with her ABC special.

In our product category, we continue to seek opportunities to provide never before offered programming to new audiences. We debuted the Metropolitan Opera channel, America's First national opera channel with a live broadcast of Madam Butterfly exclusively on Sirius, and at least three live broadcasts from the Met on a variety of programming every week. We launched the next generation of conservative talk program hosts, the Andrew Wilkow show, and we've seen strong press reaction. He's now a regular expert guest on numerous TV shows.

Finally, our biggest addition in programming is about to come in the upcoming quarter. In January, we're adding the biggest spectator sport in America, NASCAR. We expect Sirius NASCAR Radio to succeed in the same way NFL Radio has. Players, coaches, reporters and of course, fans, listened to and helped build NFL Radio. Now we are building Sirius NASCAR Radio in the same mold. We will have drivers, pit crew, owners, race experts, journalists, and all walks of life in the NASCAR community to make it the most immersive radio experience ever delivered to the NASCAR audience. We will deliver hours and hours of original talk programming, every single race that matters, access to the sport's leaders and race day in-car driver channels for numerous drivers.

In a few weeks, fans will get their first taste of what NASCAR will sound like on Sirius with the debut of our exclusive Tony Stewart Live weekly show. Sirius is wasting no time in reaching NASCAR nation to create anticipation and make Sirius a holiday purchase for NASCAR 2007. With the exciting program line-up we're going to unveil we want to make sure there isn't a NASCAR fan anywhere in the United States and Canada that wouldn't know about our programming and our upcoming acquisition of NASCAR.

In recent weeks, we have begun marketing directly to NASCAR's fans where they are, at the track, on TV during the last and most closely watched Chases, the Races of the Chase this month, in the NASCAR track magazines and publications, and online with advertising at NASCAR.com and the largest fan site, JC.com.

In addition to NASCAR, we have a multi-platform integrated marketing campaign for the fourth quarter. We will continue the Best Radio on Radio campaign with new TV and print executions that will attract new listeners by capitalizing on our superior music, sports and talk programming. We will have a mixture of mass media on high profile programs such as NFL games, including this past Sunday night's game with New England and the Colts, which had one of the highest ratings ever; key college football match-ups, Thanksgiving specials, prime events, in addition to heavy advertising on cable television. We also have aggressive print, radio and interactive campaigns, all promoting our premier radio experience. Our new TV and print executions, which have just begun and will increase steadily as the quarter continues in order to take full advantage of the holiday buying season that Jim referred to earlier.

In addition to Sirius’ own marketing, we expect to see more marketing from our partners such as OEM and retailers than we have ever seen before, as more and more of them see the value that Sirius can provide by including us in their efforts. These partners are running dedicated TV spots, print and interactive banners promoting Sirius. We will also partner with brands such as Martha Stewart, Fox, NFL, NBA, Playboy and The Who to ensure the Sirius message reaches their loyal and sometimes substantial audiences. The mix of Sirius advertising and partner advertising will create our largest marketing effort to date.

It is also with great programming brands such as NASCAR, not to mention the NFL, Howard, the Met, Rolling Stones, The Who and many others that Sirius’ brand awareness, which also contributes to our retail surge, continues to rise. Total and unaided brand awareness for Sirius has risen steadily since December 2004 and as of September 2006, we're at 74% and 54% respectively. More than 3,000 print stories have appeared throughout the third quarter, with impressions of more than 1 billion in media outlets from Forbes to the L.A. Times to USA Today and Daily Variety. Sirius was featured in broadcast segments on numerous network and cable programs, including the CBS Evening News, Good Morning America, World News Tonight, Total Access and others.

Advertising. Advertisers want to be where the listeners are. They want to be where the best programming on radio is and where the heat and buzz are generated. For the first nine months of the year, we have booked $22.7 million in revenue and as Mel mentioned, approaching $30 million compared to $3.1 million through 3Q05. That's a 632% increase in ad revenue year-over-year. No other medium can come even close to posting those numbers in advertising growth.

What's even more impressive is the number of world-class blue chip advertisers that have joined Sirius. They include Simon and Schuster, Harper Collins, Panasonic, Coldwell Banker, consumer electronics giant LG, Paramount Pictures and numerous others. We remain confident that Sirius will remain the programming leader in radio and all that goes with that.

We've proven again with Sirius Internet Radio that our content matters, it translates and it moves to other places. We are an innovator in that area. We have also proven ourselves with programming from Howard and Martha to sports and a stable of talent that growths in depth and diversity as our subscriber base does every day.

But we aren't resting on the recognition of what we've accomplished to date. We're out to break conventions in radio and are dedicated to maintaining the programming leadership position we've worked hard to accomplish. However, it will all be done within our goal of generating significant positive free cash flow.

With that I turn it over to David.

David Frear

Thanks, Scott. As in prior calls, my comments will follow the condensed income statement in our press release, which excludes the effect of equity expenses on the individual line items. The 441,000 net new subscribers Sirius added in the third quarter represents our fourth consecutive quarter of market share leadership in the one key performance metric that translates directly into revenue growth.

Total revenue increased by over $100 million year over year to $167 million as our subscriber base more than doubled to over 5.1 million subs from just 2.2 million a year ago. The nearly 3 million subs added in the last 12 months have now driven our annualized revenue run rate to nearly $700 million. This spectacular growth has been accomplished with great efficiency. We have promised you a clear focus on free cash flow and as you will see, every key financial measure has shown substantial improvement.

As Mel mentioned, SAC per gross add dropped 23% to $114, bringing net cash invested per sub close to breakeven levels. Customer service and billing expenses declined 36% to $1 a sub a month. Cost of services has dropped from 62% of revenues to 50%, fully absorbing and then some, the effect of adding Howard Stern to our line-up this year. Engineering design and development has improved to 12% of revenues from 15%. G&A has dropped from 21% of revenues to 14%. Adjusted loss from operations before SAC and marketing costs, which the analyst community refers to as pre-marketing EBITDA was positive $42 million for the quarter, or 25% of revenues. Marketing costs dropped to 25% of revenue from 57% last year, and as a result, pre-SAC adjusted loss from operations, or pre-SAC EBITDA is now at breakeven levels. These results show a clear progression to positive cash flow.

Our adjusted loss from operations, or adjusted EBITDA, improved by $43 million sequentially to a loss of $83 million, considerably better than Street expectations. The third quarter adjusted loss from operations represented a 21% improvement year-over-year, despite the additional total SAC required to support 57% higher gross additions in the 2006 third quarter; as well as the addition of Howard Stern this year, the launch of Martha Stewart Radio, Cosmo Radio, Playboy Radio, expanded soccer coverage, The Who channel and much more. As Scott indicated, while there is no missing piece to our programming, we continue to deliver and improve upon a programming slate that represents the Best Radio on Radio and we pay very close attention to the costs along the way.

Total churn, including self-paid subs and non-conversion of bundled subs in the third quarter was 2% versus the 2.75% The Street calculated for our competitor, up from 1.8% in the year ago third quarter. This increase is wholly attributable to the increase in our OEM subscriber base and the roll-off of non-converting bundled subscriptions. The self pay component of our churn has remained very consistent in the 1.6% to 1.7% range.

Sirius ended the quarter with approximately 352 million in cash, cash equivalents and marketable securities. Our uses of cash in the third quarter included $67 million of capital expenditures, largely related to our next generation satellite program, as well as a $53 million reduction in accounts payable and other accrued expenses.

The effects of clearing the FCC's concerns with the FM modulator are reflected here in the accounts payable reduction, as production scheduled and the accounts payable associated with them were pushed out of the third quarter.

As Jim and Mel have discussed, our products are approved. We are back in full production, and will have plenty of product in stores for the holidays.

As disclosed in our press release, we are reiterating all of our previous guidance today. In each of the last three years, the holiday selling season has been a big part of our year and this year is no exception. Our marketing and production plans are set. You will see aggressive responsible marketing, products will be in ample supply, and with a strong holiday selling season, we will hit our guidance, including the opportunity for this quarter, 4Q06, to be our first quarter of positive free cash flow -- not just operating cash flow, but true free cash flow. With that, let me turn it back to Mel.

Mel Karmazin

Thanks, David. As you heard, we had a blowout quarter, but on a personal note, it's now almost two years since I joined this great company and I'm very proud of the job that our team has done. We have delivered on everything we told you, and I will strive to keep that credibility in the future. Now, if there are any questions, we would be happy to turn it over for questions.

Question-and-Answer Session

Operator

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

Ben Swinburne - Morgan Stanley

Thanks for taking the call. I have two questions. David, on the SAC, can you just remind us what your full year guidance is for full year '06? Now that you have started to take delivery of the fourth generation chip set, I know there is roughly a 30% reduction in each generation, but there's some offsetting levers as we head into next year around OEM versus retail mix, and these chips get to retail before they get to OEMs. If you could just help us think about that trend.

Second, you guys did a great job this summer dealing with the FCC inquiries and all the volatility around the modulators, but how do you feel now that you've got the directional antenna on its way out, that's going to impact the installation process, self installs, professional installs, potentially impact holiday gifts, returns, things along those lines. Thank you.

David Frear

So let me handle the first one, I'll turn the second one over to Jim. SAC, the guidance for the year is approaching $110 per gross add and that remains our expectation for the year. We have not given specific guidance for SAC for next year other than to say we will continue to drive it down, that we have consistently said that within each channel of distribution, retail versus OEM, that we've been making 30% year-on-year improvements and the only reason why the overall blended SAC would be different from that is just mix reasons. So as we come into January and the year end call we look to provide guidance for next year, we'll update you on that.

Jim Meyer

In terms of the changes that we've implemented for the FM modulation issue, I'm very comfortable with the products that we're shipping now, including the directional antenna. Obviously it's never desirable to add another wire, but we've added another wire. It's very easy to route it and to install it. Not all consumers will need to do that. We've also have added what had we think is a great site, which is on Sirius.com called FM Find, which when you enter your zip code easily tells you many FM stations that you can tune to or you can set the radio and avoid the FM modulation issue.

Clearly, those are bigger issues in heavy metro areas than they are in a lot of the country. But I'm very confident and very bullish that this is a great solution for the self installer.

Ben Swinburne - Morgan Stanley

It sounds like if I take both of your answers together, you don't see the addition of professional installation or subsidizing those as having any material impact on your SAC this year?

David Frear

Our guidance remains the same. We've taken all of those factors into account in arriving at our guidance.

Ben Swinburne - Morgan Stanley

Thanks a lot.

Operator

Your next question comes from Vijay Jayant – Lehman Brothers

.

Vijay Jayant – Lehman Brothers

A question first for David. In terms of the balance sheet items, the increase in deferred revenues are only $2 million; it seems substantially lower than the historical trends, while CapEx seemed much higher. Is there any trend line you can talk about how that swings in the third and fourth quarter? Thanks.

David Frear

On the CapEx side, we do have payments both with respect to the FM Sirius Find program that we've initiated as well as payments related to the launch vehicle that will put that up in the quarter. That was the substantial driver of the $67 million in CapEx. For the deferred revenue, as the business just gets bigger and the new net additions become a smaller percentage of the overall base that, of course, the increase in deferred revenue is simply going to come down. So I don't think there's anything in the quarter that is inconsistent with most of the modeling that we've done as well as that we've talked through with various people on The Street.

Vijay Jayant – Lehman Brothers

Then on the CapEx?

David Frear

The CapEx, as I mentioned, is driven by the satellite program, both payments to the satellite and the launch vehicle.

Vijay Jayant – Lehman Brothers

Okay, thank you.

Operator

Your next question comes from Laraine Mancini - Merrill Lynch.

Laraine Mancini - Merrill Lynch

Thank you. In your conversations with your OEM partners, do you get a sense of when they may plan to go standard?

Second, NASCAR, is there an opportunity to provide other services that could be a positive impact to ARPU beyond the subscription price?

Third, your customer retention focus seems to be increasing, yet you've brought that cost down a lot. What can we look for going forward?

Jim Meyer

Starting with the OEM partners, we constantly have discussions with them about what I would call smart standard. By that I mean I think that where we are with awareness and where we are this early in the growth curve for satellite radio, that just across the board standard certainly I don't believe is going to result in conversion rates that are good for us. So we look at many areas and particularly right now with Ford and Chrysler, where we can go standard perhaps in certain vehicle line packages and in certain premium audio features and then move towards that.

I think it's very significant that Chrysler has committed to approximately a 40% penetration rate in the '07 model year and that's something that I think bodes well for the industry. Clearly on a higher end vehicle like Audi, it's much less risky to go to a much higher incorporation rate than across what I would call mainstream suppliers like Ford and Chrysler.

Scott Greenstein

On NASCAR Laraine, as Mel mentioned, it's a five-year relationship. One of the things we're most excited about with NASCAR is they feel as this rapidly expanding, growing fan base goes into all areas, that they are underserved when it comes to data and statistics and other things. As you know, there's not a NASCAR beat writer in every newspaper. It's limited coverage in a lot of places, so we're going to continue to look at opportunities, whether it's on the Internet or potentially even separate things on Sirius Internet Radio that might be unique sources of revenue to do with that fan base as they grow and go into different areas where they will be even less served than they are right now. So it's something that's always ongoing in discussions with NASCAR right now.

Mel Karmazin

I know most of you don't focus on this, on our advertising piece looking at it as a second revenue stream. But we think on your question of ARPU for NASCAR, we think that our 24-hour a day channel, where we control all of the advertising, is going to be a big boost for us in ad revenue in 2007 and you should see that reflected in our ARPU for next year. Dave will answer your other question.

David Frear

On the customer retention costs, those come in two different pieces in the P&L, Laraine, that you see a portion of them in the customer care and billing side so that the call center operators who take those calls as the base gets bigger, it's been a natural increase, we have more personnel in the call centers taking those things. The trend on that cost is already reflected in customer care and billing and we would expect to continue to drive that down on a per sub basis as we go forward.

There's another piece, which is the management overlay that Jim referred to with mentioning Vance LaVelle that's incorporated within the sales and marketing line. Again, we would expect to continue to absorb sales and marketing, in the way that we have over the last couple of years, where you've seen revenue growth far outstrip the increases in sales and marketing costs and we would expect that to continue.

Laraine Mancini - Merrill Lynch

Great. If I could have one quick follow-up for Mel. Mel, at this point you said you have about $30 million advertising on the books to date. How much inventory do you have available to still sell for the quarter? Is most of the inventory still out there?

Mel Karmazin

We have tons available and you can let the folks at Merrill Lynch know that we can accommodate any request that they have for advertising on our channels at the end of November and December. We will not let inventory stand in our way.

Laraine Mancini - Merrill Lynch

Okay, great. Thanks.

Operator

Your next question comes from Robert Peck - Bear Stearns.

Robert Peck - Bear Stearns

Congratulations. I have two bigger picture questions here. One is on a potential merger between XM and Sirius. We see that all over the press. I guess, Mel, I wanted to get your feel for what the pulse Sirius may have taken, if you think it's even feasible should both XM and Sirius want to do something like that? What is the feedback you're getting from your people?

Then number two, Mel, could you go into a little bit about the royalty situation, how you got to your 0.88%, what your view on the timeline of that playing out?

Mel Karmazin

I really don't have very much to say about any hypothetical combination that could or could not exist. I understand the basis of the question. There clearly would be a good amount of value creation that would be there, but regarding whether or not such a combination would take place, I really have nothing that I could say about it. You shouldn't take that to mean that it's possible or you shouldn't take that to mean it's not possible. You should just assume that we have nothing really to talk about.

You should assume that we will be looking to kick their ass in the fourth quarter, and we do that, and they are looking to do the same to us and we are competitors. Our business plan does not require us to do anything different than we are doing. We have enough cash on our balance sheet that gets us through to cash flow positive. Again, we feel very good about our company in a standalone mode and if in fact the opportunity ever came to create more shareholder value, it's something that obviously we would be interested in.

On the RIAA, we have worked closely with our friends at XM in putting together a response to the copyright royalty board. What we looked at were all of the things in the statute that you are required to look at and those certainly include what we are currently paying. It takes a look at the investment we have made in our infrastructure. It takes a look at a rate that would not be disruptive to the business, a rate that would be fair to those people holding the copyrights. We truly believe that our proposal was a very genuine, significant proposal that would give the recording industry a significant amount of money at just under 1%.

We think that their proposal is bizarre. I think they are making a proposal just based upon the fact that the music industry is having trouble, so if they are having trouble, maybe they should look to satellite radio to fix their problems, but we don't think that our role in life is to fix their problems. Our role should be to pay a fair price for material.

David is leading up our representation on the project and we feel very well represented and are confident that we will come to a mutual agreement sometime in 2007.

Robert Peck - Bear Stearns

Thanks, Mel.

Operator

Your next question comes from Eileen Furukawa - Citigroup.

Eileen Furukawa - Citigroup

Thanks for taking the questions. I have a couple questions. First, you spoke about reaching free cash flow as early as the fourth quarter of this year. I'm just wondering, what are the key factors that you'll need to have that actually happen? Is it reaching your sub target, reaching your SAC guidance, continuing to have the same average prepaids, or is it something else to actually reach free cash flow positive in the fourth quarter?

Also, a question on churn. Where do you think churn's going to level out in the ’07, as your OEM mix continues to increase? Also, can you tell us what churn would have been in the third quarter if you didn't consider churn from the promotional OEM subs? Was it in line with your historical churn?

Finally once they become self-paying subs, is the churn for your OEM similar or less than your retail churn? Thanks.

David Frear

Let me do the churn question first. As I mentioned in my comments, the self-paid churn has been pretty consistent at the 1.6% to 1.7% range. I think as we've said in different forums over the course of the last couple of years, that we generally find that OEM self-paid churn is a little bit better than retail self-paid churn It makes a certain amount of sense when you think about it.

There's some amount of the churn that's related to the plug and play nature of the radios, so whether or not they break the pins on the back or whether they lose the radio or whether or not it's stolen or something like that, that there's a structural churn associated with a portable product that doesn't exist with an in-dash product. So the OEM churn is a little bit less than retail.

For next year, we haven't given guidance on churn. We'll do that in the course of having finished up this year and as we provide guidance for next year, we'll be sure to do that. As the OEM base becomes a little bit bigger, it will put some upward pressure on the total overall churn rate just by virtue of the non-conversions and we'll give you an update on that in January.

But to your free cash flow question, I guess the short answer is yes, but the most important factor really is in fact the holiday subscribers. You know, as in past years, you've heard us talk a lot about how we don't believe marketing is a variable cost and so we set our advertising plans and we go to market. Those aren't going to vary based on the number of subs that we add. Our production plans for product are set and as you know our SAC is, a large part of it, is established by virtue of the chipset and the radio subsidies, which are all incurred by the time that we ship the product to retail, So variations and additions, the SAC effect they have is only just the commission portion.

So in large part, what is really going to drive free cash flow in the fourth quarter is how many subs come after Thanksgiving and how much they pay us. We've seen a lot of statistical consistency over the last couple of years in what the average prepay looks like, especially at retail as you come through the holidays, and so I think it really, Eileen, comes down to volume.

Eileen Furukawa – Citigroup

Okay. Thank you very much. I appreciate it.

Operator

Your next question comes from Tuna Amobi - Standard & Poor's.

Tuna Amobi - Standard & Poor's

Thank you for taking the question. First housekeeping, David, XM said they weren't going to provide preannouncements on net adds starting next year. Is that the case with you guys, or should we expect that you would continue to do that?

Mel Karmazin

You asked the question of David. David and I have not talked about making any change in the way we provide information to you, so if in fact the information is helpful, we see no reason why we would not continue doing what our practice has been.

Tuna Amobi - Standard & Poor's

Fair enough. Mel, as XM seems to be getting some traction with their content syndication of Opie and Anthony, has your view changed perhaps as to whether you could pursue that strategy?

Mel Karmazin

You know, it is really interesting. Far be it from me to take exception to what you would say, but it is hard for me to find out what you mean by the traction. It is really interesting that I was particularly focused on how well we did in our third quarter because you will recall that it was the third quarter that got that traction, and it was third quarter that had a great deal of talk about giving up exclusivity in favor of the promotional opportunities, and we wound up getting 75% market share when people had the choice.

I have not seen, though I am not suggesting it was not in the best interests of Opie and Anthony, or even in the best interest of XM, I really cannot speak for their business decisions, but as a competitor looking at the traction, I do not see any.

Tuna Amobi - Standard & Poor's

Fair enough. Finally, on the Internet streaming, can someone speak to the economics of that strategy in terms of the margins, the loss that you are sustaining there now? Any outlook on when you are starting to generate profit on that? Just generally, the kind of model. I would presume the opera as well for existing subscribers would be incremental. Any color around the Internet streaming would be helpful for model.

David Frear

So it comes in two pieces. There are the subscribers who upgrade to higher fidelity for the additional $2.99 charge, and that is clearly something that is a premium service. It is additive to cash flow and provides an immediate benefit to us.

I would say that the same thing is true for these subscribers that we add to Sirius Internet Radio who have decided to not buy a radio but to subscribe over the Internet. As you know, it is priced at the same price points as our other products. We do not incur any chipset or radio subsidies associated with that product. It has a different cash profile, but when you are all done mixing it up, I think it comes down to a very similar contribution per sub.

I think you should look at Sirius Internet Radio as opposed to something that is generating losses that need to be recovered, as something that is accretive to cash flow almost immediately.

Tuna Amobi - Standard & Poor's

When do you start breaking out the numbers?

David Frear

We will look at that. Obviously with just launching it in the last week, as it relates to the third quarter, there is nothing to break out.

Tuna Amobi - Standard & Poor's

Thank you very much.

Operator

We will go next to Jason Helfstein with CIBC World Markets.

Jason Helfstein - CIBC World Markets

Thank you. Two questions. One, you guys gave Trip the color on Chrysler on the penetration ratios. Is there any way you could give more color on Ford, you know, clearly going from four models to I guess, what is it, you guys had 16 to 21 beginning next year. Is there a way to think about penetration ratios in that 21? Obviously a 400% increase going from the 4 to 21 would seem a bit dramatic, but how should we think about that?

Secondly, on the family plan, one of the things, Mel, you know from radio, what people love about the concept of radio is you can hear consistency wherever you want. You can have five, six, seven radios in your life, and that is one of the great things about radio, assuming you are happy with the content. Given the economics of how you price the service, I think most people would not want six family plans. Have you thought about finding a way or thinking of a way where people could have more radios but not pay for that many more radios, so that perhaps it is a more similar type of service like they are used to? Thank you.

Scott Greenstein

On the OEM front, let me just make a couple of statements. One, I do not have approval to discuss the penetration rate at Ford, so I cannot be specific there. I will tell you a couple of things. One, Ford lags behind Chrysler by a couple of years, because we started a couple of years late, and will keep us completing the transition for virtually all their models in early ’07. We did that in early ’05 with Chrysler.

Second, obviously I think Ford is very focused on penetration rate. We are beginning to work through the premium audio lines and the trend packages for Ford on penetration, but I do not have anything else to report on it right now.

Mel Karmazin

On the subject of people being satisfied with our service and how many radios they want, we are at a point in our development today, unlike a lot of other periods in history for us, I remember when satellite radio was being valued based on whether or not the satellites would be launched or not, and then whether or not they would be able to get programming, so there were press releases issued almost daily about what content got added. Then it was the OEM penetration.

Now I think the focus for the company, and I think it should be for investors, is also on our drive to free cash flow positive and our business plan. With that, when we have a family plan, we think that makes good business sense for us. They churn less than when people have multiple subscriptions, they churn less than someone who only has one, so we obviously look at that in coming up with the pricing for that.

We also introduced Sirius Internet Radio for people who do not want to buy a radio and want to receive it in their home and make it sort of rooted. There are other discussions that we are having, which you will hear about as time goes on, about other ways of getting Sirius.

But the key focal point is what makes sense for the business, and if in fact there became a logic to having one subscription and it covers everything, you should assume that we would be open to consider that as well, Jason.

Scott Greenstein

One more thing. Bear in mind that for each subscription that we provide a streaming password to our subscribers. If you have the average household with two cars, then there are two streaming passwords. In a world of an increasing number of IP enabled devices that will allow for the enjoyment of a lot of media, that you have distribution throughout the home and the office, but it comes across the Internet as well.

As Mel mentioned, we have Sirius Internet Radio. We have the free streaming service. We have the upgraded higher fidelity streaming service to help with those fixed location demands.

Jason Helfstein - CIBC World Markets

Thank you very much.

Operator

At this time, we have time for one final question, and that final question will come from James Dix with Deutsche Bank.

James Dix - Deutsche Bank

Good morning, everyone. Just a few questions. First, in looking at your research, do you see much seasonal ebb and flow in your retail market share from having sports programming, which ramps up a lot in the fall, such as the NFL and the NBA, as opposed to your competitor that has programming that ramps up in the summer, like baseball.

Secondly, this holiday season, would you expect to use perhaps more promotions which affect ARPU as opposed to SAC, for example? You know, discount on longer term subscription plans.

Finally, for next year, should we be expecting SAC all in to be similar in the OEM versus retail channels, or should there be some gap there that we should be thinking about? Thank you.

Mel Karmazin

David will start, and then I will answer the research question.

David Frear

There is not going to be anything really different about our promotional strategy this holiday season than what you have seen us do in the past. We tend not to discount programming. We tend to bring various rebate offers to the marketplace. They come in different forms, and sometimes they are paid entirely by us and sometimes they are paid by the retailers. But by and large, you have seen us deploy a mail-in rebate strategy that is something that comes as an offset to revenue, as you know. I think that our behavior in the marketplace this holiday season will be the same as what you have seen in the past.

With respect to the SAC numbers, there will continue to be a gap between OEM and retail. As Jim mentioned, we are moving GEN-4 chipset into products now and as we roll into next year. The automakers, some of them simply are finishing their transition from GEN-1 to GEN-2. Most of them are on GEN-2 chips. We are encouraging as many as we can get to go as fast as we can go to move to GEN-3 chips.

Really, all of that stopping point along the way to the development of integrated head units. Our real focus with the automakers is on getting them away from black box implementations under the seat or in the trunk with wiring harnesses that snake their way through the car to the head unit, and actually getting them to an integrated head unit, and that is a bit of industrial transition that simply will take a few years to accomplish.

Mel Karmazin

On your programming question, when we make a decision to get some programming, we factor in many things. Obviously in the case of Howard, what was factored in was that he was exclusive. You could not get him any place else, and most importantly, it was morning drive time, which is the highest rated and most important time period in radio.

When we made a decision to do the NFL, the factors that got into it was that the games were in the fourth quarter and the fourth quarter is critical for the success of satellite radio because of the high demand from a point of view of gift-giving. That fact that they played in the fourth quarter had a great deal of visibility and interest, which helped us get sales.

We have research. We know what investments we have made in programming have gotten us more subscribers than others, and we will be that much smarter in the future because we know today what programming works and what truly gets us subscribers and revenue opportunities and what does not. I can tell you the NFL and Howard are clearly two that do, and we are also optimistic that NASCAR, starting in January, will as well. So, appreciate it.

Michelle McKinnon

Thanks very much, everyone, for your time today, and we look forward to talking to you on our year-end call in January or February.

Operator

That does conclude today’s teleconference. Thank you for your participation and have a great day.

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Source: Sirius Q3 2006 Earnings Call Transcript
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