SIRIUS XM Radio (NASDAQ:SIRI)
Q1 2010 Earnings Call
May 4, 2010 8:00 am ET
William Prip – Senior Vice President, Treasurer and Investor Relations
Mel Karmazin - Chief Executive Officer
David J. Frear - Executive Vice President, Chief Financial Officer
James E. Meyer - President, Operations and Sales
Scott A. Greenstein - President, Chief Content Officer
Lev Polinsky – JP Morgan
Barton Crockett – Lazard Capital Markets
David Bank - RBC Capital Markets
Matthew Harrigan – Wunderlich Securities
Mike Pace – JP Morgan
Jim Goss - Barrington Research
Welcome to SIRIUS XM Radio’s first quarter 2010 earnings conference. (Operator Instructions) At this time, I would like to turn the conference over to William Prip, Senior Vice President, Treasurer and Investor Relations. Mr. Prip, please go ahead.
Thank you. Good morning, everyone and welcome to SIRIUS XM Radio's earnings conference call. Today Mel Karmazin, our CEO, will be joined by David Frear, our EVP and CFO. They will review SIRIUS XM’s first quarter 2010 financial results. At the conclusion of the prepared remarks management will be glad to your questions. James Meyer, President of Operations and Sales and Scott Greenstein, President and Chief Content Officer will also be available for the Q&A portion of the call.
First I would like to remind everyone that certain statements made during this call might be forward-looking 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 upon assumptions, data and 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. For more information about those risks and uncertainties please see SIRIUS XM’s SEC filings. We caution listeners not to rely unduly on forward-looking statements and disclaim any intent or obligation to update them.
As we begin, I would like to caution our listeners today’s results may include discussions of both actual results and pro forma results. Listeners are cautioned to take special care to ensure accuracy in looking at today’s report.
I will now hand the call over to Mel Karmazin.
Thanks Will. Before I review our quarterly results I would like to cover a few broader issues.
Last week we regained NASDAQ compliance. Very importantly we regained it organically. We told you in the past the company would continue to be listed on NASDAQ. We had a hearing scheduled the day after we actually regained compliance. We believe very strongly at that hearing they would have granted us another six months even if in fact we didn’t get that waiver. We certainly had the ability to do a reverse stock split to continue to be listed.
We can debate the benefits of reverse stock splits and whether or not that is something good or bad for the company and our Board of Directors do that but it was our determination we did not want to have to do a reverse stock split to gain compliance. We are very pleased we regained the listing organically and there is absolutely no plans at this time to do a reverse stock split. So we are glad that issue is behind us.
We also weeks ago were added to the NASDAQ Q-50. That is the list that is right behind the NASDAQ 100 of most valuable companies and we are very pleased about that. Today based on current market cap we are more valuable than 92% of all of the companies listed on NASDAQ. Our stock price because there are just a significant number of shares outstanding doesn’t sort of make it appear that way.
If you take a look at the shares outstanding for the largest loaded companies; Microsoft has about 8.8 billion shares outstanding. Cisco has 5.7 billion shares. Intel 5.5 billion. Vodafone 5.3 billion. Oracle 5 billion and SIRIUS XM 3.885. So clearly we have a very valuable company. There are just a significant amount of shares outstanding. In addition to having a broad investor base, we are one of the most liquid securities on NASDAQ. As a matter of fact, in the first quarter of 2010 SIRIUS XM was the most heavily traded stock on NASDAQ.
Another issue I want to talk about is the fact we have gone through the worst recession that most of us have ever seen. SIRIUS and XM started adding subscribers in 2002 and the economy was very strong during that period and up until 2008. So we now have seen how satellite radio performs in what was this terrible recession. It was a great experience for us and what we found is that consumers love our product, they stuck with us in spite of the 10% unemployment and again I think that bodes very, very well for our future.
There is clearly an economic turn. Car sales are increasing. We are seeing improvement in retail sales and in advertising and all of these economic indicators really are very strong for SIRIUS XM. Very importantly not only are our financing metrics strong we are now back to growing subscribers at record levels. Last week the number of subscribers we currently have exceeded the December 2008 level of 19,003,000. So we are back to now having record number of subscribers and we will continue to grow our subscribers.
Turning to the first quarter we delivered 171,000 increase in our subscribers as compared to negative 404,000 in the first quarter of the year ago. Our revenue increased 11%. GDP was up about 3% and our revenue was up 11%. Because of our strong control of expenses our adjusted EBITDA was up 45%. Our ARPU was up 10%. Our churn improved from 2.2 to 2.0 and also very importantly our conversion rate improved from 44.6 to 45.2.
Advertising revenue which represents a small percentage of the company’s total revenue but it too grew 18% in the first quarter and is pacing for the second quarter to be up in the mid 20% range. So all in all it was an extraordinary quarter. Automobile sales were better than anticipated. For the first quarter our sales were up 16% and yesterday the SAR number for April was released and it shows the levels went from 9.2 million last year to 11.1 million in April which was up 22%. So we feel very good about this year and where we stand.
We are also making great progress on used cars. Our trials on used vehicles are growing and even more importantly our gross adds are growing up significantly. The levels are low but we are showing continued growth and this will be an important part of the company in the years ahead. Currently we have over 1.1 or about 1.1 million repeat customers paying for the Best Of. As you know this was our first experiment into tiered pricing and we are learning a great deal about it and about our pricing elasticity.
Expanding our growing services business has been a priority for us. We are in aviation weather. We are in marine weather. We are real-time traffic as well as travelling. Currently we are providing drivers with gas prices, movie times and other really cool features and we will continue to introduce new service offerings in the months ahead.
So we are very optimistic for the remainder of this year for both sub growth, revenue, adjusted EBITDA and free cash flow growth. We have not yet made any changes in guidance in 2010. We are being cautious about modifying it this early in the year but we are very, very encouraged by our current performance and what auto makers are telling us about auto sales for the rest of 2010. We are reviewing our current business trends with our model so stay tuned.
On the balance sheet we have been extending maturities and getting greater flexibility. We are aimed at reducing our interest expense and improving free cash flow. As you know we tapped the strong high yield market in the first quarter to raised debt that matures now in 2015 and we paid off nearly $750 million of near-term debt. As a consequence our maturity profile is the best it has been in SIRIUS XM history.
This will be reinforced by the early redemption of the $114 million of PIK notes due in 2011 which would have cost us 12-14% per annum in interest expense if we keep it outstanding. So if you look at our borrowing costs over the past year or so it has declined from roughly a 15% secured rate in the first quarter of 2009 to a 12% secured rate in the second quarter of 2009 to less than 10% secured rate in the third quarter 2009 and all the way down to an unsecured rate of below 9% in the first quarter of 2010.
Clearly market conditions played a significant role in this evolution of our borrowing rates but our improved operating performance had an even greater impact. Importantly, strong cash generation ultimately provides the company an opportunity to reward shareholders over time. Given the nature of the business and the diminishing near-term demand on our cash driven by lower CapEx and lower interest expense as we reduce debt over time it wouldn’t be unreasonable to expect an increase in shareholder value simply from de-leveraging our balance sheet.
We continue to improve our content and I would like take a couple of minutes to cover this important area. Our world class content is what distinguishes us from the competition that we have in the audio entertainment marketplace. Satellite radio offers over 65 channels of 100% commercial free music covering every genre any music fan would want. We differentiate even more with our very special music offerings like E-Street Radio, Elvis Radio, Jimmy Buffet Margaritaville, The Grateful Dead Channel, Seriously Sinatra and Metropolitan Opera channel.
Satellite radio also offers everything a sports fan would want. All NFL games, all major league baseball games, all NHL and NBA games as well as every NASCAR race. In addition to the music and the play by play on satellite radio while in your car or anywhere else you can get Fox News, CNBC, CNN, MSNBC, NPR and the BBC. We also have the most compelling and exciting personalities doing shows on satellite radio like Howard Stern, Rosie O’Donnell, Christopher Mad Dog Russo, Barbara Walters, Opie and Anthony, Martha Stewart, Oprah and Jamie Fox.
When you compare our content offer on satellite radio with that of terrestrial radios or the hundreds of thousands of internet companies such as [Last Step Down], Slacker, Real Networks, AOL, Pandora, Live 365, Yahoo! Music, etc., etc., etc. you can see why SIRIUS XM is by far the best place to get audio content regardless of technology. Our content is amazing and consumers can get it any way they want it. They get it in their car through OEM installed vehicles, through our plug and play products as well as on the Internet and on Smart Phones.
We have announced we have applications out there for the iPhone, BlackBerry and most recently Android as well as having a really cool table top IP product for your home if you have wireless in your home. So again our content really is the differentiator as compared to all of these other choices.
I also want to highlight once again for you the uniqueness of our business model which is the subscription service. If you take the audience, the cum audience of terrestrial radio and you take the total revenues that terrestrial radio generates you see they monetize their audience somewhere between $10-20 per year. If you do the same thing to the internet users and take a look at the number of people they have using their service and take a look at where their revenue is you will see they are only monetizing it to the tune of about $2 per year per user.
SIRIUS satellite radio has 19 million subscribers. We have over 35 million listeners. You take our revenue and divide it by those 35 million listeners and you see we are generating $70 per listener per year. Again, as compared to $10-20 for terrestrial and $2 for internet users. So I think you see the strength longer term of our business model.
We have a long way to go. We certainly are not in any way shape or form maxed out. Terrestrial radio’s revenues are $17-18 billion. Satellite radio is $2.7 billion. Internet somewhere just under $1 billion. So the audio entertainment space is delivering roughly $21 billion worth of total revenues which means our company is doing about 13% of that audience size. When you factor in our content and all of the advantages we have we think that 13% share is apt to increase in the years ahead.
So all in, I am very pleased with the performance of SIRIUS XM and how it has grown. The SIRIUS XM team will continue to strive to improve the service, the customer care experience and the scope of our product offerings all for the purpose of growing our top line revenue with the same vigor we have applied towards integrating the two companies and driving out expenses over the past several quarters. I believe SIRIUS XM’s future is bright and expect we will continue to deliver strong operating and financial results in the quarters ahead.
Now I would like to turn it over to David Frear.
Thanks Mel. In the course of the year and earnings season you heard a lot of concern about the sustainability of cost cut driven earnings. Pundits question the quality of earnings that weren’t growth driven but SIRIUS XM has been consistently delivering improved operating performance with both growth and cost controlled components and this quarter continued that trend.
Revenue performance was outstanding in every way. On the volume side a recovering auto sector led to strong growth in gross additions and more effective retentions efforts and an improving economy led to both lower self-pay churn and an improved trial conversion rate. On the pricing side, ARPU improved with improving ad sales, higher multi-subscription pricing, increasing penetration of our $2.99 internet streaming packaging, continued growth in our Best Of subscription packages and the rollout of the U.S. music recovery fee.
Self-pay subscriptions increased nearly 337,000 over Q1 2009 bringing total self-pay subscriptions to nearly 15.8 million. Paid and unpaid trials increased 250,000 over last year’s first quarter bringing the funnel of promotional trials up to nearly 3.8 million. Total paid subscriptions increased 345,000 over the year-ago period. The increase subscriptions combined with the dollar increase in ARPU drove total revenues up 11% to $671 million. Our contribution margin which is revenue less revenue share, royalties, customer service and billing and cost of equipment was 72.1%, a record high for our company and a 3.3 point improvement over the prior year quarter.
Fixed costs which are satellite and transmission, programming, sales and marketing, G&A and engineering design and development declined by $5 million and improved as a percentage of revenue by 4.4 points to 32.6%. Pre-SAC adjusted EBITDA improved by $72 million on a $65 million improvement in revenue and it improved by 7 percentage points to 38.5% of revenue.
With the strengthening auto sector we invested in growth this quarter in a very cost effective manner with 29% growth in gross additions over the prior year matched with a 4% improvement in SAC per gross add despite absorbing the inventory effect of increasing automotive production. Subscriber acquisition costs increased $23 million or 28% over the prior year’s quarter but increased as a percent of revenue by only 2 percentage points. As a result of the strong revenue growth and tight cost control adjusted income from operations improved by nearly 45% to $158 million or to 23.5% of revenue from 18% in last year’s first quarter.
Since year-end we have taken several steps to improve the company’s balance sheet. In March we repaid to GM $61 million of payments owed to them pursuant to monthly deferrals we took from January to November of last year. Those deferrals bore interest 15% and were repayable from April 2010 to March 2011. With our strong cash flow in the fourth quarter 2009 and the continued growth in the business in the first quarter of this year it made sense to repay the deferrals early eliminating the 15% interest component.
Also in March we upsized an over-subscribed bond offering from $550 million to $800 million and priced the unsecured 5-year notes at 8.75%. This is the lowest rate bond yield in the history of the company. We used the proceeds to retire $750 million of secured and unsecured debt obligations due in 2012 and 2013. The [call] of the 9.625% notes was completed in April. You will note on the balance sheet this debt is show in current liabilities and the cash to fund the redemption is shown in restricted cash.
We also announced on April 28th we are calling the XM holding’s 10% secured PIK notes due May 2011. In addition to the 10% cash coupon these notes have a 2% PIK component that would increase to 4% on December 1. Once again our cash position and strong operating performance allowed us to repay this debt early thus reducing our debt service requirements. Following the call these notes are our only debt maturity through the middle of 2013 is our $230 million 3.25% convert due October 2011.
On a trailing 4-quarters basis debt to EBITDA ratio is now 5.9 times and our EBITDA to interest coverage is 1.5 times. Free cash flow for the quarter declined $121 million from the prior year. There was a $49 million improvement in adjusted operating income that nearly doubled net income plus non-cash operating adjustments to $93 million in the quarter. This was offset by the repayment of the GM deferral which accounted for $76 million of the change; $61 million repaid with interest in the current quarter while the prior year quarter had $15 million worth of deferrals.
We also had a payment to a programming provider in advance of the season that had been paid over the course of the season in 2009 and in the first quarter this year the 2009 bonuses were paid in cash as opposed to those bonuses being paid in stock during the course of 2009 for the 2008 year.
Capital expenditures also increased approximately $28 million in the quarter related to satellite expenses. Although we continue to look at the business performance and we will provide an update to the market as conditions warrant our guidance remains unchanged. Over 500,000 net adds for the year. Over $2.7 billion of pro forma revenues and approximately $550 million of pro forma adjusted EBITDA. We expect free cash flow to remain positive for the full year. We continue to actively watch auto sales, general economic indicators and internal company metrics for signs about where the business is heading. The first quarter obviously gave us great momentum in hitting our operational financial targets and we hope to provide an update within the next quarter to this guidance.
As a reminder we expect to spend approximately $212 million on satellite capital expenditures this year as we launch the already completed XM 5 satellite in the fourth quarter and continue building the SIRIUS 6 program. Next year we anticipate we will spend approximately $111 million on satellite CapEx as we launch SIRIUS 6 later in the year. These amounts are in addition to the $50-60 million of annual ground based maintenance CapEx that would be typical.
As we complete the replacement cycle of both constellations in 2011 we expect satellite CapEx to be diminimous for several years beginning in 2012. This means we will have a roughly $100 million improvement in our free cash flow in 2011 from declining CapEx alone and another approximate $100 million improvement on top of that in 2012 again from lower CapEx.
All in all we are pleased with our very strong first quarter for SIRIUS XM and with that we can turn it over to the operator for questions.
Question and Answer Session
(Operator Instructions) The first question comes from the line of Lev Polinsky – JP Morgan.
Lev Polinsky – JP Morgan
I wanted to ask a question to better understand the guidance. If I look at $2.7 billion in revenue which is sort of the low end and $550 million in EBITDA and back out the first quarter then I get about 120 basis points of margin compression throughout the rest of the year compared with last year on an EBITDA margin basis. In Q1 you saw pretty good expansion of EBITDA margin ad obviously that is assuming you come in at the low end of revenue guidance. I just wanted to understand if there is spend coming up this year I should be thinking about or how I should be thinking about that implied margin guidance. Then one quick clarification question, do you have the number of the unpaid promo subscribers?
Let me take the first one. We mentioned during our opening remarks about not at this time raising guidance. There is nothing we are anticipating in the course of 2010 that is going to change the way the company has been operating and looks as it did in the first quarter. The issue that could change is if in fact we are going to add significantly more subscribers then obviously our SAC costs would go up; something we would be very happy to see occur. But we understand the issue on our guidance. We understand if you annualize the EBITDA from where it is now, we understand everything you have raised and all we can say is that we are looking at the guidance. There is no concern about the rest of the year for the company. You should anticipate it is still early in the year. We just got the April car sales numbers yesterday so you will just have to be a little bit patient before we do anything on guidance. David?
On the margin compression side to the extent you are using $2.7 billion our guidance is over $2.7 billion that will buy us your margin comparisons kind of along the way. Remember the SAR for automotive through the month of April is only 11 million. So the industry is up obviously significantly higher than that for the full year. To accomplish that they are going to have a pretty steep pickup in sales over the course of the last 8 months of the year. With the way they build inventories and the way that the accounting works for us on SAC there would be a lot of inventory loading that would go into subscriber acquisition costs if in fact the estimates of the high 11 and maybe getting to 12 come true. The unpaid trials is between 600,000 to 700,000.
The next question comes from the line of Barton Crockett – Lazard Capital Markets.
Barton Crockett – Lazard Capital Markets
I was wondering if you could update us on the copy write royalty fees and some color on the percent that we are paying it in the quarter so we can back into the revenue trend there. Then also on revenues the ARPU up 10% year-over-year can you break that down a little bit for us in terms of a little bit more in terms of the essential parts that drove the increase there since you are capped by the government on a like for like basis on pricing but obviously the premium is helping and some other things? If you could detail that contribution that would be great.
On the statutory rate, I can’t remember now whether we are at 7.5 or 8% this year. We will follow-up with you. It is publically available. On revenue components we have the effect obviously of more in essence premium load coming through the numbers. We are doing better on penetration of both Best Of as well as the $2.99 internet service so that is certainly helping to drive ARPU that the multi-receiver discounts, the increases in those prices a year ago are helping to drive ARPU as is the U.S. music recovery fee. I think the components of it are all pretty well detailed in the tables that are attached to the release.
You do have some things that are mix related that help retard the growth in ARPU a little bit. As there are different pricing packages available to consumers as they convert or different OEMs with different pricing packages that vary a little bit to the company’s retail price points for the promotional trials and we have gotten pretty good at winning back customers and finding effective promotional offers to win back. So we do have a rising proportion of customers on the win back plan. There are a lot of elements moving the number around. I think the best thing I can suggest is that you start with the table.
We first announced we were going to pass on the copy write royalty fee to subscribers there was some concern on the part of what impact would have upon our company’s churn. We are fortunate that our subscriber satisfaction level is very high, still over 90% and that we manage to pass along those fees with churn being as it was in the first quarter because as of right now a very significant portion of our subscribers as we cycle the calendar are currently paying the MRF fee. So we haven’t been permitted to raise our price so the ARPU has gone up a little bit with some advertising this quarter. Advertising revenue grew higher than our total revenue so there was some growth there as well as the MRF.
Barton Crockett – Lazard Capital Markets
I can follow-up more offline on some of that. But a little more color on how to think about the seasonal trend from here for churn and SAC. Normally churn would be rising in the first quarter over the fourth quarter and it was flat. How do you think about the self-pay churn over the next few quarters, just the seasonal variations? SAC also nice decline here quarter-over-quarter and how do you think about that for the balance of the year?
In terms of the self-pay churn I have to say we are pretty pleased with the first quarter. There is a lot going on. Clearly I think the macroeconomic environment is improving which helps. As Mel said though we had a big chunk of subscribers who their bill came due on the MRF in the first quarter and we were pleased with those results. Then we have initiated quite a few what I would call best practice initiatives across learnings from both companies as we put the cultures together on how to improve self-pay. I think we are seeing a lot of progress there. So I would say we are cautiously optimistic about self-pay for the rest of the year.
Barton Crockett – Lazard Capital Markets
Any thought about SAC from here? The seasonal trend, are you something up or down for the balance of the year?
As you know at this point it is entirely related to the shape of the auto recovery.
Barton Crockett – Lazard Capital Markets
Any more color you can provide on the used car contribution to sub growth in the quarter? Is it just going to be promising but small? Is there any more numbers you can put around that?
I certainly wouldn’t characterize it as less promising. I think it is a great opportunity for the company and for long-term sustained growth that we are just beginning to work through the process of sort of industrializing the transfer of information about second owner sales whether it is from our automotive partners or whether it is by virtue of acquiring third party list information and then crossing that against our database of radio’s in the field to determine whether or not cars have changed hands.
It is very promising. I will tell you there is nothing in the numbers where we get questions, for instance, about the effect of returning activations on SAC for gross add and is that helping to subsidize the SAC. What I would say to you is the effect of it in this quarter is no different than it was in the prior year’s quarter on a proportional basis. It is a promising area of the company and we look forward to growth there.
If you think about our SAC penetration rate is just over 60% of all the cars manufactured this year that means as years roll out 60% of all the vehicles that become used cars are going to have satellite radio already installed. So we see these percentage increases each month and the percentage increases are very, very significant but again the levels remain very low and probably will remain very low for this year. We will continue to talk about it because it is important for the future but it is not something that is going to dramatically impact our subscriber growth this year.
The next question comes from the line of David Bank - RBC Capital Markets.
David Bank - RBC Capital Markets
A little bit of a follow-up on Barton’s question. I think you actually put in some pretty helpful disclosure in the press release on the music royalty fee. If I am reading it right I think you are saying you generated about $48 million from the music royalty and perhaps some other revenue but let’s assume you take that number as a high. If you assume it is $48 million and you divide it by three months in the quarter and divide that by $2 per month it is about 8 million. It is a number that sort of implies about 8 million subs are currently paying the royalty pass through. Could you kind of sanity check me there and give me a sense of how you think it develops? Why is it like 8 million right now and will it ramp?
I think the fee has been rolled out at this point to substantially all of the people it is going to be rolled out to in the existing base. To the extent we have new people come on and new people convert from promotional trials will of course be assessed then but that is part of the growth. There really isn’t much left to do to apply to, right? So we started in August. Obviously all the monthly’s, quarterly’s and all the semi-annually’s have been through it. Substantially all of the annuals, the overwhelming proportion of the annuals have been through it. Lots of the 2 years and 3 years have been through it. So you have a sub base of those annual, 2 years and 3 years that still have to come through but there are that many subscribers in the 2 years and 3 years.
The lifetime’s won’t get it and we don’t apply it to the paid promotional trials with the OEMs so there is that component that only gets it once they come through to the self-pay side. Your $2 average is probably a little too high because we do have the multi-subscriber component so you should be looking at a number that is below $2. I think in the past you should think of it as something sort of on a blended basis in the $1.60 to $1.70 range. Other than sort of growth in the business I don’t think it will grow a lot. It will grow a little bit from here but not a huge amount. I think most of it is in the number now.
David Bank - RBC Capital Markets
I guess one quick follow-up then, assuming the $1.60 and the same kind of numbers it is a little more than half of the self-paid. Is the short answer a little north of the half of the self-paid are either multi-year or family plans? It just seems like a pretty wide gap for everyone having been rolled through for something like 60% of the sub base.
Why don’t I take you through it offline. I think there are probably some faults in sort of the off the top of your head math so let’s take it offline.
The next question comes from the line of Matthew Harrigan – Wunderlich Securities.
Matthew Harrigan – Wunderlich Securities
The SAR number of 11.19 wasn’t all that impressive in the context of the incentives that are in place. Nobody expected the economy to turn down to the extent that it did in 2009. But if we do get some fallout going the other way do you think your business would behave somewhat differently? Presumably some of your softer customers are probably washed out in 2008 and 2009 you showed more resiliency? I assume also that some of the free cash flow characteristics with respect to the automakers would actually reverse out as well. I know the issue is just how much upside there is rather than downside but if we did get an exogenous event that forced the economy back down what do you think you have learned and how do you think things might behave differently?
I think that sort of gets back to the point of what we were saying about our guidance and wanting to be conservative. We are not the ones that are making the cars. Our car partners we speak with regularly are telling us they expect for 2010 the number will probably be somewhere between 11.5 and 12 million vehicles. Our business model is not predicated on that. We have a much more conservative forecast and that is where our guidance was derived from. So the 500,000 subs and over $2.7 billion and the over $550 million of adjusted EBITDA was predicated on the lower SAR.
Everybody remains optimistic. Our information is very current from talking to the OEMs there was less promotional activity by the car companies in April than there was in March. Everybody remains again optimistic the number is going to be significantly higher than the April number was.
The next question comes from the line of Mike Pace – JP Morgan.
Mike Pace – JP Morgan
To follow-up on the SAC question from earlier, although the OEMs are going to drive total SAC I guess on a SAC per unit at the unit economics, what is driving that lower and what may continue to drive that lower or increase that going forward? Two, what is left of the capital structure or covenants in order to collapse the two restricted groups and what financial or operational benefits might you see from that?
Taking the last question first, we meet all the ratios so we under all the debt agreements could collapse the two companies now. There are a lot of contracts and a lot of them date back quite a number of years and so we are taking a look at all of the contractual arrangements to satisfy ourselves that if we were to go ahead and merge the two entities we don’t create an undesired outcome for any of our contracts. So we are working our way through that. We have said for a long time there is no inherent operational efficiency associated with merging the two entities. So there isn’t a cost efficiency driven imperative to go ahead and get it done. We will get it done in due course.
On the SAC side, since automotive drives a big part of the gross additions that it also drives the majority of the SAC per gross add. Jim’s team still is doing a great job driving cost down on the retail side of the business and we continue to have this year as we have for many years now significant improvement in SAC per gross add on the retail side.
On the OEM side it tends to be driven more by the various contracts and mixes of gross additions between the contracts. Overall you should think that we are moving down a more cost efficient path. As each year goes by we have more and more automakers that go to more advanced generations of radio modules which have lower costs to them and so we do expect SAC per gross add to be coming down year-over-year through just good, basic manufacturing and technology development practices.
I would like to add one point on the SAC question. I would like to reiterate what David said earlier, I am pretty sure that inventory in the car maker’s inventory and the end of the first quarter was as low as it has been in a long, long, long, long time. Every automaker is struggling now not only to recover their inventories but to get parts and rebuild and get these part supplies back online. So we are not just facing a build in SAR over the remaining 9 months. We also have an inventory build which is really tricky for us to fully understand as we look at SAC. It really is pretty dynamic.
Mike Pace – JP Morgan
The Howard contract, any update there and if not when should we expect to hear something?
Nothing new to report on Howard as I mentioned at the last quarterly earnings call that we probably would make the announcement during Howard’s show and if you want to hear what Howard’s plans are you should just listen to Howard. As soon as we have something to announce you will hear about it.
The next question comes from the line of Jim Goss - Barrington Research.
Jim Goss - Barrington Research
I think the conversion rate has been a very important metric and I am wondering how all of you are thinking of that? Is it leveling off at current rates? Can it go any higher again? Is there a risk of it going lower? I guess a related area to that would be if the penetration is now 60% have you maxed or will that go a little bit higher as well? You might also think about the conversion rate in terms of certified pre-owned. I don’t know if you are giving trial subscriptions in that area. That might be an interesting thing to learn about as well.
In terms of the conversion rate I was really pleased with the first quarter. There is a lot going on there. As you look at it we obviously have the overall impact of the economy. We had a bunch of vehicles that were sold under cash for clunker programs late last summer that came through with the trials expanding in the first quarter which was at least in our findings and in talking to other people in the subscription business that we are dealing with car makers that are more value conscious, that had some impact. Then we had some really impressive gains with some of our car makers that were driven by best practice.
At the same time we have some new automakers that are rapidly increasing their penetration rate. I think you can guess who that is. I can tell you conversion is a two-edged sword. We do a lot of work on conversion. We need the automaker to help us quite a bit with conversion and there is a learning curve there. Where is conversion? I am not quite sure to be honest with you.
I think we are in a range where we are getting more comfortable with it and I think you should stay tuned as we go through the year. In terms of the certified pre-owned we are out testing a lot of things right now. We have free trials. Certainly the way to drive that business is to make it as easy as possible for that trialer. We are doing a lot of things to learn on that right now.
I think the idea of the conversion being as strong as it is as we have penetrated deeper into the lines of the OEMs is very significant. If you were to look back at some of the early conversion numbers they would appear to be higher but they were really only in the most expensive vehicles. So as we have penetrated into more and more of the vehicles, having this conversion rate in the mid to high 40’s and approaching 50 is certainly our target. Not only are we pleased about the conversion rate in this quarter we are also very, very pleased with overall how the company performed during this period of time.
Jim Goss - Barrington Research
Maybe theorize about a year from this July when you are free once again to determine the overall pricing structure. I wouldn’t expect there to be any absolute jumps in prices but it certainly would seem that you could begin a lot of tiering or options or perhaps a second-pay isolated just music or just sports at a lower price or something of that nature. How are you thinking of the whole pricing structure as you approach the time when that is going to be more up to you?
The Department of Justice when they reviewed the merger they made it clear there should be no restrictions and they approved the merger clean. The SEC got us to agree to holding the price points until 2011. I think the date is sometime in July. I think those price points and the price freeze should go away. If in fact it goes away then the company will have a whole lot of flexibility. That doesn’t necessarily mean the company will just go out and raise prices but we believe we offer a great service and we offer a great value and having that restriction hopefully go away enables us to have another arrow in our bag that we can drive free cash flow and EBITDA and revenue for our shareholders and we will use every tool available to do those things. Thanks very much.
That concludes today’s conference call. Thank you for your participation.
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