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Sirius XM Radio (SIRI)

Q2 2011 Earnings Call

August 02, 2011 8:00 am ET

Executives

Scott Greenstein - President and Chief Content Officer

Mel Karmazin - Chief Executive Officer and Director

James Meyer - President of Sales and Operations

David Frear - Chief Financial Officer and Executive Vice President

Hooper Stevens -

Analysts

Michael Pace - JP Morgan Chase & Co

Benjamin Swinburne - Morgan Stanley

Bryan Kraft - Evercore Partners Inc.

Barton Crockett - Lazard Capital Markets LLC

Leah Pilla - UBS

Operator

Good morning, and welcome to SiriusXM Radio's Second Quarter 2011 Earnings Conference Call. Today's conference is being recorded. [Operator Instructions] At this time, I'd like to turn the call over to Hooper Stevens, Senior Director, Investor Relations and Finance. Mr. Stevens, please go ahead.

Hooper Stevens

Thank you, Kasey, and good morning, everyone. Welcome to SiriusXM Radio's earnings conference call. Today, Mel Karmazin, our Chief Executive Officer, will be joined by David Frear, our Executive Vice President and Chief Financial Officer; Jim Meyer, President of Operations and Sales; and Scott Greenstein, President and Chief Content Officer. At the conclusion of our prepared remarks, management will be glad to take your questions.

First, I would like to remind everyone that certain statements made during the call might be forward-looking statements as the 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 view SiriusXM's SEC filings. We advise 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 advise our listeners that today's results will include discussions about both actual results and adjusted results. All discussions of adjusted operating results exclude the effects of stock-based compensation and certain purchase price accounting adjustments.

With that, I will now hand the call over to Mel Karmazin.

Mel Karmazin

Thanks, Hooper, and thank you all for joining us this morning. On our last earnings call, I reported that we were very optimistic about the results that the company will report in 2011. We said that were it not for the uncertainty of the impact that the tragedy in Japan would have on our OEM partners' supply chain and the sluggishness of the overall economy, we would be raising our subscriber growth guidance. Well, the economy remains sluggish, but we are confident that SiriusXM will have a very strong year. So today, we raised our guidance to add 1.6 million subscribers this year. That will be up 13% from the number of subscribers we added last year. We also raised our free cash flow guidance, and I'll talk more about that in a moment.

I know that there is a great deal of conversation about all the competition we face, but SiriusXM is so well positioned in this market we continue to grow, and as a matter of fact, our growth in subscribers is accelerating year-over-year. This growth is a verification of our unique and very desirable service. We are growing in what is a very competitive market and a weak economy. Our second quarter results reflect the continued strong demand we're seeing for our service, as well as the inherent power of our business model. We grew subscribers by 452,000. Sirius has over 21 million paying subscribers, an all-time record high.

Gross adds were up 8% year-over-year to nearly 2.2 million, outpacing a 7% rise in U.S. light vehicle sales. And gross adds were up 6% sequentially despite a 7% contraction in the auto SAR number from first quarter to second quarter. This is a result of OEMs continuing to increase satellite radio penetration into their vehicles. Over 65% in the second quarter, our penetration rate has never been higher, and I think it highlights how satisfied auto makers are with our service and the broad demand shown by consumers. Just to repeat, over 65% of all new vehicles manufactured for sale in the U.S. had a factory-installed Sirius or XM Radio in the dash. In the second quarter, we had the highest number of gross adds in any quarter since our merger and had the second highest number of quarterly net adds since the merger.

Our growth was also helped this quarter by a contribution from second owners of vehicles. With General Motors' support, in April, we began enrolling Chevy, Buick, GMC and Cadillac dealers nationwide in a new program where, for the first time, we are providing all purchases of used vehicles, not just certified preowned, with a complimentary 3-month trial of SiriusXM. We have received a very positive response from dealers who have enthusiastically embraced this program as a way of increasing the value of their inventory and improving the used car sales process.

As announced in June, over 1,000 General Motors dealers are now able to activate our service in vehicles on their lots, and that service seamlessly transitions to a customer trial after sale. SiriusXM is working with other OEMs to sponsor similar programs for their dealers, and you should expect additional announcements later this year. I'll repeat: the previously owned market will be a very significant catalyst for our growth in the years ahead.

Our self-pay monthly churn rate was 1.9%, very similar to last year's second quarter of 1.8%. Our new car conversion rate was 45.2%, the best in 3 quarters, though we still believe there is room for improvement. Several automakers that recently increased their installations of satellite radio have gained share as a percentage of our installations. We are working with those OEMs on implementing best practices, which should result in conversion improvements over time.

We continue to expect that our full year self-pay churn and conversion numbers will be broadly similar to those we posted in 2010. As you know, our revenue and ARPU have been constrained by the FCC merger order, which restricted us from increasing base prices for 3 years following the merger. I am very pleased that the FCC agreed with us last Thursday when they issued an order saying there was no need for them to be involved in our pricing decisions going forward.

Considering the pricing restrictions we were faced with, I'm very pleased we were able to grow our revenue by 6% to $744 million, which was the highest revenue recorded in any quarter by satellite radio. Once again, we did an excellent job in controlling our costs. Our cash operating expenses only increased 2% in the quarter. We are particularly pleased that while we are providing the strongest content lineup in the history of satellite radio, we are doing it with less cost than last year in absolute dollars and at a lower percentage of our revenue. This is obviously not the case for satellite and cable TV companies.

The synergy of the merger has allowed us to do this, and it will continue as contracts come up for renewal. As part of SiriusXM 2.0, we will be increasing the programming we provide with more channels, and we will do this with less programming expense in 2011 than in 2010. The adjusted EBITDA growth of 20% is very impressive. Our $185 million in the quarter is also a record quarter for us. Revenue is growing faster than expenses, resulting in an improved margin of 25% in the second quarter. We believe our margins, when we are a mature business, will exceed 40%. To give you an idea of our progress in driving these adjusted EBITDA margins, our first half margin was also 25% in 2011 and up from 23% in the first half of 2010, up from 20% in the first half of 2009. And before that, in the first half of 2008, we had negative 11% before the merger of Sirius and XM. Q2 2011 is the 11th quarter since the merger, and every quarter has delivered double-digit adjusted EBITDA growth year-over-year.

Obviously, another way to accelerate margin expansion would be by driving pricing, and thus ARPU, in future periods. As I mentioned last quarter, Sirius has never increased our base price of $12.95 since we started service nearly 10 years ago. This is despite the massive expansion of our premium content over those years. We continue to believe it would be appropriate for us to increase our pricing to be able to continue investing in and delivering the best audio content in the world. Early next year, for the first time since the merger, we will be able to price our service as we see fit. As always, our price will be based upon the value we deliver to our subscribers in the context of a robust and competitive audio entertainment environment.

To remind investors of our priorities, the improved operating performance, as seen in our rising adjusted EBITDA, is really the precursor to our ultimate goal of driving free cash flow, which can be used to reward our shareholders and invest in our future growth. We raised our free cash flow guidance on last year's -- on last quarter's call, and I mentioned earlier, we are raising it again today. Our excellent first half performance gives us confidence that free cash flow will surpass our prior guidance, and we now see it as approaching $400 million this year.

In the second quarter, we delivered a 53% rise in free cash flow year-over-year to $165 million.

Looking at the history of this metric in the second quarter, from negative $169 million in the second quarter of '08 to positive $13 million in the second quarter of 2009 to $108 million in last year's quarter to $165 million this year in the second quarter. That is extraordinary growth, and we are very proud to see our strong operating results translating into real cash.

We are forecasting an increase in our free cash flow for 2011 of 90%. This great second quarter free cash flow enabled us to close the books with well over $500 million in cash, despite spending about $75 million early in the second quarter to close our tender offer for the bulk of the remaining 3 1/4% convertible notes maturing this fall. Our leverage ratio continues to improve with net debt falling to 3.7x adjusted EBITDA as of the end of the second quarter. Once again, a sharp improvement from 5.2x at the same point a year ago.

Our leverage continues to fall, and we are rapidly approaching the about 3x net debt to adjusted EBITDA target we've outlined. Our free cash flow guidance, combined with where we ended the second quarter, translates to a year-end cash balance that should approach $750 million. And next year's free cash flow should be well above our guidance for this year.

With no debt to pay off next year, we continue to think we will be in a position, subject to our board deciding to do this, to return cash to shareholders sometime next year. We continue to look at acquisition opportunities as they arise. Accretive acquisitions that benefit our shareholders would be the first priority for our free cash flow, but with our criteria and threshold for acquisitions, they are hard to come by. So absent a compelling acquisition, shrinking our shares outstanding would be a great use of our free cash flow.

In the second quarter, SiriusXM continued to add to and refresh our channels and shows. We launched a daily TMZ Live celebrity gossip show; a weekly comedy show, Live from the Upright Citizens Brigade Theatre; and we announced a new weekly show from pop music star Lance Bass. We also launched timely limited-run channels such as The Book of Mormon Radio with the creators of South Park and George Carlin Radio on the 40th anniversary of the recording of his groundbreaking album, FM & AM, and also premiered The Phone Show, which is loaded with funny, uncensored, user-generated content, all of it deepening our array of comedy programming. We also gave our listeners access to world events such as Royal Radio, a special channel devoted to the royal wedding of Prince William and Kate Middleton. We continue to broadcast the biggest sport events with the live broadcasts of the NCAA Final 4, horse racing's Triple Crown, The Masters and U.S. Open Golf Championship and the NBA and NHL playoffs.

In the second quarter, SiriusXM also demonstrated how it provides its subscribers with experiences that go far beyond just listening and offers events that they cannot get anywhere else.

On April 27, in celebration of bringing listeners 10 years of the best in country music, SiriusXM held a private, free subscriber event with Tim McGraw, a one-night only performance by the country superstar at New York's historic Beacon Theater. The event and accompanying launch of our Tim McGraw Radio channel garnered expensive press pickup, as well as lots of subscriber goodwill. We continue to work hard on our SiriusXM 2.0 product, which will be ready to launch in the retail channel by the end of the year as we previously disclosed. I'm going to turn the call over to Jim Meyer, to tell you a bit more -- a little bit more about 2.0.

James Meyer

Thanks, Mel. SXM 2.0 is a major upgrade and evolution of our satellite- and internet-delivered networks that span our hardware, software and audio and data content. We are rolling it out in phases, bringing more content and capabilities to our satellite platform, while also employing connectivity technologies such as WiFi, Bluetooth and the Internet to create exciting complements to our core radio services.

This upgrade will first be available to subscribers late this year when we make 2 new-generation radios available at retail. These radios will be able to carry more channels than ever before, thanks to expanded bandwidth, and provide functions that help you enjoy satellite radio like never before.

A primary goal of what we have called Sirius 2.0 has always been to secure the commitment of our OEM partners to the next generation of satellite radio technology. We have been sharing that vision with our car partners, and I'm happy to report they are very excited about the new technology and how it will add to the driving experience. In fact, we expect to be able to announce, by year end, launch plans for at least one of our OEM partners to begin factory implementation of 2.0 features as early as next year. I'll note here that SXM 2.0 is designed to carry us through many years and will allow us the freedom to make upgrades and additions by software without our OEM partners having to change hardware in their head units. It will also allow us 25% more bandwidth for expanded audio and data services, as well as replay and time-shift listening capabilities. We've also been working hard to upgrade our IP-delivered services. Late this year, we will add new convenience features such as pause and rewind. In addition, we will add a new feature called Start Now, which will allow our IP subscribers to easily time-shift most of our channels by up to 5 hours.

We will continue to evolve our IP offerings by adding true on-demand capabilities for music and talk content early next year. In addition, we intend to provide subscribers the ability to build true personalization of our winning, exclusive and accurately-curated [ph] content into their SiriusXM experience. We should be able to announce those personalization features in the first half of next year. Now back to Mel.

Mel Karmazin

Thanks, Jim. And just to follow up on the technology and what's happening with 2.0, I'd like to turn it over to Scott to talk a little bit about our incremental programming offering.

Scott Greenstein

Thanks, Mel. As part of SiriusXM 2.0, we are launching a compelling new suite of channels that takes advantage of our new bandwidth and bolsters our online and mobile services. As part of this new suite, SiriusXM will deliver a robust lineup of Hispanic channels that will become the top destinations for the best, most unique and exclusive audio in entertainment, sports and music for Latinos in both Spanish and English. SiriusXM will target the bilingual, bicultural, mid- to upper-income segment of the U.S. Hispanic population with this varied combination of Spanish and English language content, of course, taking into consideration their traditions, roots and values. With this new Hispanic content offering, SiriusXM will offer more variety than present in any other market in the United States, as well as unique formats that do not currently exist in terrestrial Spanish language radio. To use one example of how in-depth our offering will be, SiriusXM's new Hispanic channel, coupled with our overall Hispanic programming, will deliver over 50% more the amount of Hispanic formats that are available in Los Angeles, which is the largest Hispanic market in the U.S. and has the most terrestrial Spanish language stations. While some other markets in the U.S. do not even have one terrestrial Spanish language radio station, SiriusXM will clearly be a factor in those markets as well.

As you can see, SiriusXM intends to compete -- and compete vigorously in the Hispanic content market. We will be doing that by having SiriusXM's Hispanic content represent a combination of 100% commercial-free music programming developed by top Hispanic programming talent, coupled with leading brands in news, sports and entertainment, including exclusive Hispanic content.

In addition to the impact that this new contact -- this new content will have to the Hispanic markets across the country, SiriusXM's Hispanic offering represents significant marketing opportunities with our OEM and retail partners who have already expressed enthusiasm for the product. To complement the Hispanic channels, SiriusXM will also, as part with SiriusXM 2.0, be launching a dynamic and exclusive new suite of music and comedy channels, including in-house and branded content channels. And with that, I'll turn it back over to Mel.

Mel Karmazin

Thanks, Scott. So the competitive environment continues to evolve. From Internet radio companies to subscription music streaming companies, there is no shortage of worthy competitors. And don't forget, terrestrial radio, though wounded, they are still the 800-pound gorilla, which is still on track to deliver approximately $15 billion of revenue this year and still has most of the radio listeners.

But we do not believe there is anyone out there who delivers the value we do for consumers, and no one out there can match our differentiated offering that really combines the best in music and non-music programming available. Remember, about 50% of our channels are non-music. Today, we are integrated into every automotive OEM in the U.S. with a very desirable in-dash position, so it is easily available at the touch of a button everywhere. This is why 24 million subscribers and trialers in the U.S. and Canada love our product, and that number is increasing. Also, business models matter, and we have the best one in audio entertainment worldwide.

The power of our predictable subscription model cannot be matched by ad-supported competitors or those pushing freemium models. We will continue investing in innovative content, and we will continue innovating on ways to deliver that content via satellite and IP to give an unbeatable user experience. I continue to get questions about a reverse stock split because some investors think that there is a negative perception issue for companies with a low absolute stock price. We do not share that view. We speak with institutions all the time. We have not found one firm that wants to buy our stock but can't because of the price being under $5. We do not see any reason to do a reverse stock split. We have been adding institutional investors and look forward to that number increasing in the future. We were also very pleased that approximately 2 weeks ago, we were added to the NASDAQ-100 Index. We are now included among the most valuable companies listed on NASDAQ.

Before I turn the call over to David, I'd like to give you just a sneak peek into our thinking about 2012. Again, we will continue to grow subscribers as the OEMs are all forecasting higher auto sales in 2012. We anticipate our revenue growth will accelerate. Our revenue will grow faster than our expenses, so there will be further margin expansion. Our CapEx will be lower. Satellite CapEx will be down dramatically. Free cash flow will again grow very, very significantly in 2012. We will be providing specific guidance on 2012 no later than our next earnings call, but we are very excited about our first look into 2012.

So to sum it up, SiriusXM is a company that is executing well. Today, we've raised both our subscriber and free cash flow guidance and strongly affirm our other previously announced guidance for this year. Our second quarter numbers put us at a record-high subscriber base, record revenue and record-adjusted EBITDA. We remain very excited and enthusiastic about our short-term and long-term prospects. Thanks for participating today. I'll now turn the call over to David to discuss additional details about our second quarter before we open it up to questions.

David Frear

Thanks, Mel. The pace of U.S. auto sales fell sharply in the second quarter from the first quarter in the wake of the tragedy in Japan, though the 12.1 million car sales pace still exceeded the year ago quarter by 6%. Growth in sales of SiriusXM-equipped vehicles grew at an even faster 17% as market share shifted to higher-penetrated automakers and production penetration increased at Toyota. Overall, production penetration exceeded 65% in the quarter. Self-pay subscribers increased to nearly 17.2 million in Q2, an increase of 1.1 million from a year ago. Our self-pay churn rate was essentially flat year-over-year, and consumer conversion rates were in line with our long-term performance.

For 9 of the last 12 quarters, the consumer conversion rate has been in the range of 45% to 47%. Total paid and unpaid trials in the conversion funnel grew by over 1 million from the prior year to a record level of 5.2 million at June 30. These strong subscriber results drove record revenues in the second quarter to $744 million, up 6% from the prior year. ARPU declined in the quarter to $11.53 from $11.81 in the prior year. The $0.50 reduction in the U.S. Music Royalty Fee, which went into effect in December, an increase in OEM-paid trials and increased subscriber-retention programs all contributed to the change in ARPU.

Contribution margin, which is revenue net of revenue share, royalties, customer service and building costs and cost of equipment, was nearly 71% for the quarter, roughly flat with the prior year. Fixed expenses, which are programming, sales and marketing, G&A and R&D actually declined in dollar terms from the prior year and improved by 2 points as a percent of revenue, driven by continuing efficiencies in programming and in sales and marketing costs.

SAC per gross add improved by 8% to $54 in the quarter, resulting in a slight decline in total dollars of subscriber acquisition cost, despite an 8% increase in gross additions for the quarter. Adjusted EBITDA at 24.8% of revenue expanded nearly 20% to $185 million for the quarter.

Free cash flow also improved by 53% from the prior year, coming in at $165 million for the quarter. Free cash flow was aided in the quarter with the closing of the Canadian merger in late June. We received $54 million in cash out of the merger. We'll own 47 million shares, representing 38% of the company going forward, and we'll generate ongoing revenue from service agreements with the Canadian company. SiriusXM Canada has nearly 2 million subscribers, generates over $200 million in revenue and has positive EBITDA. We also recorded a gain of $84 million in connection with the Canadian merger during the quarter.

Our free cash flow for the 6 months has improved from negative $19 million in 2010 to positive $149 million in 2011. $100 million of this improvement came from reductions in satellite capital expenditures. Our free cash flow is generally stronger in the second half of the year than the first half. And as Mel mentioned, we are increasing guidance for free cash flow to approaching $400 million from approaching $350 million.

Our liquidity is in great shape. We finished the quarter with $528 million in cash. Debt maturities through June 2013 are less than $30 million, most of which comes due in October of this year. Given our free cash flow guidance, we would expect to finish the year with about $750 million in cash, and our net debt to EBITDA leverage would then be about 3.1x at the end of the year, quite close to our target of 3.0.

Capital expenditure requirements will decline significantly in 2012 with the launch of Sirius 6 towards the end of this year. There are very few demands on our strong and rapidly growing free cash flow in the future. As Mel mentioned, we've increased our guidance for net additions to 1.6 million. This 14% increase in the face of a very challenging economic environment is testimony to our customers' passion for our service and the strength and stability of our subscriber-based business model. With that, operator, let's open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Bryan Kraft with Evercore Partners.

Bryan Kraft - Evercore Partners Inc.

Obviously, you have good insight into auto production plans from your partners, but what degree of confidence do you have in the demand side for auto sales? We know the economy isn't great, but what are you seeing in terms of prospects for improvement in the back half of the year? And then also, I wanted to see if you could just comment on, I think in the press release, you mentioned increased retention discounting affecting ARPU. Can you just discuss kind of the level or the proportion of customers that you're having to give retention discounts to currently versus, say, a quarter ago or a year ago?

Mel Karmazin

So we're certainly not experts on the U.S. economy auto demand, but I can tell you that we're pretty confident in what we see as improvement in the SAR as we go forward the rest of this year. Obviously, we're expecting the situation in Japan to have rectified itself by late August, early September. We have seen a lot of plans that our automotive partners have for some exciting things that they intend to do in the September, December timeframe. And we're confident in our guidance and the SAR assumptions that go with that.

David Frear

And on the subscriber retention discounts, it was a business practice -- this is on the merger efficiencies, when you think about best practices -- that the XM side of the business had used more of this than the Sirius side of the business. And in the course of watching in sort of the 18 months or so initially following the merger, we came to the conclusion that what was being trialed in essence with subscriber retention programs on the XM platform was pretty smart business, that it seemed to be a very successful way of either converting customers from OEMs or convincing customers who were thinking of leaving to stick around. We find that, after some initial breakage at the end of that discounted plan term, that the subscribers, for the most part, overwhelmingly stay with us, and then they churn at the normal self-pay rate. So directly to your question, it's about 14% of the self-pay base. And it's -- the rate of increase has been -- has slowed considerably in the course of this year, that when we expanded it to the Sirius platform sort of around the late part of '09, we had some rapid expansion in it, but it's good, smart business for us. You take a little bit of money off the price. You convince a subscriber to stay. It's obviously good to get the money. And then when they come out of that promotional plan period, again, they look like a regular customer that churns at 1.9%.

Mel Karmazin

Yes, and there's really no additional SAC there, right? I mean, so with their radios in the car, it would be silly for us not to be using every step that we think is good business for us to get the people who have a radio in the car to light it up. And these plans have been helpful in doing it, and it's been a really good move on the part of the company.

Operator

Our next question will come from Barton Crockett with Lazard Capital Markets.

Barton Crockett - Lazard Capital Markets LLC

You gave us a kind of a teaser look at 2012, and I wanted to ask a little bit more about that at this level. Obviously, we don't really know what car sales are going to be next year. But if we were to assume a scenario where, let's say, car sales are flat and churn was flat, you talked about the lift from used car sales. Would that be enough to give you guys more net sub adds in 2012 than 2011? Is there [indiscernible] lift there?

Mel Karmazin

I think you can make any assumption that you would like to make on SAR, but there are about 18 companies that we follow that track and report SAR for 2012. And there are none that are not forecasting a big increase in that. The idea of the number of DX is a function of the number of subscribers we have, right? So the more subscribers you have, and assuming you keep the same churn rate, you're going to have the DX, and we're adding significantly more to the number of subscribers we're getting from the second owner. So I really don't want to give you any additional numbers at this time. We'll give it to you as we normally would. I mean, it's not like we have historically given it earlier. We'll give it to you on the next call, and we'll have a better sense as to what we think what the right number is for 2012 net adds. We just don't want to sit there and sandbag it and come up with a low number because we're going to take an assumption that SAR doesn't go up next year. So we'd like to take a look at our next earnings call or before then, whenever we have some insight into 2012, and give you the numbers then.

Barton Crockett - Lazard Capital Markets LLC

Okay. If I could switch to another metric. ARPU, if you exclude the variances and the copyright fee, it still slipped a little bit on the win back, and that makes me question what would be the churn impacts of a potential price hike next year if you're using win back here to kind of retain subscribers. Do you have any thoughts about your ability to kind of raise rates given the portion -- the positive returns you're getting from some of the win-back promotions?

David Frear

I think, Barton, you probably ought to think more about the growth we've had in OEM trials and the effect that, that has on ARPU than the win backs. All right? So the OEM-paid trials, which have risen pretty significantly, are generally at discounts to the retail price. And so the recovery in automotive sales year-over-year itself is going to bring ARPU down. And then there is some effect that comes from the discounted plans as well with respect to price increases. Generally, when you raise prices that you tend to dampen demand, but I think you've heard us say that pretty clearly that overall, for this business, that we think that price increases make a lot of sense, given the programming we're delivering and given how long we've left the price unchanged. It just makes a lot of sense to increase it in the future.

Mel Karmazin

And I think you have something else that you can look at. You can take a look at what happened when we imposed the MRF fee. So for the subscriber, obviously, that was an increase in price. And it was in the teens that the MRF added because of the copyright royalty decision. So there, we had a double-digit price increase affecting the consumer, and our churn remained relatively flat.

Operator

We'll take our next question from Benjamin Swinburne with Morgan Stanley.

Benjamin Swinburne - Morgan Stanley

One for Mel and then one for Jim, if I could. Mel, one of the things that's been a huge success for you in the last few years has been renegotiating contracts as a result of the merger. And when you look at the competitive landscape, a lot of new entrants are targeting OEM relationships. I'm just wondering, you have an economic relationship with the OEMs. You generate revenue for them. I realize it's not enormous revenue in the grand scheme of their business, but still revenue. And you pay the SAC, and a lot of these new entrants are not. So I'm just wondering, if you look at over the next few years, do you think there's an opportunity to improve SIRI XM's relative economic share of the OEM business or perhaps create more exclusivity around these relationships? Just wanted to hear your thoughts on that front.

Mel Karmazin

Well, I think our current deal with our OEMs is a very fair one. I think based on your seeing how we've been able to grow our free cash flow and our EBITDA with these existing agreements has been impressive, and that growth rate is continuing and the forecast that everybody is showing. Having said that, when contracts are up, we have discussions with our partner on what the market rate is for satellite radio. Obviously, when we speak with our partners in the car industry and we talk about the revenue share and various dollars that we give to them, we're pointing out the fact that terrestrial radio and a lot of these other IP radios are not giving them any revenue and it's to their advantage that we continue to maintain our dominance or our strong position in the dashboard because they're benefiting -- not only are their customers benefiting, but they're benefiting. So whether or not it be a programming partner, whether or not it be a retail partner, whether or not it be an OEM partner, all of the contracts that we have, have a term. And when that term comes up, the satellite radio company is talking to the other company on the other side of it and seeing what a fair deal is. And we do think that, overall, there is an opportunity as the years go on for us to improve our position in our contracts.

Benjamin Swinburne - Morgan Stanley

Great. And Jim, just on the 2.0 product. I think you mentioned you could have an OEM launch next year. And I wanted to ask, because I think historically, on the traditional radio front or traditional satellite radio front, if such a thing exists, it was a 2- or 3-year build cycle. So how are you getting this to market so quickly in terms of building? Or maybe we're thinking about it differently. Maybe it's more software than hardware. But just trying to think through the launch on the new 2.0 product over time as that builds out.

James Meyer

So 2 points. One, 2.0 is a -- in our vision is a field -- I mean, is a software-upgradable product as it flows over the model years. Number two, one particular OEM got very excited very early about our vision and on technology and has worked very closely with us to cut some steps out, wanting to get these features to market. So I'm quite confident we'll have at least one ready in the middle of next year with the '13 model year.

Mel Karmazin

And in fairness, the car company that is going to launch, we began our discussions with them well over a year ago. And in essence, we have a deal with them already. So it's not like they're going to be doing this in the next few months. They've been working on it for some time.

Operator

We'll take our next question from Mike Pace with JP Morgan.

Michael Pace - JP Morgan Chase & Co

Just a couple of quick ones here, and sorry if I missed some of this. The improvement in SAC, I'm just wondering what's driving that. Is there more room to go? And then given 2.0 is more of a software upgrade, I'm assuming that doesn't impact that. The used car market, and if I missed this, I apologize, did you discuss what the impact to your net adds has been with this distribution to date? And then probably more for Dave, but I think I asked this before, as you guys look to return capital to shareholders, I know you have a lot of cash and you have little debt that comes due in '12, but do you feel the need before you really get going with that program to extend, I guess, '13, '14, even '15 maturities?

David Frear

Okay. So let me take the last one first. I don't see a need to extend 2013, '14 or '15 maturities in connection with the return of capital to shareholders. The expansion of the free cash flow that we expect, we think we'll very comfortably handle those maturities as they come up. If -- as you know, with the call provisions or the lack thereof in the bonds and where they're trading in the marketplace, it's just not economically efficient to take a lot of those issues out now. That math could change in 2 years' time, and so you might find us redoing things. But there's nothing about the debt covenants or the existence of the debt that in the next 2 years would constrain a plan to return capital. In terms of SAC improvement, really driven by changes in mix among the OEMs as well as just kind of the general improvements in OEM subsidies. We have had long-term technology change-outs underway in the various OEMs. Those continue and will continue to continue as we go into the future. So I think you should just expect to see SAC per gross add declining for the next few years. In terms of 2.0, that our -- any impact it has on subscriber acquisition cost would be part of that directional trend that we've provided in the past, that we do expect SAC per gross adds to be coming down over time. And in terms of the used car market, it is growing. It's a great future opportunity for us. As a proportion of our business right now, it's staying about stable, but that's -- it's not because it's not growing. It's because the new car business is still growing pretty rapidly as it recovers from how far the new car sales fell a couple of years ago. But I think you should think of the new car business as robust and growing quickly.

Operator

And our final question today will come from Leah Pilla with Knight Capital.

Leah Pilla - UBS

I just have a quick question. You've talked about having a net leverage target about 3x, and you're obviously going to be there certainly close to the end of the year if not early next year. But I was wondering, as you consider returning capital to shareholders and presumably a large portion of that cash will be used for that purpose, if you could provide some idea of how you look at gross leverage going forward.

David Frear

Well, I think -- I'm not sure that there's a significant difference between the 2 that -- this is a business that has very little in the way of working capital demands. We tend to generate working capital as we grow. And as you know, our -- we won't be paying taxes, and we'll have very low capital expenditures for years to come. So other than for strategic reasons, that there's probably not a reason for us to hold huge amounts of cash on the balance sheet. The -- at $528 million just as, directionally, I think that's probably a very comfortable cash cushion for this kind of company. But I think you should think about our sort of leverage ratios of 3x as being just about that. I think the difference between net and gross isn't likely to create much of a credit difference.

Mel Karmazin

And we've had some preliminary conversations with our board of this about 3. Three isn't a magic number, but it’s -- somewhere when we get into that area, we would be comparable with it. We've also said that, obviously, if, in fact, there were some acquisitions out there that met our criteria, we would be interested in that. What would our criteria be? It would have to be within our core competency. It would have to be in a growth business, and it would have to be accretive to us on a free cash flow basis. So with that sort of threshold, there are not many opportunities that sort of come before us. But barring that acquisition, we really don't see much reason why we should be holding the cash and that I think our board would probably conclude in 2012 that a stock buyback and shrinking our shares outstanding would be in the best interest of shareholders. But again, it's up to them.

Operator

And that concludes our question-and-answer session for today. I'll turn the conference back over to our speakers for any additional or closing remarks.

David Frear

Okay. Thanks, everybody.

Operator

Thank you. Ladies and gentlemen, this does conclude today's presentation. You may now disconnect.

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