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XM Satellite Radio Holdings Inc. (XMSR)

Q2 2007 Earnings Call

July 26, 2007 10:00 am ET

Executives

Joseph M. Titlebaum - General Counsel, Secretary

Hugh Panero - Chief Executive Officer

Nate Davis - President and Chief Operating Officer

Joseph J. Euteneuer - Executive Vice President and Chief Financial Officer

Gary Parsons - Chairman of the Board

Analysts

Benjamin Swinburne - Morgan Stanley

Robert Peck - Bear Stearns

Johnathan Jacoby - Banc of America

James Rockcliffe - Lehman Brothers

David Bank - RBC Capital Markets

Eileen Furukawa - Citigroup

Mark Wienkes - Goldman Sachs

Lucas Binder - UBS

April Horace - Janco Partners

Presentation

Operator

Good morning. My name is Ashley and I will be your conference operator today. At this time, I would like to welcome everyone to the XM Satellite second quarter earnings results conference call. (Operator Instructions) Mr. Joe Titlebaum, XM's General Counsel, you may begin your conference.

Joseph M. Titlebaum

Hello, everyone. This is Joe Titlebaum, General Counsel of XM Satellite Radio. Before we begin our prepared remarks, I would like to remind everyone that certain information on this call may contain forward-looking statements. Due to a number of factors, our actual results may differ materially from those projected in such forward-looking statements. Those factors include future demand for the company’s service, the company’s dependence on technology and third-party vendors, the potential need to increase marketing expenses to meet competition or address changing marketplace conditions, and the potential need for additional financing, as well as other risks described in XM Satellite Radio Holdings Inc. Form 10-K filed with the Securities and Exchange Commission on March 1, 2007 under rule14-812 and 8-K filings more recently made with the SEC. Copies of these filings are available online and upon request from XM Radio’s investor relations department.

Now I will turn the call over to Hugh Panero, CEO of XM Satellite Radio. Hugh.

Hugh Panero

Thank you, Joe. Good morning and thank you all for joining us to discuss XM's operational and financial results for the second quarter 2007. On the call with me today are Gary Parsons, XM's Chairman; Nate Davis, President and Chief Operating Officer; and Joe Euteneuer, our Chief Financial Officer.

Before getting into the discussion of results, let me update you on our pending merger with Sirius Satellite Radio. As you know, we passed major milestones in the regulatory review process this month with the completion of the Federal Communications Commission’s 45-day public comment and reply period. Of more than 5,000 to the FCC, support for the merger was approximately four to one, including supportive comments from car makers, consumer electronics retailers, and numerous other business partners and citizens’ groups, representing a broad variety of constituencies and reaffirming our view that the merger is in the public interests and should be approved.

XM and Sirius created a new milestone in the competitive audio entertainment industry when we announced on Monday that post-merger, we would offer American consumers for the first time the opportunity to choose their radio programming on an al la carte basis, as well as five other new programming options. The new programming options are detailed in the FCC filing we made on Tuesday.

In addition to a la carte and best of both offerings, there will be two family friendly options that will enable subscribers to block adult-themed programming and for the first time, receive a monthly price credit. There will also be new $9.99 mostly music and news, sports and talk packages. We think this is going to be great for consumers and great for the business.

From day one, we said the merger would enable us to deliver more choices and lower prices for consumers. These program offerings further demonstrate why this merger is overwhelmingly good for consumers and in the public interest.

The FCC document that we filed makes the overall case to the FCC why the merger is in the public interest and refutes some of the misinformation put out by the NAB, our biggest competitor in the marketplace and biggest opponent of the merger with regulators, for obvious reasons.

We look forward to continuing to work with the FCC and the Department of Justice. We are now several important steps closer to the completion of our deal and we remain confident we will be able to close the merger by year-end.

We along with Sirius also jointly filed a draft S4 and merger proxy with the SEC to begin the review process leading to an eventual shareholder vote.

Equally important, we remain very focused on our business. Strategically, we have positioned XM to capture future growth as the satellite radio sector continues to trend towards an OEM-centric model, and we are seeing results.

This quarter we posted 618,000 OEM gross adds. This is the highest volume we have ever recorded in a single quarter and it is the best evidence that our anticipated ramp in OEM is here. In addition, total OEM self-paying subscribers reached 3 million. Overall, conversion improved and churn remains stable.

In short, XM's management is executing to improve operations and take advantage of existing and future opportunities to grow and strengthen XM's competitive position in the rapidly evolving audio entertainment market.

On Tuesday, it was announced that I will be leaving XM in early August after almost a decade as CEO of the company. When I first came to XM, it was merely a PowerPoint presentation with many skeptical that anyone would actually pay for radio. Today, with over 8.2 million XM subscribers and over 14 million for the industry as a whole, satellite radio is here to stay.

I want to thank everyone who has supported XM during my tenure. I firmly believe that the merger between XM and Sirius is the right decision for XM, its shareholders, consumers, and the industry, and that it will ultimately be approved by the regulators once they examine the competitive landscape and the public interest benefits of the merger.

As with any merger between two companies, there can be only one CEO of the combined entity and Mel Karmazin is clearly an accomplished businessman and extremely capable of leading the new company post-merger, working closely with longtime XM Chairman and friend, Gary Parsons, who will become the Chairman of the combined company.

Again, I want to thank all of our shareholders over the years, our Board of Directors, XM employees and of course our 8 million plus loyal subscribers for their support and help building this industry.

I would now like to introduce Nate Davis, a talented executive who I recruited to be XM's President and COO more than a year ago, who is named interim CEO of XM, to talk about our second quarter results in more detail. Nate.

Nate Davis

Thank you, Hugh. Let me start by thanking Hugh for his dedication and hard work in building XM into one of the fastest growing new entertainment services in existence today, bar none. I first met Hugh when I joined the Board of Directors of a very small start-up company working in an office building basement. That was in 1999. Today, XM is the dynamic company that it is because of Hugh’s vision, his passion, and his expertise.

On a personal note, I’ve enjoyed working with Hugh immensely and I know that I speak on behalf of everyone here at XM and across our industry when I say thank you, Hugh.

As Hugh indicated, we are confident in our merger with Sirius, and that it will close in late 2007 or early 2008. In the meantime, however, it is critical we maintain our focus on growing our subscriber base and improving our financials. When I joined the XM management team, we said we would tackle the challenges in operations and in the marketplace, and we have. Today I am going to review the progress we’ve made and its positive impact on our operating results.

As an overall summary, our business mix is increasingly OEM-centric, and while the retail sector continues to provide subscriber growth, it is an increasingly smaller portion of our gross and net additions. In total, we continue to add nearly 1 million gross additions per quarter in a cost-effective manner.

XM continues to deliver industry-leading programming and this quarter we further expanded our sports coverage for displaced fans nationwide. We delivered new radios with greater capabilities and we made even more strides in improving the efficiency and the effectiveness of all back-office operations, such as Listener Care.

Let me go into the details and start with our OEM channel performance. We continue to invest in the OEM channel in order to drive both current and future revenue growth. Already, XM leads in satellite radio equipped vehicles with XM radios in more than 140 models from 10 auto manufacturers who collectively account for approximately 60% of light vehicle sales in the United States. In this quarter, we recorded the highest OEM gross additions, 618,000, in our history and we added 295,000 net OEM subscribers.

Let’s put our OEM business in perspective. In 2002, XM had 180,000 factory installs. We are now on target for 3 million factory installs in 2007, and nearly 1 million of those will roll out in the fourth quarter alone. This obviously positions us very positively as we look toward 2008 OEM growth.

By the end of the second quarter, there were more than 8 million vehicles manufactured with factory installed XM equipment and of that 8 million, more than 7 million have actually been sold to consumers. As Hugh said, the OEM ramp is here now and will only get stronger in the coming quarters.

There are some other additional OEM highlights. General Motors passed a milestone, having sold its 5 millionth XM-equipped vehicle this quarter and reached a production total volume of 5.5 million XM-equipped vehicles. Toyota is adding luxury SUVs, the Lexus LX570, to its growing list of models with XM as standard equipment. Hyundai installations are on pace and for the first time, Sonata sales ranked in the top five of XM factory-enabled vehicle sales.

Beginning with the 2008 model year, XM is the exclusive satellite radio provider to Nissan and Infiniti, and all Infiniti models will carry an XM radio as standard equipment. Nissan and Infiniti reported the first significant production volume of XM-equipped vehicles with the Altima, Titan, the Armada, the Pathfinder, the QX and FX models.

In addition, Honda and Acura production is on schedule, approaching total installs of nearly 2 million and to date they have sold more than 1.75 million XM-equipped vehicles.

We are pleased at the ramp in OEM that we talked about for the past few quarters is coming online and we expect to see accelerated installs and gross adds from every OEM partners who have the balance 2007 into 2008 and beyond.

Moving on to conversion rate, our conversion rate improved from 51.5% last quarter to 52.7% this quarter, evidence of continued efficiency in our OEM channels and importantly of continued consumer acceptance of satellite radio for audio entertainment.

Given the ramp in OEM volume, our potential subscription base opportunity is large and it is growing fast. We now have five years experience in working with OEMs and we have learned a great deal about what it takes to turn a car buyer into a self-paying XM subscriber.

As I mentioned on our last call, we have been successfully working with our OEM partners to contact our new car customers at an early stage. That has allowed us to reach our trial subscribers very early, with a day 80 telephone call and a letter, and in some cases a day 20 welcome call. These kinds of programs are contributing to the solid conversion rate.

So we are pleased we have been able to expand our working relationships with our OEM partners and that is going to continue. This quarter, for example, we partnered with Infiniti on an innovative promotion that will integrate XM into Infiniti advertising.

The Infiniti promotion will include three years of service of XM radio and Nav Traffic on its 2008 QX56. This promotion launched with an integrated marketing program for television, print, billboard and online advertising. We are working with all of our OEM partners to further integrate XM into co-branded marketing programs and you will see more announcements in the coming months.

In previous quarters we’ve mentioned our focus on re-marketing or selling XM service to those customers that did not convert to self-paying after the initial trial period and in addition, selling to second owners of XM-equipped vehicles. This opportunity includes more than 3.6 million vehicles with XM-equipped radios that are not currently subscribing to XM. These vehicles are relatively new and many are sold by dealers as certified pre-owned vehicles.

This quarter, we launched a re-marketing program for both Cadillac and Hummer certified pre-owned vehicles complementing the programs we have in place for the Honda and Acura. XM will be available in more than 150,000 GM, Honda, and Acura certified pre-owned vehicles expected to be sold in 2007 and more than 223,000 certified pre-owned vehicles in 2008.

The re-marketing opportunity will be significant, particularly given that the overall industry sales volume in pre-owned vehicles is increasing. Year-to-date, more than 70,000 XM-equipped pre-owned vehicles are enjoying free trial promotions right now and we anticipate that number will double by year-end.

Like Nissan, Hyundai and other OEMs, I remind you that customers in certified pre-owned programs are not counted as subscribers until they become self-paying subscribers.

The economics of these re-marketing programs are very favorable. Much of the SAC cost on these existing radios was paid in previous quarters to bring on the original subscriber, so the SAC recorded on a pre-owned vehicle will be significantly reduced.

Early results are encouraging and we believe that the re-marketing channel has the potential to boost our sub growth.

Now let me turn to the retailer after market channel. This quarter we had 323,000 gross adds and 43,000 net adds. We believe that continued competition from other audio devices has caused sales of satellite radios to be down year over year. However, we believe our segmented marketing strategy, our new radios, and our direct channel focus will lead to subscriber growth in the future. NDP data adjusted to include Wal-mart indicates that we continue to experience retail gross additions of our share of new satellite radio sales in the mid 40% range.

Short-term results and softness aside, the retail channel has and will remain an important distribution channel. Retail will always drive revenue from customers with multiple subscriptions. Retail will also help OEM conversions because the retail customer who is familiar with XM is more likely to become a paying subscriber when they purchase an XM-equipped vehicle. And the reverse is equally true. Customers who acquire XM with the purchase of a car, new or used, are more likely to buy a second XM radio directly or at retail.

Now let me give you an update on our segmented marketing strategy. XM's segmented marketing strategy is targeting key consumer groups that are predisposed to purchase satellite radio, whether it is a displaced sports fan, a music enthusiast, or a news or talk show fan. XM's sports programming is the best, most comprehensive on radio, satellite or terrestrial, and we continue to add value. This quarter alone we launched the third season of Major League Baseball with great success. MLB play-by-play kicked off the season with an average of 1.7 million listeners. This is a top 10 channel on the XM platform and we are seeing listeners tune in an average of 10 hours a week.

We expanded our college sports lineup, adding the Big 12, which now gives us all six power conferences, the ACC, the Big East, the Big 10, the Big 12, the PAC 10, and the SEC. And we also signed a deal with Fox Sports that gives us the National Football Championship game and other BCS bowl games. On July 1, XM became the exclusive satellite radio home of the National Hockey League. We are targeting the displaced hockey fan with a joint NHL/XM branding and marketing because we want to raise listener awareness of our exclusive NHL coverage as we head into the 2007/2008 season.

XM continues to be the home of the most comprehensive selection of music available anywhere. Most recently, we provided comprehensive coverage of Live Earth, the 24-hour, seven continents, nine concert series. In total, XM's broadcast was heard by nearly 3.5 million listeners and we drew 2.8 million listeners for Saturday’s concert broadcast on six different channels. High-profile global events like this raise XM's profile and reinforce customer satisfaction.

We also have additional approaches to creating new and value-added programming. One of our newly announced channels is XMX, which stands for XM exclusive. On a single channel, XMX will deliver all of XM's most popular and exclusive music programming, including Bob Dylan’s acclaimed Theme Time radio hour, artist confidentials, and other original programming. The XM channel will provide listeners with easy access to XM's best original content.

In another public service first, thanks to Hugh Panero, XM will offer the nation’s first radio channel dedicated to a Presidential election. To launch in September, POTUS ’08 -- that stands for President of the United States -- will provide 24-hour campaign coverage and will air on any XM radio, whether it belongs to a subscriber or to a non-subscriber. This channel, created in association with C-SPAN and other media, will feature the debates, speeches and interviews, and more. That idea was Hugh’s personal idea and we think a great one.

Next I want to discuss our retail product development efforts. This quarter we introduced two new radios in our express line, which is distributed by AudioVox. The Express R is the industry’s first satellite radio with split-screen display. Consumers are able to view the current listening channel on the left side and five additional XM channels on the right, including the channel name, the artist, or the song title. With an MSRP of $129.99, the Express R also features other advanced features, such as a 30-minute pause and replay and the ability to preset up to 30 favorite channels.

The Express EZ is designed for easy entry-level and affordable access to our programming. With an MSRP of $69.99, the Express EZ has a bright, large three-line display for viewing the channel, the artist, or the song title, and the ability to preset up to 10 channels.

You can expect more radios with the same sleek innovative express styling, branding and packaging for the holiday season and beyond.

In order to integrate these new radios at a time when the overall retail demand is clearly down, we needed to show or eliminate production on some older radios and other related component parts. This generated inventory related charges that increased our CPJ. Joe Euteneuer will cover these cost increases in his discussion.

But delivering a diverse and attractive product set strengthens the XM appeal in this increasingly sophisticated, competitive audio entertainment market. Customers will always have choices and we believe these new devices will help convince them to choose XM.

Also this quarter, we continued the solid performance out of Listener Care. As a result, our XM customer service experience is a positive experience which helps reduce churn and keep churn stable and drive additional direct sales. Our churn remained stable at 1.84% in the quarter and in fact, we hit or exceeded all of our customer service level targets in June. And for the seventh consecutive month, our customer satisfaction survey index improved. As I noted last quarter, this index is measured by an independent OEM partner, not an internal measurement.

Customer service is mission critical and we’ve said before it is one of our highest priorities. We made a lot of improvements and the benefits of which we think we will continue to see in coming quarters. We re-engineered and increased our Listener Care training for all of our care reps and we are now positioned to have 100% of all activations onshore. Remember, the initial activation is XM's first contact with our customer so we are going to ensure that the first touch is from an onshore XM trained customer service rep.

These improvements in Listener Care can and should help drive family plan subscription rates. In the second quarter, overall Listener Care sales volume increased and we did it at an equivalent or better subscriber acquisition cost than existing retail arrangements.

One last point -- because XM is choosing the radio and the promotion on a weekly basis, Listener Care has also been an effective tool in managing overall inventory levels.

So in summary, we are pleased with our progress this quarter. We are positioning the company to meet the challenges of this fast-changing industry. The gains we achieved in the quarter, particularly in OEM, the stability in churn and improved conversion rate underscore overall customer satisfaction levels and the value proposition of XM.

Now to review the financial performance, I’ll turn over to Joe Euteneuer. Joe.

Joseph J. Euteneuer

Thanks, Nate. Good morning, everyone. As Hugh and Nate said, we are pleased with the consistency of second quarter performance. In looking at the last several quarters, we have demonstrated stability and consistency in our results as we transition the position of the company to capture future growth by being more OEM-centric. The financial highlights of this quarter compared to the second quarter of 2006 include strong revenue growth driven by subscriber growth, steady churn, and stable ARPU; strong OEM performance in both XM-equipped vehicles produced and gross sub adds, along with an improved conversion rate; continued development of a segmented retail marketing strategy, which is showing promise for future subscriber growth; consistent subscription margin and solid liquidity with $275 million of cash and full availability of $400 million in committed credit facilities.

Now let’s review the results in a little more detail. Total revenues increased $49 million, or 22% to $277 million compared to $228 million in the year-ago quarter. Subscription revenue also increased by 22% to $246 million from the $202 million in the year-ago quarter, and for the sixth consecutive quarter, ARPU remains above $10. ARPU for the second quarter was $10.15, flat with the first quarter and up $0.07 compared to a year ago.

The mix between full price subscriptions and the discounted family plan and multi-year plan subscribers continues to govern the direction of ARPU in the near-term.

Subscription margin was 67.3% compared to 68.1% in the first quarter and 68.2% in the second quarter of 2006. This slight decline in margin compared to last quarter is due to a relative increase in revenue share paid to distribution partners and to bringing customer care onshore. And, as we have said for some time, we anticipate the impact to subscription margin from the initiative to bring customer service onshore will be approximately 200 basis points.

This investment in customer care is paying off in better conversion rates, steady churn, greater direct sales, and overall customer satisfaction with the XM experience.

Fixed costs in this quarter was $127 million compared to $125 million in the first quarter and $102 million in the second quarter 2006. Fixed costs for this quarter include $4 million in merger-related expenses and $8 million in elevated legal and regulatory expenses compared to the second quarter 2006.

XM will continue to see elevated legal, regulatory, and merger related expenses throughout the remainder of the year.

Our pre-marketing adjusted operating loss improved to a positive $66 million, up from a positive $56 million last quarter and $60 million in the year-ago quarter. This would have increased even more positively if not for our $4 million in merger-related expenses as well as the elevated legal and regulatory expenses.

This financial performance is driven by our ability to grow revenue while leveraging our fixed cost base. Again, let me remind we calculate pre-marketing adjusted operating loss by adding back total marketing, excluding retention and support, to adjusted operating loss as defined in the financial attachments to the earnings press release.

The fully loaded cost to add a new subscriber, or CPGA, was $121 in the second quarter. That compares to $103 in the first quarter and $112 in the second quarter 2006. The increase in CPGA is a result of the increase in SAC, which I will discuss in a moment, and not discretionary marketing. In fact, discretionary marketing, which includes media, is essentially flat year over year in both dollar and on a per gross add basis.

In second quarter 2007, SAC was $75, up from the $65 in the first quarter and up from the $67 in the second quarter 2006. Included in SAC this quarter is $10 of inventory-related charges. As you heard from Nate, these charges are a result of our transition to a next generation of radios.

In the second quarter, SAC was also impacted as a direct result of our strong growth in OEM production, which increased 54% from the second quarter 2006 and is up 14% over the last quarter.

As a result of our continued OEM growth from increased production by our newer partners, we recognized approximately $10 in SAC this quarter as compared to the second quarter 2006.

As we have noted in previous quarters, OEM growth will have an impact on SAC through 2007. In addition, this increased mix to OEM, combined with inventory related charges, will push year-end CPGA to the higher end of our guidance range.

Adjusted operating loss was $47 million, which was essentially flat compared to second quarter 2006.

GAAP net loss narrowed to $176 million, a 23% improvement over the $229 million net loss recorded in the second quarter of 2006. Please note that we recorded a $36 million non-cash impairment charge relating to our Canadian satellite radio investment in the quarter.

We ended the second quarter with $275 million in cash and full availability of $400 million in credit facilities, resulting in total available liquidity of $675 million.

In conclusion, our key financial metrics continue to trend in the right direction. These include strong revenue growth, stable ARPU, steady subscription margin and improved conversion rates coupled with solid liquidity, all of which sets the stage for long-term growth and self-sustainability.

Now back to Hugh.

Hugh Panero

Just to summarize, I think our merger is moving along. We’ve hit several key milestones. Our quarterly results were solid and we would now like to open it up for your questions. Operator.

Question-and-Answer Session

Operator

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

Benjamin Swinburne - Morgan Stanley

Thanks for taking the question. Good morning, guys. Joe, I just want to go back -- I only had one cup of coffee so far this morning so I am a little slow but did you say if you adjust out the new OEM partners from your CPGA, there is a $10 impact?

Joseph J. Euteneuer

No, what I said was that the impact of the new growth in factory installed cars was worth $10 in the quarter.

Benjamin Swinburne - Morgan Stanley

Okay. I think we’re probably saying actually the same thing.

Joseph J. Euteneuer

The same thing, right.

Benjamin Swinburne - Morgan Stanley

And then the inventory charge of $10, that is effectively a one-time obsolescence issue, right?

Joseph J. Euteneuer

Right, it is a one-time charge within the quarter.

Benjamin Swinburne - Morgan Stanley

Okay, great. And then maybe just more a broader question for the whole team -- as you look forward, OEM seems to be across the board for yourselves and Sirius working well. You really haven’t had much in the way of new products at retail. Your marketing spend has been pretty flat. How much do you think the gross add declines in retail are a function of a pull-back in investment, both from the product side as well as marketing costs versus you’ve sort of tapped the market of people who are interested in buying after-market radios and putting them into the car at this point.

Nate Davis

I think there is actually a third factor. We did think for a while it was the amount of cut-back in marketing spending but I think moreover, we are seeing the competition from other sources, candidly MP3 players and cell phones and iPods and other things like that I think are having an impact. I don’t know that we’ve tapped the market because we are still seeing a lot of people buying new radios. And as we talked about, we had several hundred thousand gross additions in retail but we are seeing less of that than we used to see I think because of the competition from other sources.

Benjamin Swinburne - Morgan Stanley

One last follow-up and I’ll let someone else, but on the conversion ratio which ticked up this quarter, you mentioned some of the things you guys are doing operationally to make that happen. Has that impacted at all just the math of the conversion ratio by the fact that you’ve got certified pre-owned subs and Toyota Hyundai subs that are not counted in the sub count? I am just curious as to how those numbers might move around because of that counting change.

Nate Davis

No, it is not impacted by those at all because certified pre-owned are not counted as subscribers, number one, and the other manufacturers are not included in the conversion rate calculation.

Benjamin Swinburne - Morgan Stanley

Okay, great. Thanks a lot.

Operator

Your next question comes from Robert Peck from Bear Stearns.

Robert Peck - Bear Stearns

Hugh, first I wanted to say farewell. One of the questions I have been getting a lot from investors was the timing of your announcement, considering upon the deal you’ve extended your contract through March. Could you talk just a little bit about the timing around your announcement? I just have two follow-ups.

Hugh Panero

Sure. As you know, back when we were discussing the merger, Gary and I had obviously very deep and long conversations about what we thought was best for the industry. We clearly -- you know, many CEOs in different situations or management can have different agendas when they do these kinds of things. We are clearly always looking after the shareholders and even though it was pretty obvious that the CEO slot would be taken by Mel, we felt that this is in the best interest of the company and consumers.

Basically a year ago July I had recruited Nate to be the President and Chief Operating Officer and had -- and he has done a pretty excellent job of taking over a lot of the operational aspects of the business and my role was to do more strategy and work with some of our bigger partners, and then the merger happened and over the last -- since the merger, I have helped Gary with the merger, meeting with regulators, meeting with different constituency groups, doing a lot of the work with our various partners and lobbyists in that regard, and I felt that the merger had progressed to a significant level or hit a number of milestones where, understanding that there is going to one CEO at the end of it and it was time for me to move on and this is a great time for me to do it after having been with the company for over a decade.

So that’s my short answer, rather than to say I was going to spend more time with my kids or explore other options.

Robert Peck - Bear Stearns

Okay, well then maybe a question for Gary; Gary, just one quick question on the merger. Could you give us an update as far timing, as far as getting documents back to the DOJ and when you expect a resolution right now? Along with that, could you also add in, how has your confidence factor changed at all since February on the deal?

Gary Parsons

Thanks, Bob. As Hugh says, we’ve hit a lot of milestones on this and quite frankly, the reply comment elements that we put in, if any of you really want to do a deep dive on the entire essence of audio entertainment in America today, I would recommend to you the 1,000 page filing that we made on this. It really is a very comprehensive set of reply comments. I think it very strongly makes our case and quite candidly, many of the expert parties that reviewed this from an econometric basis, from an efficiencies and synergy basis I think completely debunked many of the misinformation campaigns that the NAB had put out there, so we felt very positive about that.

We are in the midst of our document productions for the DOJ in response to the second request. My guess is we will complete those within the next month to two months. Some time in the early fall we would likely certify that we have complete that document production and then generally in a relatively short period after that, you then get some indications from the DOJ how that is going.

In general terms, I think the timeframe is still a fourth quarter type of a timeframe. Relative to confidence levels, I remain confident throughout but I will have to say I was very -- I was particularly pleased in the comment round, not only with the response from the general consuming public, which as you guys know, we didn’t go to great effort to try to generate that. That was just people opining on it and it was like a four to one margin in favor of the merger. But also the fact that a very broad constituency, including groups that felt very underserved by terrestrial radio, whether it is Hispanic, African-American, rural constituencies, Christian or family values groups -- large numbers of supporters came out positively for this and I think that is pretty impactful.

And then finally the -- you know, the announcement of the various pricing plans that we put out Monday, I think, is by any measure a bold or pioneering move and I think that will be recognized in shoring up the continued support for it.

Overall, I think we feel pretty good on where it stands.

Robert Peck - Bear Stearns

Last question and I’ll let somebody else go; Nate, I ask this every quarter, the guidance XM has historically given in 2010 is high-teens subscribers. Are you reiterating that guidance today or are you removing guidance? How should we think about 2010 numbers?

Nate Davis

No, we are not making any guidance statement about 2010 today. The way to think about it though is this; we are seeing an acceleration of our OEM efforts. We are getting more cars on tuner, all the manufacturers are committing more and more to putting XM radios in cars. At the same time, we are looking at an after-market that continues to be soft, a retail market that continues to be soft.

So when you look at all of that, I think it would be very difficult for us to say that we are going to achieve the kind of high numbers you are thinking about in 2010. We are seeing a softer after market. Unless something turns around in that market, we are going to see some softness here.

Robert Peck - Bear Stearns

Thank you.

Operator

Your next question comes from Johnathan Jacoby from Banc of America.

Johnathan Jacoby - Banc of America

Good morning. I just want to also say, Hugh, goodbye. You’ll be missed. I have three questions, the first is Sirius’ Chrysler announcement yesterday, is that somewhat indicative of what we should start expecting out of GM? What cost is there to get from your OEM partners to take it up to 70% penetration levels?

The second question is you guys, as you mentioned, rolled out the tiered a la carte pricing strategy. I am wondering from an internal standpoint what you think the net ARPU result might be from this, and obviously the flipside is, I would assume -- perhaps wrong -- but that it should drive an increase in demand for subscribers. So the question then becomes why not offer it, even if you don’t have the merger go through?

Lastly on the conversion rate, very nice improvement. Could you give us a little bit more color what happened, and should we start extrapolating this upward trend going forward?

Nate Davis

I’ll give a short answer, Gary, to the Chrysler issue and you can do the rest. I think you are referencing an announcement that Sirius made yesterday about Chrysler going to 70% penetration and is that indicative of what we are seeing. You can see from all my steps today, we don’t have any quoted, specific numbers for a target but that is pretty indicative of where we see the big manufacturers that we work with going, very high penetration levels. I actually know a little bit more than that but we are not at liberty to announce because they don’t want to announce, but I can tell you that they are committed to pretty strong penetration levels.

Gary Parsons

And on the conversion rate, I think we -- I don’t want to start extrapolating upward trends on that thing because most of the analysts -- I think we’re just trying to keep analyst from projecting downward trends, but I think what it really shows is it is pretty solid along those lines in that area and by the way, it will fluctuate up and down, quarter to quarter depending upon the numbers that come in and at what times. But the bigger takeaway is that is the same sort of levels and receptivity that you are seeing out of a new subscriber when we were at 1 million per year and 2 million per year and 3 million per year and 40 million per year next year. Those sort of numbers are showing increased penetration while still keeping stability in the conversion rate.

Hugh Panero

I think it is also an indication of just that satellite radio is still very popular. You may have a weak retail market but you could see this very large OEM market still believes in it and it is popular and it is showing up in our conversion rate, in our churn and obviously in the acceptance of the automakers.

Gary Parsons

Your third question, Jonathan, was regarding all of these various tiers and multiple types of options and what would happen if you put those different ARPUs together in a package, and I have to tell you I know you guys will do the same thing that ours have done. You can make assumptions relative to how much is in each one of those and you can show existing subscribers loving this and can’t wait to get the best of both, so they add to an ARPU.

The a la carte everyone noticed do roll out with new radios, so they will not roll out as rapidly on that front as some of the other packages will. And clearly when you do offer lower cost packages, you do expect to get a positive up-tick in available subscribers that are willing to take those new packages.

So we think overall, it is a positive thing but I also think the final question you asked on that front, the synergies associated with the merger is what gives us this opportunity to put forward some of these discount packages and then clearly the synergies on programming with the merger is what allows us to put a best of both combination type package together, so it really is pretty well tied to the ability to get the merger completed.

Johnathan Jacoby - Banc of America

Just to be clear -- no merger, these packages are not going to be offered?

Gary Parsons

That’s clear.

Johnathan Jacoby - Banc of America

Thank you.

Operator

Your next question comes from Vijay Jayant from Lehman Brothers.

James Rockcliffe - Lehman Brothers

Good morning. It’s James Rockcliffe for Vijay. I was hoping you folks could update us on two topics. First of all, the copyright royalty board process, how that is going and when we should expect to see a resolution on that. And secondly, the RIAA litigation over the Inno Helix, where we are on that. Thanks.

Gary Parsons

Thanks for the question, James. The answer is no. I’m joking a little bit but I mean obviously there really isn’t much update that we can give you on those. They are in the middle of arbitration or they are in the middle of the litigation, both of those and from that standpoint, we are somewhat constrained as far as what we can provide out as to the input from those arbitrations process that is going forward.

James Rockcliffe - Lehman Brothers

Do you have a trial date for the RIAA?

Gary Parsons

No trial date, necessarily. We are just entering discovery phase right now but the arbitration I think does have some pretty set type schedules and we would expect to have a resolution of that by the end of the year.

James Rockcliffe - Lehman Brothers

Great. Thank you.

Operator

Your next question comes from David Bank from RBC Capital Markets.

David Bank - RBC Capital Markets

Thank you very much. Good morning and we wish you the best, Hugh, on whatever it is you do next. Two questions; the first one is our back-of-the-envelope math indicates that the after-market churn trends on OEM and retail, or the self-paid trends on OEM versus after-market retail are a little bit different. We see a lot more stickiness in terms of the OEM side. I’m wondering if you could -- is that reflective of your better than back-of-the-envelope math and what you think the drivers are there?

The second one is a follow-up on what Jonathan was asking, which was as you see the penetrations ramp, Nate, and it sounds like it is great you have some commitments that you feel comfortable with, have we hit the threshold already where the revenue shares will be stable, or is there margin impact as you increase the penetrations from the GMs of the world at this point?

Nate Davis

Let’s talk about the churn for after-market versus OEM. I think it has always been clear to us, so the answer to your question is yes, your back-of-the-envelope math is indicative of what we know when we look at our internal stats. After-market churn has always been higher than the OEM churn and you have to think about when you say what are some of the factors, the installation of a radio in a car, the quality of the sound, the quality of the installation, the ease of the customer making the decision to convert to XM -- all of those factors basically say it is an easier process and it is a higher quality process. It is easier for them to understand the issues when they go to a store and the rep has to explain to them what is going on, that is not quite as quality of an installation. It is very inconsistent on the information they are going to get about the service. And then the installation process itself is a later on, go to someplace to get it installed or install it yourself -- not quite as good as the quality installation in the car.

So we’ve always known that churn would be better with the OEM manufacturers than it would with retail. We think that will continue over time.

David Bank - RBC Capital Markets

Are you seeing any marginal up-tick or down-tick, like a derivative on those trends? Are the retail churn numbers getting better or worse? Are the OEM churn numbers getting better or worse?

Nate Davis

No, not really. You asked a question about the penetration ramp. Ask that question again.

David Bank - RBC Capital Markets

It sounds like you certainly feel confident that your partnerships with your OEM partners to deliver increasing penetration, maybe not quantifiable but sort of directionally where this, what the equivalent to the Sirius/Chrysler ramp is -- is there an increased cost or an increased revenue share for your OEM partners as you start to ramp to those more significant levels in penetration?

Nate Davis

No. The short answer is no. The way these relationships are set, it is essentially either flat to down over time, so no. The answer is no.

David Bank - RBC Capital Markets

Perfect. Thanks, guys.

Operator

Your next question comes from Eileen Furukawa from Citigroup.

Eileen Furukawa - Citigroup

Thanks for taking the question. First, I just want to know, if the merger for some reason does not go through, do you already have a contingency plan in place that would include any big changes to the way that you are currently running your business? If so, what types of changes could we expect? For example, would a price hike be in the cards?

My other question is you talked about the $10 incremental increase in SAC from increased production in OEM and how that will continue through ’07 but I’m assuming that might continue through ’08 and if so, what kind of magnitude of increase should we expect from the OEM ramp-up?

Nate Davis

On this if the merger doesn’t happen question, we’ve never gotten into and won’t get into speculation about rate increases but I would say this -- we do have some specific thoughts about what would we do if the merger didn’t happen. One of them is obvious and that is we look at the cost structure of the business and we’ve talked a lot about the fact that our legal expenses are a little higher than we think they will be. That won’t continue in the long run. We know that we want to find a way to continue to either flat or marginally down on programming expenses and you can think about Listener Care. Joe talked about the fact that there are a couple of basis points of increase in cost in Listener Care in the near-term but think the long-term, after we’ve gotten better and better with our vendors, I think we will be able to bring the Listener Care cost down.

We have a number of items like that that we think on the long term, if the merger doesn’t happen we know things we would do.

Gary Parsons

But generally, we just don’t even entertain questions about what if it doesn’t go through. But to the second part of --

Eileen Furukawa - Citigroup

Positive thinking.

Gary Parsons

Yes, that’s right. To the second part of your question relative to the $10 elevation because of the rollout of the new OEM mix and particularly for the ones that don’t go through a promotional period is adding stress to the SAC, that is largely an ’07 type of an issue because when you start looking at the numbers after you pass first quarter of next year, you actually start getting into a more balancing situation where certain quarters, you are actually getting the positive benefit of new gross additions and in that case, gross and net additions that are coming in as full-time, self-paying subs that are offsetting those that were paid for in prior quarters.

It is largely an aspect of the timing of it from that standpoint.

Eileen Furukawa - Citigroup

Thanks a lot.

Operator

Your next question comes from Mark Wienkes from Goldman Sachs.

Mark Wienkes - Goldman Sachs

Thank you. Good morning. I was wondering if you could talk about what goes into your recent decision to offer longer initial promo periods on some of the newer deals, such as the one with Infiniti. It is starting to look more like the longer term approach that Sirius has adopted. What do you expect in terms of the difference in churn and the economics of the deal? And then, how easy would it be to change GM and Honda, and would you do that?

Nate Davis

We’ve been talking to a number of these folks for a long time about this. As a matter of fact, this is an idea we’ve been pushing for over a year but not every manufacturer wants to go to it.

The number one factor is the churn is better, and the reason the churn is better is because if a customer doesn’t have to make a decision every year or every month or every quarter, and instead stays on a longer term plan, we think that is better economics. Churn, as you know, it takes a lot to spin the subscriber acquisition cost and the CPGA to acquire new customers, so the churn is better.

The conversion rate is also one that you don’t have to worry about. You’re not out there trying to convince a customer at the end of the trial to convert because now they are simply on our service.

For both of those perspectives, we think this is a much better way, and it also reduces our internal costs. Think about the fewer number of calls into Care, think about the lower amount of collections activity.

We think it is a much better arrangement if we can get this done. It is not really a change in philosophy. It is something that we have been talking to them about for a while and we are starting to see more of them adopt.

Gary Parsons

The key element on that though is being able to implement that in a cost-effective manner because obviously we are getting solid positive conversion rate results out of what they have on their. It is by the way not a change in the trial period. It is that they have elected to actually purchase it, a year’s worth or three years’ worth, up front and so that means it has positive economics for us.

I think on the overall conversion rate type situation, we are clearly off of our three-month trials experiencing a superior conversion situation. I know Sirius does not announce theirs but it is pretty easy to back into some of the numbers on the thing from what we have currently.

Mark Wienkes - Goldman Sachs

You talked about the new plug-and-play devices but not the portables. We just noticed that they are at different, between the Helix and the Inno, they are different price points on your website. They have been out for about a year. Could you just talk about your strategy in that specific segment?

Nate Davis

The Helix is not a product that is being manufactured and that is why it has a slightly different price point. The manufacturer has done some pricing that is really not XM pricing, it is the manufacturer.

The Inno on the other hand is one that is continuing and so it has a little higher demand right now and as such, the price is a little higher. We think that device is going to be around for a while. It is a very popular one and we don’t see any change for it in the coming months.

Mark Wienkes - Goldman Sachs

Final question, I just noticed that the year-end targets weren’t reiterated. I know you are not talking 2010 but as far as the ’07, is there a reason why that was left out?

Gary Parsons

No, no change to guidance.

Hugh Panero

Except that we said that CPGA would be at the higher end of the range.

Mark Wienkes - Goldman Sachs

Okay. Thank you, guys.

Operator

Your next question comes from Lucas Binder from UBS.

Lucas Binder - UBS

Good morning. I just have a couple of quick questions for you. You mentioned earlier, Gary, about how in the second quarter of 2008 we should start to see normalization on the SAC side from these new OEM partners. You’ve had Hyundai launched now for almost nine months. You are a month into the third quarter. Could you talk a little bit about what kind of success you’ve seen for the existing factory-install Hyundai cars? Have you started to see those cars come on board as full-time subscribers, and if there is any sort of sense of what that success rate is?

Gary Parsons

Actually, I think it is still a little bit too early to do that because as you remember, on conversion rate we measure that on a 180 day cycle, so it is still a little bit early. I will have to say early results look pretty positive on that front, so I guess we are pretty pleased with how it is going on that. We think that that is clearly indicative of what you are likely to see as you move up to very high standard like installation rates. But we still have probably another couple of quarters before we will start giving you more precise information in that level.

Lucas Binder - UBS

For Joe, on CapEx, could you talk a little bit about what you spent during this quarter and also what you expect for the rest of the year? You mentioned where your liquidity is. Do you think that you are going to tap the market at all before the year is out?

Joseph J. Euteneuer

Actually, Lucas, we really don’t give out the CapEx numbers on this call, although I will tell you they were very modest just because we really didn’t have a lot of satellite CapEx during the quarter. The Q will be issued on Monday and you’ll see it but it is clearly a relatively calm number.

Lucas Binder - UBS

Okay, so you think you have the liquidity that takes you through to --

Joseph J. Euteneuer

Yes, without a doubt from a liquidity standpoint, we are in a great position.

Gary Parsons

Maybe if we can just do one more question because I know we are coming up to the top of the hour here.

Operator

Your last question for today comes from April Horace from Janco Partners.

April Horace - Janco Partners

Thanks for taking the question. Hugh, I just wanted to comment that I think you’ve been really instrumental in developing the satellite radio business and you will be surely lost -- missed, sorry.

Hugh Panero

I’ll be lost, too.

April Horace - Janco Partners

A couple of quick questions; the a la carte radios, have you made any plans with respect to putting those kind of radios in the OEM vehicles? Have you talked to GM about incorporating those radios? Because the consumer may want the a la carte plan but bought a GM car.

Gary Parsons

First, on that front let me just say that as we become more and more OEM centric, you can guarantee that we will be looking after our OEM partners in any of these types of products as they go forward, and we clearly understand the different implementation cycles that they have but I think we will be able to work effectively with them to make them competitive on all of those fronts.

April Horace - Janco Partners

Do you think that your a la carte plan will confuse the consumer even more? If they were confused with two services, with eight options is that going to confuse them more at the retail level? How did you balance the offering with the consumer?

Nate Davis

I think the way to look at that is that there is not universal reaction from the market on these offerings. In other words, some customers are going to look at it and clearly understand it, going to sign on through the Internet, play around with different choices and pick them and they will understand exactly what they are doing.

There will be other customers who will say way too confusing, I just want the standard $12.95 package or I want the $16.99 package, and so there will be some set of customers we think will just choose the packages because they are easier.

You can see that today in any other place where people, whether you are buying a car and you look at all the different choice, options on a car. Some people just want an option package.

So we think we will see a little bit of both. Some people who will love the flexibility and others are simply going to want the packages because it is too confusing.

April Horace - Janco Partners

Last question; because you and Sirius report your subscribers differently and they report a subscriber that they got paid by Chrysler under the one-year plan, in order to try and better compare you subscriber additions, could you give us a feel as to how many cars from Nissan and Hyundai, Toyota have been sold but they have not yet come off the promotional period?

Gary Parsons

I am not sure we can break it down by the individual new manufacturers. I think some of the -- in essence, there’s probably a million difference between manufactured total GM, Honda, everybody and those that have actually been sold and began entering through the subscriber basis. So there’s probably about a net million difference between those two particular numbers.

April Horace - Janco Partners

Okay, great. Thanks.

Gary Parsons

Thanks a lot. Actually, I wanted to close off on a quickie note to say one thing that we do feel good about, the growth situation. This is the first quarter in over a year where gross additions were actually up year over year, rather than down year over year and we hope in the coming quarters we’ll begin returning to positive net additional growth year over year versus down year over year. It has been a tough year’s number of quarters and we are positively looking to some of the improvements that we see going forward that way.

But as we close this off, both on behalf of the full management team that is represented here in the room with us, particularly Nate and myself and most particularly myself, because Hugh and I started this whole thing a decade ago and we’ve been great partners and great friends throughout. You’ve built a heck of a product, a heck of a service, a heck of a company and it has been a great run. I know it is never a fun time or an easy time or a best time to pick to leave, but you sure have created something great and we really appreciate everything that you have done on that front, so good luck going forward and we’ll look forward to talking to all the rest of you analysts in the October timeframe with third quarter results. Thanks a lot.

Operator

This concludes today’s conference. You may now disconnect.

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Source: XM Satellite Radio Q2 2007 Earnings Call Transcript
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