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Sirius Satellite Radio Inc. (NASDAQ:SIRI)

Q2 2007 Earnings Call

July 31, 2007 8:00 am ET

Executives

Paul Blalock - Senior Vice President, Investor Relations

Mel Karmazin - Chief Executive Officer, Director

James E. Meyer - President - Sales and Operations

David J. Frear - Chief Financial Officer, Executive Vice President

Analysts

Ben Swinburne - Morgan Stanley

Laraine Mancini - Merrill Lynch

Robert Peck - Bear Stearns

Bryan Kraft - Credit Suisse

James Rockcliffe - Lehman Brothers

Eileen Furukawa - Citigroup

James Dix - Deutsche Bank

David Bank - RBC Capital Markets

Presentation

Operator

Good day, everyone and welcome to the Sirius Satellite Radio second quarter 2007 financial and operating results conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Paul Blalock, Senior Vice President of Investor Relations. Mr. Blalock, please go ahead, sir.

Paul Blalock

Thank you, Matt. Good morning, everyone and thank you for your participation. This morning, Mel Karmazin, our CEO, joined by Jim Meyer, President of Operations and Sales, will review our second quarter 2007 operations and our outlook for 2007. David Frear, our Chief Financial Officer, will then discuss our financial results and our guidance for 2007 as outlined in our press release this morning. Scott Greenstein, President of Entertainment and Sports, is currently traveling and will not be joining us this morning. At the conclusion of our prepared remarks, management will be glad to take your questions.

I would like to remind everyone that certain statements made during this call might be forward-looking as that term is defined in the Private Securities Litigation Reform Act of 1995. These and all forward-looking statements are based on management’s current beliefs and expectations and necessarily depend on assumptions, data, or methods that may be incorrect or imprecise. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. More information about those risks and uncertainties is contained in Sirius' SEC filings and we caution listeners not to rely unduly on forward-looking statements and disclaim any intent or obligation to update them.

I will now hand the call over to Mel Karmazin for his opening remarks.

Mel Karmazin

Thanks, Paul. Good morning and thank you for joining us. Second quarter financial and operating results were once again very solid and continue to demonstrate strong customer demand for our service, as well as excellent execution by our team. Healthy subscriber growth of approximately 561,000 net additions in the second quarter topped first quarter subscriber additions and drove a 53% increase in our ending subscriber base from last year’s second quarter. Sirius now has approximately 7.14 million subscribers. In the first-half of 2007, we added slightly more than 1.1 million net new subscribers, and while third quarter should reflect seasonal slowness, we are well on our way to meeting our 2007 outlook for more than 8 million subscribers at year-end.

In the second quarter, Sirius added 62% of total satellite radio net segment additions. This is the seventh consecutive quarter where Sirius has attracted the majority of the satellite radio segment subscriber net additions and the third consecutive quarter where Sirius has attracted the majority of gross subscriber additions as well. I will let Jim take you through more details in a few minutes but I would like to highlight our continued progress in the OEM channel.

During 2007, numerous announcements have been made by our automakers. Last week, Chrysler announced that Sirius will be installed in more than 70% of their production, dramatically exceeding previously established installation targets and in my view, this represents a very positive signal for continued growth towards standard installation of Sirius. Chrysler’s 70% installation rate is the highest public commitment among the big automakers toward satellite radio.

The emergence of stronger growth in the OEM channel is an important development for Sirius. During the first six months of 2007, OEM subscriber growth continues to be stronger than expected and represent in excess of 70% of our year-to-date subscriber growth. Jim will discuss some of the implications this has for our business while investors should view this as a big, positive development for the long-term growth of our business.

On the retail front, Sirius continues to capture greater than the majority share, albeit in a softer-than-expected retail environment. During the second quarter, Sirius represented 75% of the satellite radio net segment subscriber additions and we continue to believe that the retail and after market channels are an important indication of the strong consumer preference for Sirius.

OEM gross adds, OEM net adds, retail gross adds, retail net adds -- no matter how you look at it, Sirius has the majority of the additions to satellite radio.

On the programming front, we launched The Foxxhole, Jamie Foxx and Siriusly Sinatra during the quarter. And for all you deadheads out there, we are very excited about the upcoming launch later this summer of our Grateful Dead channel. I reiterate what we have been saying for years, and that is we have the best radio on radio.

On the financial front, second quarter results demonstrate that Sirius is scaling the business, managing our costs and accomplishing our goals. With more than $226 million in second quarter revenue and over $430 million in the first six months, Sirius is well-positioned to approach $1 billion in revenue this year. We will achieve $1 billion of revenue faster than any company in the history of radio.

It is also apparent that we are focused on controlling costs relative to our growth. Second quarter revenue grew 51% when compared to last year. However, our total operating costs, excluding stock-based compensation and depreciation, grew only 6%, while our net loss decreased 44%. The monthly customer churn rate fell to 2.1% all-in in the second quarter, down from 2.3% in the first quarter and we are very pleased with the progress we are making on consumer satisfaction. SAC per gross subscriber addition was $108, down 17% from last year’s second quarter figure of $131. We now expect our full year SAC per gross subscriber to approach $100 due to the greater proportion of growth from OEM.

Overall, Sirius had a solid second quarter. It is important to realize that demand for Sirius continues to be strong, our financial performance is on track, and we are executing very well on our business plan. I will now hand it over to Jim.

James E. Meyer

Thanks, Mel. Second quarter 2007 was another very successful quarter for Sirius. As you know, our goal for 2007 was to maintain our market leadership position and we accomplished that goal, capturing 62% of total satellite radio segment net adds share. As Mel said, this marks the seventh consecutive quarter for net add leadership and also the third consecutive quarter of gross add leadership.

During the second quarter, Sirius added just over 1 million gross adds, an increase of 21% over gross adds one year ago. On a net add basis, second quarter results were also impressive, adding 561,000. So far this year we have posted just over 1.1 million net adds, which obviously puts us well on our way toward accomplishing our target of ending 2007 with more than 8 million subscribers. Second quarter net additions of 561,000 were comprised of approximately 435,000 net adds from our automakers and 130,000 net additions in the after market.

One of the highlights of the second quarter was our all-in or total churn rate of 2.1%. This was a decrease from the first quarter churn of 2.3% and just below our guidance for full year churn at 2.2% to 2.4%. We have historically mentioned our self-paid churn is in the 1.6% to 1.7% range and I can tell you that we’ve been hitting the low-end of that range, which is a very positive sign of consumer satisfaction.

As you know, we had been focused on developing, on organization and the strategic management tools necessary to understand and implement effective customer relation management and I can tell you that the investment and efforts are now beginning to pay off.

Turning to the after market channel, the 130,000 retail net additions for the second quarter are clearly below last year’s strong momentum. However, our share of satellite radio segment retail growth was 75%. Overall, I am quite satisfied with our after market share position and particularly satisfied with the trends, particularly when you realize that our average selling price is significantly greater than other satellite radio products. We are very focused on this key channel of distribution and continue to work with our retail partners to achieve our share objectives.

I would also like to mention that retail inventory is in good shape and we are preparing for the launch of some new after market products, including a new wearable product, Stiletto 2, and a new Sportser, SP5. Stay tuned for more details on these exciting new products next month. We now believe that Sirius has reached market share parity in the wearable category and we expect to be the leader with the introduction of the new Stiletto 2 this fall.

Lastly, while we continue to believe that the after market channel will remain an important long-term contributor, our assumptions for the future are grounded in the reality of the softer after market results and we are not assuming a near-term reversal of recent after market trends. It is abundantly clear that satellite radio competes with an increasingly broad spectrum of entertainment and consumer electronics options. Our long-term challenge is to continue to innovate so that we can leverage our outstanding content in today’s increasingly competitive entertainment environment and we will meet that challenge.

Now, let’s turn to the OEM world. In second quarter 2007, we added a record 435,000 OEM net additions, capturing 61% of total OEM net adds. As the numbers attest, during the second quarter Sirius, in conjunction with our OEM partners, continued to execute extremely well on all fronts. Much of the second quarter success can be attributed to greater penetration rates, as we are exceeding initial projections and gaining both customer and dealer demand pull for Sirius.

We believe that these results speak volumes about an exciting, evolving strategy with our OEM makers. Through our program and our technology, Sirius has emerged as a key marketing differentiator to the vehicle buyer. In fact, over the past year, strong consumer preference and demand combined with excellent OEM execution, has rewarded us with a 60% share of OEM net additions, a reality that some of you might find surprising.

As you should be aware, our automakers are confidently stepping up their rollout now of Sirius with packaging and bundled strategies, including multi-year and lifetime subscription offerings. We will continue to explore additional opportunities for consumers at the point of vehicle purchase.

We were also very pleased to inform you last week Chrysler announced it is now targeting a 70%-plus installation rate for model year 2008. This is a major milestone. In the second quarter, Mercury ran an impressive two-month promotion featuring a three-year subscription to Sirius in a number of their models. This nationwide event was support by extensive TV advertising, as well as print and electronic media. This is the second year that Mercury has used Sirius in a nationwide campaign to help drive vehicle sales.

I’m pleased to say that both Mercury and Sirius are very pleased with the results of this promotion and the confidence Mercury has in Sirius to help drive dealership traffic.

Also, as a reminder, Ford Motor Company’s Lincoln product line will install Sirius as standard equipment on virtually all of their models beginning with the ’08 model year around the corner. Additionally, Mercedes-Benz is hitting their stride with over 80% penetration rate and going higher. Volkswagen and Audi have recently begun a number of standard equipment offerings in various 2008 models and just last week we added another marquee nameplate as Aston Martin announced the launch of Sirius with lifetime subscriptions.

Backseat TV -- we are now preparing for the launch of after market backseat TV products, which will complement the current OEM rollout happening now with the 2008 model year Chrysler Dodge and Jeep vehicles. Sirius Backseat TV is not just a product; it is a very exciting new service offering passengers a live broadcast of Nickelodeon, the Disney Channel, and Cartoon Network, the biggest names in family TV.

Through Sirius, our automotive makers are able to differentiate their vehicles and create unique marketing messages by offering new levels of programming which make it clear that Sirius continues to become more important to both customers and to our OEM partners.

In closing, I would like to say we are very optimistic about reaching our goals in the second-half of the year, but let me remind you there are reasons to temper near-term expectations and each year that goes by gives us a better understanding of the seasonality in this business. The third quarter typically has softer net and gross subscriber additions, in part because there is a pause in auto production or summer shutdown, as the automakers implement changes to accommodate new model builds. In addition, the third quarter does not contain a key retail selling period.

In conclusion, Sirius continues to execute well in both the OEM and after market channels and we will continue to focus on reducing our per unit cost and economically growing our business.

Now let me turn it over to Dave Frear.

David J. Frear

Thanks, Jim. Sirius added over 1 million gross adds in the second quarter and a very strong 561,493 net subscribers, well above consensus estimates. Total revenue in the quarter was up 51% to $226 million, an annualized revenue run-rate that is now in excess of $900 million. All of our key financial metrics are improving -- SAC per gross add, customer service and billing cost per sub, contribution margin, fixed costs as a percentage of revenue, and most importantly, free cash flow.

As mentioned earlier on the call, SAC per gross add continues to improve and at $108 was 17.6% better than the year-ago quarter, because of continuing strong performance in the OEM channel. As Mel mentioned, we now expect SAC per gross add to approach $100 for the full year.

Total churn, which includes self-paid churn as well as non-conversions of bundled subs, was 2.1% in the quarter, below our guidance range for the year of 2.2% to 2.4%, and a sequential decrease from the first quarter’s 2.3%, bringing us to the low end of our guidance range for the year to date.

Our operating results are scaling and continuing to show solid gains. Our contribution margin, revenue less customer service and billing, revenue share and royalties and cost of equipment, continues to exceed 70% of revenue. Our total operating expenses in the quarter, excluding depreciation and stock compensation, were up only 6% compared to the 51% growth in revenue. As a result, about $0.61 of each dollar increase in revenue turned into an improvement in pre-SAC EBITDA, which was positive $29 million for the quarter.

When you add to that the improvement in subscriber acquisition costs, our second quarter adjusted loss from operations improved by $47 million.

On the non-cash side, stock compensation expenses fell 75% versus the year-ago quarter, as we continue to move away from historical contracts with significant equity components. These operational and non-cash improvements together drove a 44% reduction in net loss.

All of the operating improvements in the quarter benefited our free cash flow, which improved by over $53 million year over year, about $0.70 for each dollar of additional revenue.

We promised you cost-effective growth and we have delivered on that promise, but we have done so while continuing to make investments in the business. As Jim discussed, we are investing in the customer relationship management functions to increase retention and drive down churn, keeping the subscribers we have worked so hard to win. As Mel discussed, we continue to invest in programming like NASCAR and Jamie Foxx’s Foxxhole to drive subscriber demand. In fact, in the second quarter we increased gross adds by 20% over the prior year and did so with lower total SAC. And we continued to drive product development, delivering exciting new products and services, like Sportster 5, Stiletto 2, and Backseat Video this fall.

Turning to the financing front, during the quarter we raised $250 million through a secured 5.5 year term loan at libor plus 2.25. Fantastic execution and, as we’ve all seen, incredible timing with respect to the markets.

We ended the second quarter with roughly $429 million in cash and cash equivalents and have plenty of liquidity for our business plan. We also filed our rebuttal case last week with the copyright royalty board in a royalty proceeding, and we do expect to get a decision in this proceeding by the end of the year.

Lastly, we have contracted with Space Systems Laurel to construct the Sirius 6 satellite. An option contained in our Sirius 5 contract allowed us to acquire it on very favorable terms and at a cost similar to Sirius 5. Sirius 6, which will be completed in 2010, has been designed as a HEO satellite but may also be flown as a GEO satellite in the event we decide to change the constellation. Like Sirius 5, it will carry double the power of our existing satellites, providing a path to continuing service improvements for our subscribers.

Payments under the program are somewhat similar to the Sirius 5 program, with a significant portion of the payment due in the final year of construction and after launch.

To conclude, the second quarter was another important period in the growth of Sirius as we added a strong number of net new subscribers in a very cost-effective manner, continued to enhance the best radio on radio, and made significant strides in furthering our OEM deployment. As we disclosed in our press release, we are reiterating our subscriber and revenue guidance for 2007, including revenue approaching $1 billion for the year, ending subscribers of over 8 million, and average monthly churn of approximately 2.2% to 2.4%. Additionally, we now expect SAC per gross add to approach $100.

With that, let me turn it back to Mel.

Mel Karmazin

Thanks, David. Thanks, Jim. Now I would like to take a few moments to update you on our pending merger with XM. We are very pleased with the diverse public support that our pending merger has received. Last week, reply comments were filed with the FCC and a number of organizations and business leaders have expressed their support. It is clear from the reply comments that there is widespread confidence that competition will be preserved in the audio entertainment marketplace following the merger of our companies.

Last week, we also announced a la carte offerings and new packages which illustrate the many benefits of this merger. In an increasingly competitive environment, this transaction will strengthen satellite radio’s position within the marketplace while maintaining robust competition for consumers. We also continue to respond to the second request from the DOJ. We anticipate certifying that we are substantially compliant by the end of the summer.

The bottom line is this -- the merger of Sirius and XM is good for consumers and good for shareholders. The efficiencies created by this merger will be extraordinary. We believe they exist on every line item of the P&L. These efficiencies will allow us to offer more choices and lower prices, which we believe will attract more subscribers.

A prominent third party recently independently confirmed there are billions of dollars of long-term merger synergy which translates into hundreds of millions of dollars of estimated efficiency annually, so we remain confident that the regulatory authorities will carefully weigh the merits of the transaction and conclude that this merger is not anti-competitive and is in the public interest.

We continue to expect that we will close the merger by the end of the year, but in the meantime, we are running the company as if the merger will not happen. So let me close by saying that Sirius is executing very well, continuing to scale our business, attract new subscribers, and meet our financial objectives.

Thank you for listening and we are now ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Ben Swinburne with Morgan Stanley.

Ben Swinburne - Morgan Stanley

Thank you. Good morning. A couple of questions, one for Mel on the a la carte decision and the pricing scheme. What research could you share with us that you guys have done on customer appetite for tiering and for price points? I’m trying to understand from a long-term perspective how you think this impacts both the addressable market as well as your ARPU and cash flow trends over the long term. And maybe some color on how you put the tiers and the packages together.

And the second, just for Dave, the deferred revenue line on the cash flow statement continues to grow nicely year over year. Could you just give us a sense for the average prepaid trends and if you expect that benefit increase to continue through the remainder of this year? Thanks.

Mel Karmazin

Let’s take the second one first.

David J. Frear

Average pre-pays continue to be pretty much in a pretty consistent range. They’ve been between eight and nine months using a $12.95 standard. We expect them to stay in that range. They’ve been working their way down a little bit as the mix of Ford subscribers has been rising and I think, as you know, that Ford includes a six-month bundled pre-pay in their numbers.

We don’t really expect any significant changes in the weighted average pre-pays until the movements in deferred revenue just becomes from that point a mathematical thing. Based on the way you run your model, how many gross adds you have and what the amortization rate is on the active subs that are out there just produces the result. But from an input perspective, nothing really is going to change in the weighted average pre-pay.

Mel Karmazin

The idea of lower prices for us is a no-brainer. Anybody who likes the service that they are currently getting, they are paying $12.95, what we said we’re going to continue to offer that service and nobody will have to pay more.

You have to remember that we are competing with free, so the fact that we are able to capitalize on these synergies of the merger and be able to offer people more choice has been the original premise of the merger.

What we’ve said is that this merger is in the public interest because it is going to offer the consumer more choices and lower prices, and we believe that the a la carte option that will start at $6.99, as well as the packages that we offer, live up to exactly what we said about more choice and lower prices.

We also believe that at this early stage of development of satellite radio, where we are not a mature cable company, what we are is a very growing company, that having a lower price point is going to enable us to pick up substantially more subscribers, so that the consumer is going to be able to pay $6.99 or $9.99 or $12.95, or if they want the best of both services, the $16.99, and then we have some family plans.

We’ve really considered the pricing of this merger and we feel that we are going to get a significant number of people who are going to want to get the best content from both services and pay more than our ARPU, there will be people who want to avail themselves on our lower prices and we believe that we will make up so many more subscribers to offset any concern that might even exist on the subject of ARPU.

Ben Swinburne - Morgan Stanley

Great. Thanks a lot.

Operator

We’ll go next to Laraine Mancini with Merrill Lynch.

Laraine Mancini - Merrill Lynch

Two questions for you; your churn in 2Q was lower than your guidance range. Is there a reason that we should expect that the range for the year isn’t at that lower end, especially since XM has said that they think they can keep their churn flat for the rest of the year? So should we expect more likely the 2.2 than the 2.4?

Second, since you’ve got a big pick-up with Chrysler’s commitment and Mercedes, what is your view on when this could be standard equipment in a car, or do we even get there?

Mel Karmazin

Jim, why don’t you take the second one first.

James E. Meyer

I think we have to be careful with the term standard. I think there are some cars we will never get to and there are some parts of the sales for the car makers that we still have to work on the economics, things like fleet sales and those kind of things.

I think the 70% with Chrysler is, I think Mel stated very well, approaching standard. We have to swallow this increase first but I certainly would expect in ’09 we would increase the penetration rate some more. In terms of Mercedes, I think at a 90% penetration, we’re effectively at standard and we are very pleased with that.

One thing we didn’t say is, and I won’t give the exact number, but we are very pleased also with the penetration in Ford. It showed a very nice increase from what we had modeled and I see no reason to believe why that also is not good news on the horizon.

David J. Frear

On the churn performance relative to guidance, I think the range is still the best guidance that, as you know, the churn rate is just the math, so fairly small changes in either the number of gross adds in the second-half or the number of accounts that can churn if you get two of those moving in the same right direction or the same wrong direction. It is easy to move that churn number a couple of tenths, so I think it is just best to stick with the range.

Laraine Mancini - Merrill Lynch

One follow-up, if I could; your customer care and billing came down sequentially. Your competitor’s did not, and they seem to be spending to manage their customer satisfaction. Your customer satisfaction has been strong without that. What do you think is the difference there?

David J. Frear

I can’t speak to what’s going on within their organization. I do know that we’ve spent a lot of money and a lot of time over the course of the last couple of years and the last 12 months in particular in really building up our customer relationship management team. We believe that we have a fantastic team in place now. They are supported by very good IT systems as well as business practices. We believe we can do better than we have been doing and are just spending money in what we think is a prudent fashion.

Mel Karmazin

And I think you really have to factor in our branding and our content. We think that that obviously impacts consumer satisfaction in a very significant way.

Laraine Mancini - Merrill Lynch

Great, thanks.

Operator

We’ll go next to Robert Peck with Bear Stearns

Robert Peck - Bear Stearns

Just revisiting Ben’s question for a second here, back to the pricing structure changes, because they are predicated on the synergies you would get from a merger, Mel, is it therefore fair to assume that your own internal models would show it MPV negative or MPV neutral? How should we look at that?

Mel Karmazin

I think that we are going to have to wait and see. There are very, very substantial synergies of this merger. We have not been able, for anti-trust reasons, to be able to do the kind of work with each other’s companies as we would both like, right? We can’t go through their contracts and they can’t go through ours and we’re not allowed to talk about some of these business situations. So we hired a third party, a very prominent third party who was able to review all of the Sirius documents, all of the XM documents, met with Sirius management, met with XM management, and they identified what the synergy and efficiencies of the merger would be. And they were very, very substantial, probably on the high-end of any analyst number that is out there for synergy. They had the benefit of reviewing documents which most of the analysts did not.

We are unable to opine on it because we have not been able to see those same documents that they looked at, so we have to take it at face value that there are tremendous synergies.

Because again, I mentioned earlier, that we would like to have everybody be a subscriber to satellite radio and one of the issues continues to be that people say “gee, I’m not going to pay for radio”. Now, there’s an awful lot of people -- there’s over 15 million people that have found it worthwhile to pay for radio and we know that by offering some lower prices, we’ll be able to improve conversion rates. We believe that we’ll be able to tap into subscribers who haven’t felt that it’s worth the $12.95 and that it would be worth a lower entry point. We also think, as I mentioned earlier, that there’s the upside opportunity whereas we’ll be able to offer some of the select content from XM on some of our receivers.

I think at this point we are not able to give you any more information than what we have given you to date on the merger efficiencies, on our pricing, on our viewpoint going forward but we absolutely see the companies benefiting from this merger financially, particularly our shareholders, in a very substantial way.

Robert Peck - Bear Stearns

Two quick questions for David, if I can; David, what number or percent of the OEM gross adds are these cars still on the lot? Second of all, can you also give us an idea of when you expect to turn free cash flow positive?

David J. Frear

On the second one, Bob, as you know, in January in the call we said that we weren’t going to be providing guidance with respect to free cash flow. We want to see how the merger settles out and then we’ll consider coming back with that.

On the percentage of OEM gross adds that are sitting on the lot, it hasn’t really changed much over the course of the last year or so. It is one of these things where -- I’d have to double-check but even if you go back 18 months, I just don’t think the percentage of the total base has changed very much. It’s a number that’s been bouncing around 9% to 10% and it seems to stay pretty consistently in that range. It can go up a little bit some weeks and then it comes down a little bit other weeks.

Robert Peck - Bear Stearns

Thanks, David.

Operator

We’ll go next to Bryan Kraft with Credit Suisse.

Bryan Kraft - Credit Suisse

Thank you. Assuming the merger is approved, first, what will be the timeline for commercial availability of an integrated chipset and how would you expect the costs of that chipset to compare to your current costs? Secondly, how long do you expect it to take to get the integrated chipsets into the vast majority of your OEM --

Mel Karmazin

I’ll let Jim answer your question on chipset but I will tell you that we believe we will begin to offer our packages that we have identified that we are going to do within six months, so our hope would be -- let’s assume, as an example, that we close by the end of this year. We believe that by Father’s Day, dads and grads, we would be selling and offering our services with all of the packages. We also would expect that by Christmas, we would be offering the a la carte service, so on the subject of the chipset and things that are in development --

James E. Meyer

Right. I think you need to be careful. It is not a given assumption that we need an integrated chipset to offer any of the things that Mel just talked about and I want to reiterate what Mel said. The packages will be available by Father’s Day of next year. More importantly, they will be retroactive to virtually all of the products that are in the field, so there is not a risk of obsolescence at any of those. And then the a la carte will take more work and will require a new radio, which will be in the market to support the Christmas selling season of next year.

That said, if the merger goes through, I’m very positive that we will very, very aggressively go after an integrated chipset. The timing of that chipset is probably somewhere between one year and two-and-a-half years, depending on what we decide to feature in it. And we won’t be able to begin that work until it is clear that the merger’s approved.

Mel Karmazin

And the -- Jim’s again mentioned on Father’s Day is premised on the fact that the FCC would approve the merger by year-end and what we’ve said is that we would not be able to have as many choices as we are offering, particularly the a la carte but for the efficiencies of the merger, so all of this is conditioned on the merger.

Bryan Kraft - Credit Suisse

Okay, so if it one to two-and-a-half years to actually having the integrated chipset, as far as getting them into the OEM production, what kind of additional time do you think it takes to get there?

Mel Karmazin

Number one, one of the things I’ve learned the hard way in this business is everything takes longer in the OEM world than you would like because they are very careful about how they make changes across mass volumes, and in particular I’m talking about the big automakers. I don’t know the answer to your question yet.

James E. Meyer

We would provide the auto manufacturers with what they need as quickly as we can possibly commercially do that, and then we’re at the mercy of what the OEMs do on timing and integrating it into the vehicles.

Mel Karmazin

I think one thing is clear is that we think that both the packages and the a la carte option are very exciting for consumers and I believe the OEM carmakers care very much about incorporating exciting features in their products and so once those chipsets are available, it will be up to them how quick they go. I think they are going to want to go fairly quick but I cannot guarantee that.

James E. Meyer

Our experience with the OEMs has been that clearly they don’t want to lose business to the after market, so that if in fact there’s new cool features that are out there, they are going to want their customers to get them so we are going to accelerate as fast as we can to get them what they need and we are at their mercy for when they put it into the vehicles, but we think that they will be responsive pretty quickly.

Bryan Kraft - Credit Suisse

Thanks very much.

Operator

We’ll go next to Vijay Jayant with Lehman Brothers.

James Rockcliffe - Lehman Brothers

Good morning. It’s James Rockcliffe for Vijay. A couple of questions on the OEM segment. First of all, what portion of the OEM customer base at this point is still under the subscription that originally came with the car? Secondly, for new OEM customers, how long is the average included subscription over the entire gross add base and how is that trending? Are you seeing changes in that? Thank you.

Mel Karmazin

The second question, James, was what is the average length of the OEM bundle?

James Rockcliffe - Lehman Brothers

Yes, exactly.

Mel Karmazin

Okay, I don’t have a precise number for you. I can tell you that for the most part, Chrysler and Mercedes vehicles run a year. For the most part, BMW runs a year. For the most part, Ford runs six months, and those are the ones that have real volume out there, so figure it’s between six months and a year.

And then, in terms of the number of subscribers that are under their promotional plans, that’s not a number that we’ve been providing to the street. It’s obviously something that we do track internally. I can tell you that we track much more closely than what the total is. We track the number that are coming up for conversion in any particular point in time so that we can focus our CRM team in on the renewal and conversion efforts.

James Rockcliffe - Lehman Brothers

Can you give us any guidance on how those conversion levels are going, at least how they are trending?

James E. Meyer

We are pleased with the level they are going and they are incorporated in our all-in churn rate of 2.1% for the quarter.

James Rockcliffe - Lehman Brothers

Thank you.

Operator

We’ll go next to Eileen Furukawa with Citigroup.

Eileen Furukawa - Citigroup

Thanks for the question. I have a couple. On SAC, you saw a slight lift from the first quarter in SAC and I’m just wondering if you could quantify how much of the increase in SAC is due to the increased production of your OEM compared to the $10 that XM attributed to their increase in OEM production?

Also, regarding your Chrysler deal, I was just wondering, is the 70% installation rate the specific percentage penetration that you were really pushing for and a number that you internally calculated as sort of the financially optimal installation rate or is this a decision that came from Chrysler’s side, and the 70% was a [basic mix] for them. Thanks.

James E. Meyer

I’ll take the second one first. This is a decision that came from Chrysler. I don’t think we’re still at the optimum rate yet. I think there is still more room for some growth. As I said earlier, the dynamics that we have to particularly optimize are -- a big factor in conversion rate clearly is the percentage of fleet and rental vehicles that go into that base, and so we are learning a lot and watching that closely.

We are very pleased with the 70%. It’s a number the came from Chrysler but it was a goal that we had set to try to be certainly in that range. I will say we got there quicker than we thought we would.

Eileen Furukawa - Citigroup

So what -- but you do think the optimum number for you is higher than 70?

James E. Meyer

I don’t know yet what the optimal number is. I don’t think 70 is the optimal number. I think there is room to go higher.

Mel Karmazin

There are companies that obviously have committed to total standard. We also have Mercedes, which is committed to be over 90% in future years, so I think it has a lot to do with the mix of the vehicles and again, important is how many of the vehicles being manufactured are going into fleets and going into rental. But we don’t feel that the 70% represents any optimum number. It just represents a huge improvement and something that we’re very pleased with.

I’m not sure, David, did you --

David J. Frear

On the mix impact on SAC, I think the way that you should think about it is that as we look at the underlying costs associated with SAC that we are at or better than we expected to be in our different channels, and so the change in our guidance is due to the change in the mix associated with the out-performance of OEM this year and a little bit softer performance at retail than we had been looking at. So I think your answer lies in the guidance.

Eileen Furukawa - Citigroup

Okay, thanks.

Operator

We’ll go next to James Dix with Deutsche Bank.

James Dix - Deutsche Bank

Good morning, gentlemen. Two questions; your merger filings last week included some data showing that satellite radio seemed to generally have higher penetration in markets served by fewer terrestrial signals. Do you consider this one of the strongest pieces of evidence in your case that you are part of a larger market? And if there are other facts or pieces of evidence you think are particularly compelling, what would they be?

Secondly, what do you think is accounting for the softer-than-expected retail environment you are seeing right now and do you expect satellite radio as a category to grow at retail next year? If so, what would drive that change?

Mel Karmazin

Jim will do the second part and then I’ll do the first.

James E. Meyer

I think all you have to do is walk into a Best Buy store and it’s pretty obvious how much competition there is. We are working hard on understanding the softness at retail right now. I have to be very honest, we were disappointed that we didn’t see a closing of the gap more rapidly for the Father’s Day period. We haven’t concluded yet -- we’re working hard to temper our Fall plans. I will tell you that one of the things I think seems pretty obvious to us is there’s quite a bit of confusion still on buying satellite radio and we need to simplify that process even more in the after market and we are working hard on making sure that that process is very, very simple as to how do you get the product in the after market. More importantly, how you get it installed so it works very, very easily and very, very quickly and how do I have my service right away after I buy it with some simple options. I think that’s all that we can say right now.

Mel Karmazin

I think one other thing on that point is I think the merger will be a great stimulant for retail sales because I think there is indecision on the part of people about buying satellite radio now. We think that there is some noise in the market on the merger so we think that there’s some people holding off on that.

We also think that offering these new packages and ultimately a la carte is going to stimulate some sales. We know the retailers will be happy to have some new products there, so we think that things will pick up, certainly as a result of the merger, assuming the merger is approved about the end of this year. We think that would be a factor for next year.

Regarding our reply comments, they were extensive. They hit upon every area that you could imagine. Certainly our competitor, the terrestrial broadcasters, were filing lots of comments, many of which were just not true, about the merger and we responded to that. We’ve cleared the air so that there’s no confusion, that this is not a Dish/DirecTV scenario and we pointed out the differentiation between our market and the television market.

We also pointed out there were some points made that said that we didn’t have the technical ability to deliver on what we were saying and we filed comments that proved that. We talked a great deal about the efficiencies. We talked about the number of cars that have AM/FM radio, over 240 million vehicles on the road that have our competitor in them. We talked a lot about HD radio. We talked about Internet radio that was coming. We talked about telephones that were competitive. We talked about how robust the market was. We demonstrated from economists as well the fact that there are such great efficiencies of this merger that they’ll result in lower prices and that’s good for the consumer.

So it was a very extensive filing that addressed any potential issue. It is hard -- again, I am very close to it and again, I am biased, so I’ll tell you that up front but it is very hard to believe that you can look at the audio entertainment market and the radio market and sit there and say there’s not a whole lot of competition so that two companies that have a total of 3.4% of the audience share together, that that combination would be anti-competitive. I think that you have to see that we should be able to achieve and win that argument.

And then the other argument at the FCC is, is this in the public interest? And that gets back to the choice and that gets back to the lower prices and that’s why we feel that our a la carte offering and our packages -- you know, I had somebody do the math and I don’t know, I can’t even give you the exact number of choices because the number is so big. But if you wanted to estimate that before the merger, consumers have one choice. They could pay $12.95 and get satellite radio. Afterwards, there are billions of choices --

James E. Meyer

I actually thought it was a gabillion. One of our guys came to us, you guys can check out the calculation, and told us that the number of permutations is 1.5 times 10 to the 55th.

Mel Karmazin

Okay, so I don’t even understand that. I’m just a radio guy but certainly by us having all of these choices and having lower prices serves the public interest, so we think that our reply comments fulfilled making all the arguments that we need to make for the merger.

James Dix - Deutsche Bank

Thank you very much.

Operator

We’ll take our final question from David Bank with RBC Capital Markets.

David Bank - RBC Capital Markets

Thanks very much. Good morning. Just a couple of merger regulatory follow-up questions. The first question is the FCC filing process has been a pretty public one and versus the DOJ process, where we don’t have quite as much transparency. Can you give us a little bit of insight in terms of what you are communicating to the DOJ to help make the point that you guys should be able to merge, if there is any sort of different message or any other different key themes than what you’ve put in the FCC filings?

The second issue is in your joint filing, you address a tremendous amount of issues I think pretty effectively. The one issue that you probably didn’t address because it is in a separate NPRM is the prohibition of joint ownership in the original license grant. Could you give us a sense of timeframe when you expect to react to that issue?

And then just a last question; if you could give us anymore update on the overall timeframe and how you see things developing.

Mel Karmazin

Okay, so the DOJ process is a less transparent process. They sent us a second request. That second request asked for substantial amounts of information. I can’t tell you how many gigabytes worth of data that we sent.

I think since most of our stuff was electronic, I think we paid a little bit over $1 million just for photocopying the material that we had to send them, and that doesn’t include any of the electronic stuff.

The two main areas that the DOJ will focus on, one would be what’s the market and obviously they will look at a lot of material in making the definition as to is the market the satellite radio market? And if somebody believes that there is a satellite radio market, that would be one viewpoint.

The other is what we believe and what most of the people who filed believe, that there is this audio entertainment market and that we do compete with AM and FM radio and iPods and the jacks that are in the vehicles and the Bluetooth for cell phones.

So the one big area that the DOJ focuses on is the definition of market, and then the second that is equally -- I shouldn’t say equally important. It’s up to the DOJ to say whether it’s equally important or not, but the other one that is important is the efficiencies because the government wants to make sure that the consumer benefits as a result of merger and not gets hurt. And if there are efficiencies of a merger, the belief is that those efficiencies will be passed along to the consumer and that’s good. That would be pro competitive.

We think that our filings are on those two messages about the market and as well as on the efficiencies.

Regarding the issue that came up as to whether or not there is or is not a rule, what we have said is that back in 1997 when we got our licenses, there was a public policy statement that said that the intent was that one company would not own the two licenses. There’s some disagreement that says whether or not there is a rule or there isn’t. The FCC has issued a notice of proposed rule making on that subject.

I believe our comments are due on August the 13th, which is when we have to respond to that issue. We will respond that says that we believe a policy statement, or even a rule that was made 10 years ago that didn’t contemplate the competition that exists in the marketplace today, is something that should be changed if there is a rule, or it should be just taken as a policy statement. The Chairman of the FCC has stated publicly that when they issued the notice of proposed rule making is number one, if there is a rule, should we change the rule, is a question. So at this point, if there is a rule, then we think it should be changed. And if in fact there is not a rule, then it will be addressed that way.

Regarding timing, I’ve mentioned that we are hoping to certify that we are substantially in compliance by the end of the summer and therefore the clock starts ticking at the Justice Department. And again, we have responded to the reply comments. On August 13th, we’ll reply to that second piece that is out there and that pleading cycle, or the official pleading cycle, will have been completed. We hope that the regulators will deliberate and conclude as we feel that the merger is in fact not anti-competitive and in the public interest.

David Bank - RBC Capital Markets

Thanks very much.

Operator

With no further questions, I would like to turn the call back to management for any additional or closing comments.

Paul Blalock

Thank you very much for listening today.

Operator

That does conclude today’s teleconference. Again, thank you for your participation. Have a good day.

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