XM Satellite Radio Q4 2005 Earnings Conference Call (XMSR)
February 16, 2006
Hugh Panero, President and Chief Executive Officer
Gary Parsons, Chairman of the Board
Joseph J. Euteneuer, Executive Vice President and Chief Financial Officer
Joseph Titlebaum, Senior Vice President, General Counsel and Secretary
Steve Cook, Executive Vice President of Sales and Marketing
Jonathan Jacoby, Bank of America Securities
Robert Peck, Bear Stearns
Craig Moffet, Sanford C. Bernsted
April Horowitz, Hoeffer and Arnett
Lucas Binder, UBS
David Bank, RBC Capitol Market
Jason Helfstein, CIBC World Market
Good morning, my name is Toni and I will be your conference operator for today. Our lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star and the number one on your telephone keypad. If you would like to withdraw your question, press star and the number 2 on your telephone keypad. Thank you.
I would now like to turn the call over to Mr. Joseph Titlebaum, Executive Vice President and General Counsel. Sir, you may begin your conference
Joseph Titlebaum, Senior Vice President, General Counsel and Secretary
Hello everyone. This is Joe Titlebaum, General Counsel of XM Satellite Radio. Before we begin our prepared remarks, I would like to remind everyone certain information on this call may contain forward looking statements. Due to a number of factors, our actual results may differ material from those that are projected in such forward looking statements. Those factors include future demands for the company service, the company’s dependence on technology and third party vendors, and the potential need for additional financing, as well as other risks described in XM Satellite Radio holding statement form 10Q filed with the Securities and Exchange Commission on November 7, 2005. Copies of this filing are available on line and upon request from XM Radio’s Investor Relations Department. I will now turn the call over to Hugh Panero, President and CEO of XM Satellite Radio.
Hugh Panero, President and Chief Executive Officer
Good morning everyone and thank you for joining us. In the call with me are Gary Parsons, Chairman, Joe Euteneuer, Chief Financial Officer, Steve Cook, Executive Vice President Sales and Marketing and Joe Titlebaum, who you just heard.
This morning I will review XM’s results for the fourth quarter and full year 2005. At the outset, however, I would like to focus on the current state of our business and our objectives for 2006.
On the content side we have been engaged in extensive effort over the last two years to acquire a strong mix of live sports events, talk personalities, and news programming to augment our broad and deep collection of commercial free music channels.
Last week, we put in place the last major piece of our current content portfolio with the Oprah and Friends channel. (inaudible) delivers to the American consumer an unparalleled combination of entertainment and information we all can be proud of. Appealing to both a large mass market as well as to smaller segments of the population. I can think of no other entertainment medium that has so rapidly matured, provides such rich compelling portfolio contents so early in its history. On this distribution side, we have exceeded other new entertainment media in depth and strength of our partnership including factory installation agreements with nearly 60% of the automotive market and a pervasive nationwide retail network.
Our radios now fill virtually every price point and listening need from plug and plays to portables to revolutionary radio memory and MP3 capability. The rapid acceptance and growth of satellite radio is undeniable.
Our overall focus in 2006 is to continue driving rapid growth in a cost effective manner to achieve three integrated objectives. More than 9 million subscribers by year end 2006, positive cash flow from operations in the fourth quarter and positive cash flow from operations for the full year 2007. We are committed to achieving all three of these objectives. The company has put in place all the elements necessary to reach profitability and at least 20 million subscribers by 2010.
I will now discuss the major events of the fourth quarter and full year 2005 and our initiatives going forward to achieve our 2006 major objectives. At the start of 2005 XM had 3.2 million subscribers and lead the competition by 2.1 million subscribers. Over the course of the year, XM increased that rate to 2.6 million subscribers adding 2.7 million net new subscribers or 45% more than we added in 2004. We closed the year with 5,932,952 subscribers an 84% year over year increase and the following week crossed the 6 million subscriber mark as holiday gift recipients continued to activate their radio. Despite an intensely competitive marketplace in the fourth quarter, XM acquired 898,315 net new subscribers, representing a 26% increase over the 713,101 subscribers added in the fourth quarter of 2004, including a 59% increase in year over year subscriber additions in the retail channel. On the other hand, our new car or OEM sales channel was weak in the fourth quarter due to higher gas prices contributing to an overall auto sales slow down at the end of the year.
As a result of our overall strong subscriber growth, we more than doubled our subscription revenue for the full year 2005 compared to the previous year ending with revenues of 503 million.
For the 2005 holiday season, we increased our media spending to counter the one time media public relations blitz surrounding Howard Stern, thus leveraging the attention of the entire satellite radio industry to raise expense brand awareness and capture mind share. This strategy also included offering attractively priced radios at the point of sale. As a result of our strategy, our direct costs to gain a subscriber or SAC rose to $89 in the fourth quarter 2005 from $65 in the fourth quarter of 2004. Your will recall that during the first three quarters of the year we maintained an average SAC of $52 in anticipation of greater fourth quarter costs. And, therefore, our total year 2005 SAC was $64 in line with the prior year’s SAC of $62.
Across 2006 we expect retail competitive activity to return to more normal levels as the current hardware promotions expire and SAC is expected to decrease significantly compared to the fourth quarter 2005. Accordingly, XM’s cost per gross ad or the fully loaded total cost including discretionary advertising and marketing costs to gain a subscriber in the fourth quarter of ’05 increased to $141 from $104 in the fourth quarter of 2004. XM’s full year for 2005 cost per growth ad was $109, compared to the 2004 CPGA of $100. In 2006, CPGA is also expected trend lower. With XM subscriber growth in the fourth quarter and for all of 2005 we continued to be one of the fastest growing consumer electronics products ever, hitting 6 million subscribers in a little more than four years. Moreover, even at the year end 2006 subscriber level of more than 9 million subs XM will have captured less than 5% of the total radio listeners, leaving us with a huge market still to conquer with XM products that can be used in the car, in the home, in the gym or on the go. What will drive XM’s continue growth? The combination of innovative radio products and our tremendous range of content that provides listeners with an entertainment experience of much greater value than the monthly subscription price.
Turning first to our radio products, XM unveiled in January a rapid evolution of our winnable radios, the Pioneer Inno™ and the Samsung Helix™, the INO and the Helix will change the way people listen to music. These sleek portable devices, smaller than a deck of cards, combine live XM and MP3, two of the most popular forms of audio entertainment over the last twenty years. Subscribers will be able to record or time shift XM content for enjoyment at their convenience, similar to television time shift capabilities, plus purchase and download their own MP3 songs and listen to their music anywhere. These products will begin shipping in March and will be available in significant quantities during the second quarter.
Other key products for XM in 2006 will be the recently introduced plug and play radios including the Audiovox Express, Delphi Rodi XT, and specifically designed for the sports fan the AGT Sportscaster. We will also introduce our first mini tuner, the XM Passport, a tiny, portable cartridge that delivers XM’s 160 digital channels to a wide array of consumer electronics product including home stereo, theater systems, DVD Players, clock radios and boom boxes. The Passport is another example of XM’s commitment to maximize our listener’s experience and making XM available anywhere they want to hear it. XM complements its leadership and satellite technology with unmatched premium music, live sports and talk programming. XM expanded its content through 2005 and its appeal will only grow in 2006 with our recent programming acquisitions.
Last week, we announced an exclusive $55 million 3-year agreement with Oprah Winfrey and Harpo Productions to create and Oprah and Friends Channel launching in September. There is diluted equity to close this deal and it will not affect XM’s objectives of achieving cash flow from, positive cash flow from operations in the fourth quarter of this year. Oprah is to women what sports are to men. 89% of women and 59% of men have a favorable impression of Oprah. The Oprah and Friends Channel will include a weekly reality show hosted by Oprah Winfrey and Gail King, as well as shows featuring Oprah’s friends, celebrities in their own right, including exercise physiologist Bob Greene, author Marianne Williamson, psychologist Robert Smith, heart surgeon Dr. Mehmet Oz and the interior design expert Nate Berkus.
Last Friday, on Oprah’s number one ranked syndicated talk show, that reaches over 49 million viewers per week, she promoted XM and the launch of Oprah and Friends by giving viewers a glimpse at the helpful advice her XM Channel will offer. Even prior to Oprah and Friends, XM was ahead of the curve developing content for women with our Take 5 channel, featuring Ellen DeGeneres, Tyra Banks, Satellite Sisters and Good Morning America Radio. Woman today represent 35% of our subscriber base and a growing segment for XM as awareness of our service increases and our factory and placement program for new cars expands. Women buy 59% of new cars and influence 80% of car purchases in the Untied States. XM is clearly the leader in women’s lifestyle content.
Oprah joins XM’s other super branded talk content, we offer the top rated cable news network, Fox News Channel and recently launched the Fox News Channel featuring some of the most well known personalities in TV news and commentary. Along with its top rated talk programming, XM offers, as you know, 67 commercial free music channels. Each music channel has a distinct sound and dedicated listeners. XM’s high profile host enhance our channels’ uniqueness. Music legend Bob Dylan and hip hop superstar Ludacris are each hosting his own exclusive XM music show starting this year; they join Tom Petty, who has a show on SM, Snoop Dog, the executive producer of our hip hop channel, the Rhyme and Quincy Jones who produces content for XM. If that isn’t enough for music enthusiasts, XM has broadcast over 1,000 live musical performances, including most recently, one by Paul McCartney as part of our Artist Confidential series.
And last week we took our listeners to the red carpet and inside the 48th Grammy Awards to our exclusive multi-year deal with the National Academy of Recording Arts and Sciences. XM also broadcast the annual pre-Grammy Awards Party, featuring performances by well-known artists, hosted by Clive Davis, Chairman of BMG. The sports band, XM offers 5,000 sporting events per year; the best sports talk and live play by play coverage available on radio. As pitchers and catchers are preparing to report to spring training, we are gearing up for the first pitch of the 2006 major league baseball season when America tunes in to its favorite pastime. MLB is the foundation of our sports lineup and we anticipate our extensive live coverage will attract a significant number of new subscribers and baseball fans as it did last year.
This year we are enhancing our baseball coverage by broadcasting the 39 games of the World Baseball Classic, featuring the United States and 15 other national teams from around the world that features stars from the world of baseball. Soccer is also in our plans for 2006. This May, XM will broadcast the play by play of 64 soccer matches of the 2006 World Cup, in both English and Spanish in cooperation with legendary sportscaster Andres Cantor. And this week we announced our exclusive satellite radio broadcast of the Big East Conference college football/basketball games, complementing similar deals we have with the ACC, the PAC 10 and Big 10. 2005 was also the first year of our ten year agreement with the National Hockey League which will become exclusive with the 2007-2008 season. XM enhances our play by play coverage with dedicated talk channels for major league baseball, and the national hockey league featuring an inside look at sports through athletes and other personalities.
As you can see, we are building brands designed for women, Hispanics, music enthusiasts, and sports fans. With XM’s leading technology and the portfolio premium content firmly in place, we are leveraging the investments in these two areas through our penetration in the automotive and the retail markets.
Let’s look at the automotive market. For the full year 2005 XM added 964,000 net OEM subscribers, an increase of 20% or 158,000 subscribers more than in 2004. While OEM subscribers grew substantially for the year, the weak auto market resulted in fewer OEM subscribers than anticipated in the fourth quarter of 2005 when XM added 114,000 net (inaudible) subscribers, a decline of 220,000 acquired in the same period in 2004. The decline was caused by a combination of two factors.
First, large numbers of promotion of OEM subscribers were added in the second and the third quarter when GM sales incentives were at their peak. Therefore, the natural falloff was larger when the promotional period spired in the fourth quarter.
Second, gas prices were up during the fourth quarter and sales for XM’s larges automotive partner fell 14% compared to the same quarter 2004, translating directly to lower OEM subscribers. So far, in the first quarter, GM auto sales have strengthened and we expect to return to a more normal quarterly pattern of OEM activations in 2006. This year, GM will introduce 19 new vehicles to refresh its product line focusing on the conversion of its full-size utility vehicle and pick-ups into more fuel efficient models, the two highest volume categories for XM factory installation.
For vehicles in its 2007 model year which launched in calendar year 2006, GM also is expected to attract XM subscribers by lowering the equipment price of XM from $325 to $195 across the board. Additionally, we have been working with all of our automotive partners to improve our conversion rate. Towards that end, GM is aggressively promoting its unique OnStar diagnostic performance service which provides the status of the vehicle’s health, along with XM activation and billing status to OnStar subscribers via email. GM has 650,000 users of the diagnostic service signed up to date and projects 2 million by the end of the year. In 2006 we expect our OEM (inaudible) to post a solid year of growth, driven by XM’s exclusive arrangements with General Motors and American Honda.
GM has produced 3.5 million cars with XM factory installed and is on track to produce 1.55 million more during 2006. Honda has already announced it will equip over 550,000 of its 2006 model year vehicles with XM radios. Most importantly, 2006 is the staging year for more substantial OEM growth in 2007, in 2008 and beyond with our newer, exclusive factory installed automotive partners. For example, Toyota and Hyundai will launch their XM factory installation programs towards the end of 2006 for their 2007 models. By year end 2006, Hyundai plans to begin factory production of XM Radios on many of its models. Toyota will expand XM availability and Lexus will commence its first XM factory installation program. Toward the end of 2007, Nissan will start contributing significant buy-ins to our factory installation OEM program, with more than ½ million 2008 model year Nissan Infinity vehicles. Taken all together, existing OEM partner plans should result in nearly 5 million vehicles with XM factory installed during calendar year 2008. Our OEM leadership position helps us secure for the long term, with the biggest and the fastest car companies
Now turning to the retail distribution channel. XM added 1,720,000 net new subscribers in 2005 and increase of 63% from the prior year. In the fourth quarter of 2005, XM added a record 782,000 net new subscribers. The fact that XM’s penetration across the retail distribution channel is expanding bodes well for the Company. Our early stage growth was driven by traditional Bid Box consumer electronic super stores, Best Buy and Circuit City, along with specialized independent retailers. As satellite radio becomes more mainstream, and XM portable radios increase market penetration, we are making substantial progress in the general merchandise outlets like Wal-Mart and Sam’s Club as well as Target, Cosco and Staples. We expect this important trend to continue in 2006 and beyond.
Finally, a brief update on our strategic partnership with Canadian Satellite Radio, known as XM Canada. In November, XM Canada launched its service and soon after conducted a successful IPO. In January, XM Canada issued guidance of 75,000 subscribers by their August 31st year end. And they expect to have 1 million subscribers by 2010. In addition to excess of 23% ownership of XM Canada, XM receives a 15% share of subscriber revenue. XM Canada is an excellent extension of XM’s network and brand and represents a promising future source of value and revenue for us.
In summary, we will be relentless in pursuing our three integrated objectives of more than 9 million subscribers by year end, positive cash flow from operations in the fourth quarter and positive cash flow from operations for the full year 2007.
I will now turn the call over to Joe Euteneuer for a detailed discussion of XM’s financial performance.
Thanks Hugh. 2005 was another year of significant growth for XM Radio. We continue to build a solid customer base by adding 2.7 million subscribers. This morning I will focus my comments on three areas: 2005 results with year over year comparisons, fourth quarter 2005 trends and a look ahead at 2006.
First I’d like to comment on the makeup of XM subscribers and refer you to the financial attachment to the fourth. quarter and year end 2005 Press Release.
XM added more than 898,000 subscribers during the fourth quarter and ended 2005 with 5.9 million subscribers. XM’s total subscribers at year end fall into four categories:
First, XM ended 2005 with 5.5 million self-paying subscribers, making up approximately 91% of our total subscriber base, an increase of 93% or 2.6 million from the prior year.
Second, OEM pre-paid promotional subscribers totaled 461,000 at year end 2005, an increase over the 402,000 at year end 2004. OEM pre-paid promotional subscribers as a %age of our total subscriber base decreased to 8% at year end 2005 from 12% at year end 2004.
The balance of our total subscriber base reflects 44,000 rental car subscriptions and 19,000 data services subscriptions. Data services subscribers consist of those customers receiving stand alone XMWX Satellite Weather service and XM Radio on-line service.
For the first time, we are reporting these data services subscribers separately on the financial attachment to our quarterly release since they are growing rapidly. While we are pleased with the 2.7 million net new subscribers added in 2005, and our strong growth potential going forward, we were disappointed in not achieving our increased subscriber guidance objective of 6 million total subscribers by year end, while we surpassed the 6 million mark during the first week of January instead.
Last July when we increased our subscriber guidance from 5.5 million to 6 million following our strong second quarter results, we did not anticipate the depressed level which reached our sales during the last quarter of 2005. Simply put, our strong retail sales were not able to offset fully the softness in our OEM channels. Subscribers value their XM service highly, with strong word of mouth recommendations and continued moderate churn levels. The churn rate on self paid subscribers for the fourth quarter was 1.57% with full year 2005 churn coming in at 1.46%. We continue to see little difference in churn between self pay subscribers acquired through retail versus those acquired through the OEM channel.
As a result of growth in our subscriber base and the upcoming renewal of discounted annual rate plan, we expect slightly higher churn in 2006 than in 2005. In addition the self paying churn levels, we also tracked the OEM conversion rate for the %age of OEM promotional subscribers who eventually become self paying customers after the promotional period expire. The conversion rate in the fourth quarter 2005 was 54.3%. Now let’s move to revenue. Total revenue increased 128% to 558 million for 2005, from 244 million in 2004. This increase in revenue was due to the significant growth in our subscriber base, in addition to an increase in the average revenue per subscriber. Recurring subscription revenue for 2005 increased 128% also to 503 million from 220 million for 2004. The run rate of our recurring subscription revenue for the fourth quarter 2005 was 625 million annually. In 2005 ad revenue was $20 million, more than double that of 2004, and this trend of significantly increasing ad revenue will continue into 2006.
Accents recurring average subscription revenue per subscriber or ARPU for all subscribers increased to $9.51 for 2005, compared to $8.68 for 2004. This ARPU reflects the positive effect of our April 2005 increase partially offset by greater participation in annual and multi-year prepayment plan and family plan subscriptions. We expect this gradual increasing ARPU to continue in 2006 as the impact of our 2005 rate increase takes effect with our annual prepayment subscribers.
Annual and multiple and multi-year prepayment plan subscriptions contribute significantly to our cash flow, and now represent approximately 42% of XM’s 2005 NE subscribers, compared to 24% of 2004 NE subscribers.
Family plan subscribers had grown to 19% of our 2005 NE subscriber base, up 7 %age points from 2004.
The average prepayment period for annual and multi-year plan subscribers is now 9.2 months, compared to the 6.9 months reported at the end of 2004. These prepayments are included in subscriber deferred revenue, which was 361 million at year end 2005, compared to 152 million at year end 2004, an increase of 209 million for the year. These prepayments are an important element in allowing XM to reach positive cash flow from operations prior to reaching EBITDA break even.
Variable expenses which include the cost of equipment sales, revenue share and royalties, customer care and billing and ad sales and excluded such costs as CPGA expenses were 220 million in 2005 up from the 109 million in 2004.
Changes in variable expenses are the direct result of growth in revenue and subscribers. The contribution margin of our subscriber business which equals subscription revenue minus revenue share, royalties and customer service cost increased 8 %age points to 66% of revenue for the full year 2005, compared to 58% for the full year 2004. Increasing contribution margins to lower variable expense as a % of revenue is a clear indicator of the economic leverage the Company is capable of achieving. We expect this trend to continue in 2006.
Fixed expenses which include satellite and terrestrial, broadcast and operations, programming and content, research and development, general and administrative and marketing retention and support were $282 million for the full year 2005, up from $158 million for the full year 2004. This increase in fixed expenses was largely due to new programming content initiatives in 2005, including those associated with major league baseball, the national hockey league and the expanded content for women and Hispanics as well as increased broadcasting operation expense to support these new channels. The remaining elements of this increase are the cost of support XM3 satellite operations, additional R&D efforts associated with next generation technology such as the Inno™, the Helix™ and higher G&A expense related to significantly higher subscriber rates during 2005. Our guidance of positive cash flow from operations in the fourth quarter of 2006 is inclusive of the full year effect of these 2005 initiatives as well as the addition of Oprah and Friends to our programming lineup.
I will now address subscriber acquisition costs of SAC and the fully loaded cost per gross addition of CPGA both of which are calculated on a per unit basis. Subscriber acquisition costs as a subset of CPGA and reflects the direct cost of manufacturer subsidies, distribution expenses, promotion and the negative margin on direct equipment sales. XM SAC for the full year 2005 was $64, compared to $62 in 2004. In the fourth quarter, SAC increased to $89 as a result of significant promotion and discounting during the competitive holiday season.
The draw to measure of cost per gross addition or CPGA is the fully loaded measurement of the cost to gain each new subscriber. CPGA includes SAC, which we just discussed, as well as all discretionary advertising and marketing costs. CPGA for the full year 2005 was $109 compared to $100 in 2004. During the fourth quarter, CPGA was $141 due to our increased media spending. We expect SAC and CPGA to drop sharply in the fist quarter as we scale back media spending and hardware discounts. It is important to say that fourth quarter $89 SAC and $141 CPGA were abnormally high based on the need to counter a one-time marketplace channel. SAC and CPGA will come back in line and will improve upon previous ranges during the rest of 2006.
As a result of the fourth quarter marketing costs discussed previously, XM’s EBITDA loss for the fourth quarter 2005 was ($199) million, including de-leveraging charges of $25 million, compared to an EBITDA loss of ($140) million which included de-leveraging charges of $42 million for the fourth quarter 2004. The EBITDA loss for the full year 2005 was ($434) million which included de-leveraging charges of $28 million compared to an EBITDA loss of ($388) million including de-leveraging charges of $77 million in 2004. As a consequence, we missed our EBITDA guidance for 2005 of $395 million which did not include the $28 million in de-leveraging charges by $11 million. Although we expect once again, to add a significant number of net new subscribers in 2006, the business has now reached sufficient scale that we expect will absorb the increased subscriber growth expenses while significantly reducing our EBITDA loss.
In 2005 total expenditures totaled $180 million as compared to $170 million in 2004 and it was in line with our expectations. The majority of capital expenditures were for satellites, with the balance for back off assistance to support our growing subscriber and revenue base. At the end of 2005 XM had total cash and short term investments of $711 million and an un-drawn GM facilities of $135 million. Taken together, the total liquidity position of XM as of December 31, 2005 was $846 million, representing adequate funding to execute our business plan and achieve positive cash flow from operations in the fourth quarter of this year
In 2005 we continue to strengthen XM’s balance sheet by selected de-leveraging activities. Specifically, in 2005 XM redeemed or entered into agreements to exchange debt with carrying value of $80 million, $94 million accrued at face value at maturity for $41 million of cash, 18.3 million common shares. This activity related to the retirement of 100% of the 23 million face of our original 14% notes due 2010, 15 million of our 12% notes due 2010 and 56 million of our 10% notes due 2009.
From these activities we recognize de-leveraging charges of approximately $28 million while eliminating $45 million of future interest payments. Our primary de-leveraging focus recently has been to stimulate early conversion of our 10% notes due 2009 since the notes term cash pay effective January 1, 2006 of this year. These notes appear as debt on our balance sheet although they are convertible as common stock at $2.18 per share. They will ultimately be converted into liquidity and are currently counted in our full diluted share count. If these instruments are not yet callable, we have incented the conversion of a number of these notes at the end of the fourth quarter where we transacted the $56 million exchange. In January, 2006 we exchanged $52 million of these notes for 17.1 million shares. We estimate this transaction will eliminate an additional $21 of future interest payments over the next four years. We will recognize an approximate $18 million de-leveraging charge in connection with this transaction in January 2006.
We believe that encouraging conversions of these highly in the money convertible notes positively benefit the Company. In addition to the extremely forward de-leveraging efforts, we believe the Company’s improved financial position and credit may permit an overall lowering of the cost of our debt. This could include simply lower coupon financing of some of our more expensive debt instruments or even establishing a more classic bank reviver to add standby liquidity without bearing the cost of carrying excess cash on our balance sheet.
In November 2005, Canadian Satellite Radio or CSR, the Company’s exclusive Canadian licensee launched its satellite radio service in Canada and issued XM 11.1 million shares of common stock representing a 23% equity ownership with a fair value of $152 million. The associated gain from this equity issuance will be amortized in the net income over the expected fifteen year term of the contract. As a result of this investment, we will record our 23% share of CSR’s net income or loss in our income statement on a quarterly basis.
In addition, we will receive 15% of all subscriber fees earned by CSR for its basic service. In July 2005 we made a $25 million investment in the common stock of WorldSpace, a leading satellite provider for Asia, Europe, Middle East and Africa. In addition, we acquired warrants to purchase 37.5 million in additional WorldSpace stock. This investment is mark to mark quarterly in the equity section of our balance sheet.
Also in July, XM announced an agreement to acquire WCS Wireless for 5.5 million shares of the Company’s Class A common stock. The principle assets of WCS Wireless are the wireless spectrum licenses in geographic areas covering 163 million people throughout the United States, including 15 of the top 20 metropolitan markets. XM and WCS Wireless are waiting necessary regulatory approvals for license and ownership transfer.
Now let’s look at an overall recap for the full year 2005. XM finished the year with 5.9 million subscribers, subscription revenue of $503 million, fourth quarter recurring subscribers annual run rate revenue of $620 million, a full year SAC of $64 and CPGA of $109 and an EBITDA loss of ($434) million, approximately $11 million higher than our $395 million guide in, excluding the de-leveraging charges in primary to higher SAC and CPGA.
For 2006 XM expects to achieve more than 6 million ending subscribers, I’m sorry, more than 9 million ending subscribers, subscription revenue of $860 million and EBIDTA loss of ($250) million, excluding the impact of any de-leveraging activities and the expensing of employee stock option expense.
Finally, we project that XM will achieve positive cash flow from operations in the fourth quarter of 2006. Hugh, back to you.
We’re now ready to take your questions. Operator.
At this time I would like to remind everyone if you would like to ask a question, please press star and the number one on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster.
Our first question comes from Jonathan Jacoby from Bank of America Securities.
Thank you. Three questions to you. The first just to get a little more color on sort of the expense side? Should we view the declines off the year end ’05 numbers meaning the fact of 64 in CPGA of 109 and if you’re comfortable with things like will these declines coming in ’06, can you give us a little viability on what you’re seeing in the retail channel right now, not just in your promotions but sort of perhaps with your share versus your competitor, and then really, that question will be the last question, on the conversion rate as respect that it came down a little bit to 54%, what are you seeing now sort of could you give us a little color as to what’s happening and where we go from here? Thanks.
Joseph J. Euteneuer, Executive Vice President and Chief Financial Officer
Hey Johathan. Yeah, the on the stock and CPGA side again fourth quarter was clearly an aberration, where as Hugh and Joe said we’re expecting that to really trend lower through ’06 and clearly off of the fourth quarter levels. I’ll remind you that you know both SAC and CPGA if you look at the first three quarters of the year the trend is very low, so we really expect to be able to repeat those lower levels. In retail channel we really don’t know what the fourth quarter net results we’ll see those when SIRIUS reports their quarterly numbers per share but total net share was about 44% in the forth quarter and that’s probably reflective of what we expect in the retail channel. And I think your last question was related to the conversion rate? We came in around 54% for the fourth quarter. And we do see that as a low point, in fact, we saw October came in that was actually our lowest point in the fourth quarter and we’ve seen some pickup since then. So I think we do see some of the trends heading in the right direction, particularly with some of our new programming that we’ve added and some of our improved trial contact procedures, we expect that to pick up.
Our next question comes from Robert Peck with Bear Stearns
Hey guys, a couple of quick questions on content. Could you tell us what your thoughts are on the Q1 impact from Howard Stern? Do you expect to see sort of a spill over effect that’s going into Q1 and with that, have you seen any sort of geographic split? Have you been hit more in the northeast, on the west coast? Any sort of color where you’re seeing an impact from Howard Stern. Number 2 is, can you disclose how many people, I know there aren’t major league baseball subs per se, could you maybe give us some color around the attractiveness or how many people are taking XM because of major league baseball, and lastly, could you see if you can give us a little more color around the resignation and the current direction of the Board right now?
I don’t have the numbers on major league baseball, but in the past what we have said is based on some surveys we did it was like 60%-70% of new subscribers during a particular period signed up to XM for major league baseball, based on their responses to questions we get out of our customer service center and some other research we did. With regard to the impact of Stern, in January, I think basically he remained pretty strong in the first week and a half or so because he was obviously launching on January 9th so you still had, you had a normal decrease in total retail activity going into January, and you had an increase I think in Stern subscriptions or radio purchases in the first two weeks.
And lastly, on the Board issue, this is Gary Parsons, Bob let me hit that one since it is a Board Related issue and going into a little bit of depth on it, you know this morning we did issue an AK noting that Jack Roberts who served for five years on the Board was stepping down and Jack’s explanation of that departure involved his concerns but frankly XM was spending too heavily in order to achieve the rapid growth that we were experiencing and his belief that slowing down that spending would result in a more immediate positive cash flow. And Jack expressed his concern for some period of time while other Board members supported stronger programming content, marketing efforts and accelerated growth. And frankly, this is a balancing act for management and for the Board, we take very seriously the differing opinions are quite similar to the differing opinions we hear when we visit investors at large. We clearly understand that the company can turn strongly positive on a cash basis as soon as we pull back on the accelerator. But we also understand that adding you know significant assets and enterprise value comes with every subscriber that we add and as long as we continue to do so by the way, on economically rational terms. Frankly, based on the numbers from the fourth quarter we did grow strongly but we failed to do so as economically as we had expected or planned to. In prior quarters and in prior years we have grown strongly and we have grown cost effectively or economically. And we feel frankly, when we look at the ’06 plan that we will continue to grow strongly and economically and will return to that pattern of solid economic returns and growth with a moderating SAC and CPGA, declining EBITDA losses, positive operating cash flow later in the year and you know we feel very positive about the upcoming ’06 outlook. And on a personal note, frankly, Jack has been a long-time friend of mine, you know, I hate to see him go and frankly, I think that we put together a Board specifically designed to have a strong diversity of views, people with different backgrounds from finance and marketing and media and the car companies and others and I think in the long return that sort of diversity does build a stronger company.
Your next question comes from Craig Moffet with Sanford C. Burnsted
Good morning guys. I’d like to draw down a little bit more on conversion rate if I could. You said in the past you expected to come back up, could you give us some of the reasons that customers don’t convert, and are there any changes in those reasons, and then what specific initiatives you’ve got in place to try to raise their conversion level going forward and then if you could de-average the conversion rate a little bit, are you seeing different conversion rates in high end vehicles versus low end vehicles, in different sales processes and that sort of thing that can give us some comfort that the conversion rate can actually turn around?
Okay, hey this is Steve again, I think that we have seen as I mentioned the in the past some softening of the conversion rate. What we have also seen though is when we add new content that helps in terms of our conversion a lot of the customers that fail to convert say that they’re doing so just because they don’t see the value or they’re not spending sufficient in the vehicle so as we add more content, particularly content oriented towards the female buyer, that’s really going to help. We do see differences in conversion rate based on vehicle type, higher end vehicles, full size trucks, utilities and luxury cars do convert at a slightly higher level than lower priced vehicles. I think there’s some natural evolution as you push into more mainstream vehicles that you’ll see conversion rates tend to pull down, what tends to work counter to that is the fact that as our awareness increases and content improves and the whole value equation improves, then that tends to be a force that pushes things up. So, we said in the past, we think we can manage it sort of in the mid-50% range and we believe that’s the case.
I think one thing you should note though is, in the third and fourth quarter you had a specific auto industry issue as it related to fuel prices being high, General Motors obviously had a certain number of challenges that they were meeting and that affected their auto sales. Clearly there’s a bit of a trickle down effect during that quarter. Weaker sales, you know maybe even weaker activations, clearly GM was also in the process of spending a period of time converting its very high volume and important SUV and trucks to their more fuel efficient models which also probably caused some of the conversion rate issue. Clearly what’s happened, what we’re seeing in the first quarter is GM is coming back stronger because if you’ve seen all their advertising and now they’ve taken the Tahoe some of these other key products that they have and exercising their fuel efficient gas mileage and I think that’s going to help in this process and as I mentioned earlier, OnStar is now working pretty aggressively to communicate more with its subscribers with regards to this diagnostic that they have and in the tool, it let’s people know what the status of XM is along with the status of the more important things actually in the car. We think that this communication is going to evolve to help us get conversion rates up, get activations up because of the sort of integration we get with OnStar going forward.
You said in the past that there’s a disconnect between the number of people who have the ability to get XM and the number of people who know they have the ability to get XM that it’s some people just don’t know they have it. Is that something you’ve been able to a gap you’ve been able to close of reaching out to non covents and making sure at least they know the option is there?
Yeah, it is that is a day to day, week to week blocking attack we issue. What we actually do is we have you know regular meetings with General Motors on various levels of the company and a quarterly meeting where we have a score card where we go through a variety of these issues that you just raised which is what is the statistical result of a particular period in terms of how many subscribers who they poll actually were aware of XM? And some across their dealers sometimes we have very high results from these subscriber surveys but sometimes we have low. Clearly what is happening is certain other variables you know impact the auto market then they impact our ability to have dealers talk about XM if there are other bigger issues going on, so it is a day to day week to week blocking attack issues but you’re very, you’re totally pointing out something that we focus on and constantly try to improve.
Our next question comes from April Horowitz with Hoeffer and Arnett
Hi, good morning. A couple of quick questions on the family plans, last year you were 15% now you’re at 19%, which comes out to be about 1.2 plus radios per self paying subscriber. Can you give us any color as to where you think that will go you know in 2006 and then if you could any color on churn as it relates to family plan subscribers and then I have a follow up.
I think the second part of your question was churn as it relates to family plan? Clearly our family plan subscribers and our multi-year subscribers tend to be our stickiest subscribers. Those have the greatest commitment to the Company and tend to have the lowest churn over all and relative to where we see that family plan levels going in the future, I think you’ll see very gradual, probably not as quick escalation as you’ve seen in the past but a very gradual increase of that as you go throughout 2006 and frankly, one of the things as we look even further out in the future, when we start seeing the 2008 or 9 time frame when you’re actually putting out 5 million new car in factory installment installations, and you get a very large group of people there that have it fixed in their car, they have it, they love it, they enjoy it, that is a driver for them to then go get that family plan subscription for the home or some other car.
Is Nissan and Hyundai when they start rolling out their cars are they also going to have a 3 month promotional program or are they going to sell one year subscriptions? Can you give us any color as to how to think about that when they come aboard?
Sure April. Right now their plan is to launch with a 3-month commercial plan and that’s worked well for us.
And lastly, with respect to becoming (inaudible) positive (inaudible), that churn, does that include any special promotions you know try and guide (inaudible) subscribers or is that sort of just business as usual?
No, that’s pure business as usual.
The next question comes from Lucas Binder with UBS
Hi guys. I want to focus in a little bit on the cash flow from operations comments. First of all, is this changing your outlook to actually be free cash flow positive in 2007? And secondly, with respect to capital expenditures expected for satellites in 2006 and 2007, can you discuss a little bit about what we should expect our account backs this year on into next?
Lucas, we’ll probably have to catch up with you on this specific quarterly amounts of what the satellite CAPX program is or something like that. Maybe we can do that on a model type of a basis, but you know, I don’t think we’ve given any free cash flow guidance. It’s clearly that the satellite construction thing is the biggest thing and that’s disclosing the cash flow statement.
So you expect to are you still expecting to be free cash flow positive in ’07?
I don’t know that we’ve ever given that guidance.
Basically what we’re seeing, Lucas is if you take the positive cash from operations right off the statement of cash flows, that is going to be positive starting in ’06 and for the full year of ’07.
Thank you very much.
Your next question comes from David Bank with RBC Capitol Market*
Thanks, good morning. Three questions. The first one is you know appreciate the sense you’re giving us for the trends on CPGA, can you give us a sense you know talk about returning to normal, are we expecting a CPGA number in the fourth quarter, in the first quarter of ’06 to be sort of a sub 100 number or is it going to take awhile to get back there? The second question is, I’m a little confused because in previous quarters or at least at last quarters call, we talked about the conversion rate down ticking a little bit, probably more due to some of the aggressive promotions that GM made on auto sales and it kind of sounded like a lot of people who might not necessarily have bought cars, bough cars, they’re really price sensitive, they were more likely to churn, had a little bit less to do with the price of gas. And so I just kind of wanted to know has your view changed a little bit because, you know it’s really hard to predict the price of gas and I’m trying to get a sense of how much of this is about really price sensitive people that bought cars versus some other factor. And the last question is, anecdotally, you know we know that Oprah Winfrey has something like between 10 and 15 million unique viewers every week, so, Friday was the first big push from a publicity standpoint on the show. Have you heard anything anecdotally about you know were there any retail sale pickups and can you talk a little bit you know more about how you think Oprah can feature the product on here TV show and what you think that will do for sales?
Well that’s three very separate questions. Let me maybe hit the first two and Hugh will hit the last one there. First, very directly to your question on CPGA and how long does it take to come down and will it be sub 100, the answer is it will be sub 100 immediately. And once again, we just don’t see that as being the normal trend. It was something that we had warned and projected the fourth quarter was going to be high, but yeah, it will be back to its normal levels immediately. The second part of that was just a little bit on the conversion back to the conversion rate and why we have pretty good confidence that it is coming back up. In the first one, it’s just what we’re seeing on a monthly basis. I think Steve indicated October was the low point and both November and December and actually our January numbers have all ticked off from that standpoint, and then secondly, I would mention that as we’ve kind of noted in the past, some of that conversion level is also controllable by the amount of packing that you do, whether it’s a 3 pull option where the person just actually buys the XM radio as an option in the new car versus whether it’s packaged in as part of a premium group or standard equipment. So to the extent that you in fact want to move it a little bit more to the stand alone option, you will immediately get a tick off in your conversion rate, so some of that is within our control. We’re comfortable at least in the ’06 timeframe that that’s moving in the positive direction. Oprah, do you want to hit that?
I was with Oprah last week when we made the announcement. I was there for the taping of the show, I think we reached about 15 million people where she basically spent the show promoting the announcement that Oprah and Friends will be on XM. Obviously, Oprah supports her friends, she supports her partnerships. Clearly, she will be very careful about how she markets it and commercializes it, you know she has a certain relationship with her very, very, devout fans. I know she will do to the point where it makes sense and is appropriate, but she will clearly not be hawking it in a way that’s going work against her kind of brand image and identity. But she has indicated on the call that she’s very excited about this relationship, clearly she’s an enormous supporter of her friends and she’s going to have a weekly show. So, we’re pretty excited that however she selects to promote it, it’s going to be extremely effective and help us build to this 9 million subscriber level by year end and grow the business even beyond that.
Do you see any kind of pick up after that show aired?
There’s a little buzz at retail from the sales associates, but remember it takes a number of weeks to get the in-store materials out there, which we’re in the process of doing, but yeah, I haven’t really seen it in the tick up in the numbers yet but we expect to see as the materials get out there we’re really able to market it.
Okay, great. Thanks a lot. Good luck with that.
I think we have time for one more question
Okay, your next question, your final question comes from Jason Helfstein with CIBC World Market
Thanks. Two questions, first you made a comment earlier about you were focusing on your trial contact procedures relating to OEM’s. (inaudible) you were spending more money to do that, would that show up in retention of support or advertising and marketing? That’s question number one. Question number two, it looks like the implied increase in ARPU for 2006 which is back of the envelope at about 50¢ kind of and it looked like in the back half of the year you guys (inaudible) of the question is, does (inaudible)
The most successful television personality I think she’s associated with she normally associates with leaders in different categories and (inaudible) in satellite radio, I think she’s (inaudible), I think the relationship will be (inaudible) over the last couple of months, with introductions that we got to Oprah to various people who are friends and our own personal appeals, and she came and visited us last summer, and then the relationship developed and we consummated the deal just recently.
The other question was on ARPU growth and VAT, VAT does not I think reflect any unusual rate increases or things like that in there. That is a flow through just on a normal basis.
But there’s an inherit delay. You guys raised the price April 1, it takes awhile for that to flow in.
Absolutely. Because of the number of people on annual and multi-year pre-payment plans, you’ll see the effect of that rate increase halfway throughout ’06 and ’07, but on a very you know even basis, because the other thing you’ve got to remember, Jason, is the fact that we do have family plan that will continue at a slow growth rates and also the annual end year plan.
And relating to that ARPU, when you, if you give someone let’s say additional (inaudible), does that effect ARPU.
So we’ll see some of that as well. And then the last question. Where does it show up?
It shows up in advertising and marketing.
I will add that a lot of the things we talked about or we’re envisioning are not really things that cost incrementally, like the vehicle diagnostic report that Hugh mentioned, that’s something that GM is doing on their own.
Thank you very much, I think that concludes our call.
This concludes today’s conference call, you may now disconnect.
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