Sirius Satellite Radio 2005 Financial and Operating Results Conference Call Transcript (SIRI) February 17, 2006 ET
Michelle McKinnen, Senior director of Investor Relations
Mel Karmazin, CEO
Jim Meyer, President of operations and Sales
Scott Greenstein, President of Entertainment and Sports
David Frear, EVP and CFO
Eileen Kavel with Citigroup
Bob Peck with Bear Stearns
Benjamin Swinburn with Morgan Stanley.
Lorraine Mancini, with Merrill Lynch
April Horowitz with Hoeffer and Arnett
Craig Moffet with Sanford C. Bernstein
Lucas Binder with UBS
Michelle McKinnen, Senior Director of Investor Relations
Good morning everyone and thank you for participating in this morning’s call. Today, Mel Karmazin our Chief Executive Officer, joined by Jim Meyer, President of Operations and Sales and Scott Greenstein, President of Entertainment and Sports will review our 2005 achievements and current outlook. David Frear, our EVP and Chief Financial Officer will discuss our 2005 financial results and provide guidance for 2006. At the conclusion of our prepared remarks, Mel, David, Jim and Scott will take your questions.
I would like to remind everyone that certain statements made during this call might be forward looking statements 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’s filings with the SEC. we caution listeners not to rely unduly on forward looking statements and disclaim any intent or obligation to update them. Now I will turn the call over to Mel Karmazin for his opening remarks.
Mel Karmazin, CEO.
Thanks, Michelle. Good morning everyone and thanks for joining us today. 2005 was an excellent year for Sirius and 4th quarter results were our strongest ever. In 2005 Sirius also had significant strategic accomplishments as listed in our press release, including extending all of our exclusive OEM partnership agreements, launching service in Canada, creating the first satellite radio partnership with the wireless industry and our relationship with Sprint, strengthening our balance sheet and liquidity and expanding our management team with new key hires.
One year ago, we promised parity with our competitor in retail market share and we certainly delivered that. In 2005 Sirius achieved 55% retail market share for the full year and 61% retail share in the 4th quarter, using NPD data. When the consumer has a choice, they pick Sirius. This is dramatic improvement for us in the very important retail channel and it will continue in ’06. Remember, content matters every day when the consumer is making their buying decision. Full year revenue for 2005 of $242 million was up 262% from prior year, solidly beating expectations and our revenue guidance. For 2006, we expect revenue to dramatically jump to approximately $600 million, a 148% increase above 2005.
Advertising revenue increased over 500% in 2005 to $6.1 million and we have significantly more advertising commitment already on the books today than we had in all of 2005.
January, which is historically a slow advertising month, was the highest ad revenue month in Sirius’ history reflecting the very strong advertiser interest in Howard Stern. We will continue to expand our sales staff in 2006 as advertising will be an important component of our business.
Continue low average monthly subscriber churn of 1.5% for the year as well as 4th quarter, indicates continued high levels of customer satisfaction among Sirius subscribers. Our customers continue to rank us very high for overall satisfaction, likely to continue to subscribe and likelihood to recommend our service to others. Brand awareness of satellite radio also continues to rise. At the end of 2005, approximately 80% of the population in the US now indicates familiarity with the industry. And our research ranks us higher than our competitor in unaided awareness, providing us with great confidence for our growth prospects.
SAC per gross ad also improved as we said it would. We came in at $139 SAC per gross ad, beating our guidance of under $145 and delivering $113 per gross ad in the 4th quarter. The 4th quarter SAC per gross ad of $113 was approximately the same as the amount our average customer prepays us and marks the first time in our company’s history that our prepaid revenue per subscriber closely approximated our SAC per gross ad. We also expect SAC per gross ad to improve another 20% in 2006, approaching $110.
For the full year of ’06, we anticipate cash prepaid per subscriber to be greater than SAC per gross ad. This contributes significantly toward our path to free cash flow positive.
Going forward, we anticipate 2006 to be another great year and we are off to a fantastic start. We also expect to continue our significant progress in the OEM channel. We anticipate that we will increase our OEM subscriber base in 2006 by more than 100%. Combine this with our parity at retail and you can see why we are so bullish about ’06.
In December, Sirius contributed the industry’s first and by the way so far the only combination MP3/satellite radio in the marketplace. I will let Jim give you an update on reaction to the S50, as well as some exciting new products we anticipate introducing. You will hear about our first live satellite radio wearable product with MP3 compatibility, targeted for this summer. We recently demonstrated this wearable product to senior management of our retail partners at the consumer electronics show and they were very excited about it. Scott will fill you in on our programming initiatives but I want to comment on a few things.
We have said this before and I repeat it today, Sirius has the best programming in all of radio. All you need to do is compare our lineup with any other radio offering and we are sure you will agree. There is no missing piece to our platform. Whether it’s sports, including the NFL, NBA, college football, basketball, NASCAR which will be joining Sirius in January of ’07, our music programming, women’s programming including Martha, soon to be launched Cosmo, our news or our Oh Wow entertainment programming, including our comedy, the upcoming Playboy channel and the one and only Howard Stern. Sirius’ content is superior to anything being offered on radio. You will continue to see us add new and exciting things. We have a couple of deals that we are very excited about that will be announced shortly when the agreements are fully signed. These new programs are not material in cost, but will further enhance our lineup.
On the issue of Fox News, we have said that we think their content is great, the brand is terrific. We respect and like the people involved and we want them on Sirius. We were unable to reach an agreement with them at the end of the year and Fox went off Sirius and they lost our approximate 6 million listeners. We continue to negotiate with them over the last 6 weeks and I’m very pleased to report that Fox will be returning to Sirius in March. We were able to secure all of the programming at a price acceptable to Fox and at a significant reduction in the cost that we would have had to pay in December. We are very pleased, both for our subscribers and our shareholders, that fox will be added back to Sirius. Since this was non-exclusive content, and there were reciprocal MFN’s for both satellite radio companies, our negotiations also enabled our competitor to receive Fox at our lower rate.
Lastly, David will take you through our financial highlights for 2005 and our guidance for ’06. But I would like to make a few observations.
First, our operating cash flow in the 4th quarter was an 84% improvement over the use of cash in the 4th quarter of 2004. $99 million used in the 4th quarter of ’04, down to only $16 million used in the 4th quarter of ’05. With this performance I want to reiterate that we continue to believe we could reach free cash flow break even as early as the 4th quarter of this year and for the full year of 2007.
Today, we are providing more long term guidance and that is, we estimate revenue of approximately $1 billion in ’07. And when we look out to 2010, we see revenues of approximately $3 billion and free cash flow of approximately $1 billion. And, upon achievement of our ’06 plan, we will be on target to deliver this. Satellite radio is red hot and I think you will all agree that Sirius is on a roll. And we’ve delivered on all of our commitments that we have made. Sirius is off to an explosive start this year and is on track to deliver a great ’06. We will add even more subscribers in ’06 than we did in ’05. The ride has just begun and things look great.
I’d like to turn the call over to Jim Meyer who will fill you in on all of these exciting things happening in his area.
Jim Meyer, President of operations and Sales
Thanks Mel. Let’s start with a look first at the retail channel. Perhaps the best news of all in the 4th quarter was a very strong overall industry growth of over 90%. Satellite radio was clearly a very hot product in the Christmas selling season. Sirius achieved outstanding results in the retail channel in the 4th quarter, with approximately 901,000 net additions, 139% growth versus 2004.
This explosive performance resulted in a fourth quarter NPD market share of 61% and more importantly a full year market share of 55%. If you adjust the NPD data to include estimates for Wal-Mart, Sam’s and Costco who do not report, our full year market share was approximately 52-53%.
We were very pleased with our fourth quarter performance, but more importantly all of our retail partners experienced significant growth in the 4th quarter, making satellite radio a very important category for them going forward.
Growth through the first 6 weeks of 2006 has been outstanding for us and we feel very good about the first quarter outlook.
Despite our best efforts, we did experience some product shortages in the holiday timeframe, which we are now rectifying. Of particular note are the very strong sales of our Replay, priced at $149 and promoted at $99 for the holiday season, which significantly exceeded our expectations. We are working very hard to get this model back in stock.
We expect strong growth in 2006 from all of our retail partners. In addition, we have also taken steps to improve our share position at Wal-Mart and expect to make real progress here in 2006. Now let’s talk about product for a few moments.
In the 4th quarter, we introduced the critically acclaimed S50. The industry’s first wearable device with MP3 capability. Sales were strong and more importantly we’re receiving great feedback from subscribers who use this exciting new product. The S50 in my opinion is the most technically advanced product in the marketplace and will continue to be unchallenged in the first quarter. Building on the technology of the S50, we will introduce a new line of wearable products targeted for this summer. These exciting new products will feature live satellite radio in a portable mode, mp3 capability, a buy button for easy purchase of favorite songs from our music channels and a few other surprises we think the consumer will like. We showed this product to select retail partners privately at the CE show and received great feedback.
One point I do want to make, is that while much is written about the portable satellite radio category, it continues to be a relatively small category. In 2005, it represented approximately only 12% of NPD industry sales and more importantly, less than 7% of total satellite radio net additions. While I expect this category to grow in 2006, I think the majority of new subscribers still see satellite radio as a car experience.
In 2005, we also made very strong progress in driving down the cost of our new products, which allowed for a significant reduction in SAC. We will continue to stay very focused on this in 2006 and expect to make a lot more progress here in the 12 months ahead.
Now let’s move to the OEM channel.
As Mel indicated, we also had a very strong 4th quarter in the OEM channel. Net adds of approximately 242,000 which was 134% growth vs. 2004. Perhaps more impressive was full year net adds of approximately 620,000, which was growth of 240% vs. 2004. Strong 4th quarter results, which were driven primarily by two factors. First, good performance with Daimler Chrysler where we now have available Sirius radio as a factory install in 90% of the Chrysler vehicle lines. And also, a strong ramp up of the Ford rollout, which began in mid-September. We were particularly pleased with the take rates for the F-150 truck group, by the way, America’s number one selling truck, where order rates exceeded our projections.
As we focus on the 1st quarter and the rest of 2006, to be honest it’s difficult to predict what overall US auto industry sales will be. We are confident, however, that we will double our subscriber base in this channel and finish 2006 with at least 1.65 million net OEM subs. In the 4th quarter, we extended our exclusive agreement with Daimler Chrysler through 2012. High volume installations continue in virtually every Chrysler group vehicle line. We are continuously working together to explore ways to drive higher penetration rates. We’re quite pleased so far with our performance so far at Daimler Chrysler and we expect an even better 2006.
On the Ford front, we now have five vehicle lines up and running with satellite radio factory install. Perhaps more importantly, in the remainder of 2006, we target to add 14 additional new vehicle lines with Sirius available as a factory installed option. Current order rates are good and we expect dramatic growth with Ford in 2006.
We’re also seeing good progress with Mercedes Benz. We expect to see significant increase in penetration rates in 2006 and we’re very optimistic here.
And finally, we announced in the fourth quarter an exclusive deal with Rolls Royce for standard equipment with a pre-paid lifetime sub. If only they could all be like this. Now let me turn it over to Scott Greenstein.
Scott Greenstein, President of Entertainment and Sports
Thanks Jim. In the area of programming, Sirius continued our practice of signing and executing the best programming in all of radio entertainment in all of 2006 and certainly in the 4th quarter we clearly reached mainstream and niche audience with superior publicity making offerings. However, before I get to programming details, let me talk briefly about brand awareness. By creating in-house the best content in radio and partnering with premier brands, we’ve been able to generate nationwide publicity for our programming that has heightened the brand awareness of Sirius. In that way, our programming serves two very important purposes that you’ve heard me stress on numerous calls before but it’s clearly highlighted in the fourth quarter. First and foremost, our programming will make Sirius the best programming provide in radio, but it will also result, also the resulting publicity and marketing efforts that come with some of that content, will prove to be an effective substitute for marketing dollars spent and a compliment to enhance any marketing dollars we did spend.
In January, Sirius’ unaided total brand awareness reached unprecedented levels. Our unaided awareness of Sirius was more than 10 percentage points higher than our competitor, Sirius’ brand awareness among men and women, individually in separate categories and collectively as a whole, was significantly higher for us than our competitor. Our content is being recognized every day in the retail and OEM environment and it list sticking in the minds of consumers.
Let’s look at some specific highlights in our voluminous lineup of programming content.
First and foremost, Howard Stern. On January 9th, Howard Stern went on our air, but well before that in the 4th quarter, the marketing effort . We believe the programming marketing and PR campaigns were as unique in their initiative form as they were when executed. Just to sum it up, the NY Times I think said it best when they called Howard Stern’s new show ingenious, displaying maestro skills while still keeping listeners on edge. Stern is continuing to deliver new subscribers. Let’s remember at this point people choose content and until something in morning radio proves to be an attractive alternative to Howard Stern, that we don’t already have on our air at Sirius, not only will this huge movement of subscribers continue to Sirius, it may also increase. Remember, those alternatives put in place for Howard Stern in terrestrial radio still have a lot of listeners who said let’s give it a try. Therefore it is likely that unless the replacement programming in terrestrial radio takes hold, another wave of Howard Stern subscribers to Sirius could certainly occur.
Martha Stewart launch in the 4th quarter. I’ll talk more generally about women’s programming in a moment. But Martha Stewart was our anchor to launch our women’s programming. As all of you know this was an initiative I laid out last year as an area we were going to get into. All our programming is well thought out and crafted; Martha was the first piece of that. We started with having a teaser channel of non-stop tips for the thanksgiving weekend. Then, we rolled out a full channel of Martha Stewart living radio, featuring relevant topics and experts in a definitive lifestyle channel for women. It received numerous promotions in other areas at no cost to us, on Martha’s syndicated program, on NBC’s the Apprentice Martha Stewart as well as other programming partners and promotional partners, including Howard Stern and Richard Simmons and among others in the Sirius family.
Women’s programming in general. Sirius is once again the leader in original programming. This time for women. In addition to Martha Stewart living radio, which also begins streaming on the internet today for our internet subscribers to better suit our women listeners’ multi-tasking lifestyle, this was the first channel created in radio primarily devoted to women. As Mel mentioned, Sirius will soon launch cosmopolitan radio with our partner Hearst Corporation. We also have several more announcements coming shortly in the original women’s programming area. Those additions will reinforce Sirius’ position as the first choice in women’s programming. Our women’s initiative, as promised last year, is now in full bloom with the launch of Martha and the soon to be launched Cosmo over the next 30 days. Our programming announcements and launches in this area will follow shortly. However, remember this area of programming like all our others, is work to craft these channels and shows that require the high level of satisfaction our consumers and subscribers now require and since we don’t build our women’s programming simply out of the compilation of multiple TV feeds, these have to be grown from scratch and we will continue to do so in the women’s area.
In sports, another primary driver for subscribers, Sirius once again is clearly the leader. In the case of the NFL we had every game, ev4ery team, everywhere in the continental US. We provided multiple Super bowl feeds in multiple languages. We had hours of headline making radio on our 24 hour NFL radio channel. We launched Tiki and Ronde Barber’s barbershop radio show a weekly show in season, hosted by Tiki and Ronde Barber. We created a special feature for the Super bowl on NFL radio called MVP radio where tom Brady’s only live Super bowl appearance at Super bowl 40 was to broadcast on MVP radio exclusively for Sirius and feature numerous Super bowl MVP’s as his guests. Very highly acclaimed, very highly covered by the press, and yet again an example of programming generating awareness and a substitute for marketing dollars. In the NBA we’re pleased to have launched our exclusive relationship with the NBA at Sirius, including developing an exclusive NBA channel. In addition, Phil Jackson, the Laker head coach and well known personality, returned to the coaching ranks. He agreed to an in-season weekly show, exclusively on Sirius. Again, more programming, more awareness.
In other areas, Sirius won the 2005 Eclipse award for the best coverage in horse racing for the breeder’s cup. Sirius’ college football program that Mel alluded to in his earlier remarks continues to be the best in all of radio. We have all the top colleges that matter the most nationwide. Just as an example, the participants in the national championship game, USC and Texas, are both Sirius exclusive schools. As part of only having the best brands that matter the most to consumers and future subscribers and current subscribers, in the area of Hispanic programming, we again launched with numerous initiatives. We launched ESPN Deportes radio in a partnership with ESPN’s Spanish-language initiative. It’s a 24 hour Spanish language sports channel; Sirius is the exclusive satellite provider of talk and news programming on ESPN Deportes radio. Our English premier league soccer, the most popular soccer league in the world, continues to be exclusive on Sirius. And of course, the Wimbledon tennis was always a big feature among tennis fans at Sirius.
In more mainstream programming, again, in the area of Christian talk, we launched with Family Net programming. Well received, compliments Sirius’ expanding Catholic programming including a unique programming and marketing opportunity we had with this year’s midnight mass with the full cooperation of the archdiocese. This adds to our music channels of spirit, revolution and praise to give Sirius once again the definitive programming in the area of Christian programming.
In music, one of the most significant and attractive drivers to subscribers all year long we continue to shine compared to anything in radio. We have Jimmy Buffet’s Margaritaville, BBC radio 1 and others that provided fourth quarter exclusives. We had numerous concerts on New Year’s Eve for those choosing to stay in. we also have several channels now representing music genres that are totally unavailable in select major markets, such as oldies and country music in New York, classical alternative in LA and dance music channels more numerous than on regular radio in Miami.
Most importantly in the 4th quarter, we had huge success with our ground breaking limited engagement channels. We had Rolling Stones radio and Bruce Springsteen’s E-street radio all going at the same time, driving subscribers. The 4th quarter was very successful and now the best content on all of radio has one more addition to it. As Mel mentioned, Fox news returning, another asset added to an already strong and dominant lineup.
In Canada, we launched in Canada with strong offering of 10 channels of Canadian content as well as Howard 100 and the launch and return of Howard Stern, not only to just other markets that he was previously in, in Canada, but to the entire country. Likely results will be strong sales and subscriptions as with here in the states.
Hispanic programming in general. As I mentioned to you, ESPN Deportes was launched to compliment our sports programming and make sure Hispanic listeners had an offering exclusive to them. That joins CNN Espanol which is coming later this year as part of our new arrangement with CNN, also joining BBC Mundo. Once again in the Hispanic area, the brands that matter most to listeners of that source, are at Sirius.
Finally in music, the hottest Hispanic category is regatone. And Sirius launched ahead of the curve the Rhumbone channel, featuring regatone which is now becoming more and more common on free radio.
When we look ahead at programming, we look ahead at what will continuing to be a strengthening of our programming platform in 2006 and trying to provide the best and more diverse programming at a cost effective pricing model which will allow multiple marketing, publicity and brand databases to compliment any programming costs. In 2006 alone NASCAR will be getting ready for launch in less than a year from now. Blue collar radio will launch during this year, playboy radio will launch and numerous other programming and channels are underway and it will be exciting to go from there. Our programming will continue to excite, it will continue to surprise, but it will be cost-effective and when reviewed against customer satisfaction, marketing, brand awareness and publicity, it will reinforce that the Sirius model is the right model.
I turn it over to David.
David Frear, EVP and CFO
Thanks Scott, good morning everyone. As you have heard we had an incredible quarter and an incredible year. We promised you a laser light focus on costs and cash flow and we have delivered. Revenue grew 262% and subscribers grew 190%, while the cost to support this growing base increased less than 50%. Gross additions increased 155% and net adds grew 138% while sales and marketing costs increased only 10%.
We ended 2005 with over 3.3 million subscribers, beating all published street estimates. Sirius added almost 2.2 million net new subs in 2005 with more than half coming in the 4th quarter alone.
Gross subscriber additions in 2005 exceeded 2.5 million, 2.5 times our 2004 levels.
Fourth quarter subscriber growth vastly exceeded our expectations with over 900,000 retail net additions in the quarter and almost 242,000 from our automotive channel. The retail channel represented approximately 79% of fourth quarter net adds, almost identical to the prior year’s level, despite a 134% increase in OEM 4th quarter net adds. For the full year, retail accounted for 72% of our net adds.
We added over 300,000 subscribers between Christmas and New years and more than 100,000 on Christmas day alone. Our strong holiday sales performance has continued in this early part of 2006. As Mel said, we expect to exceed 6 million subs by year end.
In 2006 we also expect to be at parity with XM in retail and expect more than double our OEM subscriber base.
Our churn for 2005 averaged 1.5% per month, in line with guidance. The churn in the 4th quarter was also 1.5% per month. We continue to experience extraordinary levels of customer satisfaction with 86% of Sirius subscribers recommending Sirius to a friend.
As we move into 2006, we do expect churn to rise to approximately 1.8% per month, reflecting the impact of OEM subscribers rolling off bundled programs during the course of the year.
Our strong holiday sales and the associated inventory sell through, pushed SAC per gross add well below our guidance of $145. SAC per gross add decreased 21% from $177 in 2004 to $139 in 2005 and will decline further in 2006, approaching $110 per gross add and this decline will continue as we go into 2007.
We averaged about 9 months of prepaid revenue for new subscribers in 2005, based on a $12.95 standard monthly price. With about 2/3 or our subscribers on annual or longer plans at year end.
We expect prepaid revenue for new subs to come down slightly in 2006, given the increasing impact from Ford’s 6 month bundled subscriptions. However, we expect the average prepay will exceed our SAC per gross add in 2006 and as we have discussed before, this is a key milestone in our path to free cash flow as we expect to generate positive, working capital cash flows with each new subscriber.
The near tripling of our subscriber base in 2005 drove total revenue to $242 million ahead of our full year guidance of $230 million and a 262% increase above 2004. For the fourth quarter of 2005 total revenue increased by 217% to just over $80 million; ARPU for the full year was $10.34, up from $10.16 in 2004, including a $.28 impact from advertising revenue.
We generated $6.1 million of advertising revenue in the full year, compared to less than $1 Million in 2004. For the fourth quarter of 2005, total ARPU was $9.42, including $1.77 offset from the mail-in rebates as a result of our strong holiday selling season and a positive $.40 per subscriber impact from advertising revenue.
As we drive the more than 6 million subscribers in 2006, we expect to generate approximately $600 million in total revenue with rapid growth in advertising revenue that will approach 10% of total revenues over the next couple of years.
Our adjusted loss from operations, which we generally refer to as adjusted EBITDA, increased by $111 million to $568 million for 2005, driven by a $176 million increase in total subscriber acquisition costs to support the 155% in gross adds. As we move into 2006, we expect our EBITDA loss will improve to approximately $540 million.
Compared to 2004, our pre SAC adjusted EBITDA improved in 2005 by $65 million to a $218 million loss and will continue to improve in 2006 to approximately $140 million, reflecting the operating leverage inherent in the business model as we move toward generating positive free cash flow.
As Mel mentioned, cash used in operating activities improved dramatically in the fourth quarter, requiring only $16 million vs. $99 million in last year’s 4th quarter. This incredible performance increases our confidence that Q4 ’06 will be our first quarter of positive cash flow.
Our net use of cash for the year, defined as cash used in operating activities plus CapEx and restricted investments was $334 million, well ahead of guidance of $375 million despite payments related to our satellite launch contract in the fourth quarter of 2005.
Positive working capital cash flows in the fourth quarter of 2005, were driven by a $109 million increase in accounts payable and expense accruals as radio production shifted into the fourth quarter and the associated subsidies are paid out in the first quarter of ’06. And a $129 million increase in deferred revenue from subscriber prepayments during the quarter.
Cash used in operating activities is expected to increase to approximately $370 million in 2006 from $274 million in 2005. In 2006, we expect to product the bulk of our holiday product needs in the 3rd quarter. So we’ve planned to pay the associated subsidies in Q4 of 2006.
Despite the absence of recurrence in Q4 ’06 of 2005’s big cash flow benefit from the growth in accounts payable and accrued expenses, we are expecting Q4 ’06 to be our first quarter of positive cash flow.
As you know, last quarter we elected to begin making some infrastructure investments we believe will serve to grow as well as protect our revenue base that is rapidly approaching $1 billion. Capital expenditures increased by $21 million year over year to $50 million for the full year, reflecting $21 million of satellite launch contract payments made during the fourth quarter.
In 2006, we will make investments totally $110 million, yet our launch vehicle, our terrestrial repeater network, our broadcast and administrative infrastructure to support the resiliency of our operations and to support the phenomenal growth we are experiencing, as well as investments that will deliver new revenue streams in the future through our video, telematics and navigation offerings.
Sirius ended the year with approximately $879 million in cash, cash equivalents and marketable securities. We continue to expect to be free cash flow positive, after CapEx, as early as the 4th quarter of 2006 and for the full year of 2007.
As many of you know, our spectacular 2005 performance resulted in the accelerated delivery of 34.4 million common shares to Howard Stern and his agent. The contract obligated us to deliver the shares in 2010 or earlier, if certain performance parameters were met. After consultation with our accounting firm Ernst and Young and consistent with the way we record other performance based incentives, we will accelerate the charge associated with this stock approximately $225 million, to the first quarter of 2006.
So in summary, the business plan we bring to you today is very strong. 6 million subscribers, $600 million in revenue and positive free cash flow in the 4th quarter of 2006. $1 billion in 2007 revenue, positive free cash flow for the full year 2007, $3 billion in revenue for 2010 and $1 billion in free cash flow in 2010.
With that, I’d like to open it up for questions.
Our first question comes from Eileen Kavel with Citigroup.
Thanks for taking the question. I have a few questions. First, there’s been a lot of talk about balancing sub growth I guess against expense growth and I want to know, do you feel that you’ve struck the correct balance or can we expect changes ahead? Specifically, with Oprah launching within the year, could we see you get more aggressive in terms of marketing or ? Also, you gave quite optimistic goals for 2010, the $3 billion in revenues and $1 billion in free cash. What in particular do you think is giving you confidence to reach that strong guidance that you’re giving so far ahead? And my last question is, does you ’06 and ’07 revenue guidance incorporate a subscription price hike? Thanks.
Mel Karmazin, CEO
Okay, so let’s start. We’ve said this quite clearly that we believe that our programming lineup is complete. That there is no missing piece. That anything that we would add in the way of programming would be because it is consistent in our business plan, which is to get to free cash flow positive and to be a very profitable company. So there is nothing that we have to have. If an opportunity comes up, we will weigh that opportunity with an eye toward is this going to generate us right away more subscribers, more revenue and therefore pay for itself? And that will be the criteria. We factor in both streams of revenue. In doing so the advertising piece as well. And if the answer becomes yes, it is going to be consistent, then we will go for it. On the model for 2010, what do we see there…we feel confident in looking at the OEM deals that we have completed and the number of vehicles that we’ll be rolling out over that period of time. We look at what we think the churn will be, we take a look at our assumptions on retail. There are an awful lot of analysts out there that talk about a general consensus in 2010 that there will be around 40 million subscribers to satellite radio and that we take a look at what our share will be. We take a look at what our ARPU will be, we take a look at what our margins will be and we very comfortably concluded that we will be able to deliver the numbers or we obviously would not have given them to you. We have not given you anything that we have not lived up to. So we feel pretty good about it and we’ll continue to update you as we go on. Regarding the ’06 and ’07 revenue numbers, those numbers were not factoring in any price increase, though we do assume there will be continued ARPU growth in there from our advertising. We certainly believe there is an opportunity for Sirius to raise the price. We are the premium priced content company in Canada. We were at $12.95 when our competitor was at $9.95. Before we added Howard Stern they rose to our price. So we think that there is an opportunity and we continue to evaluate it. David, anything you want to add?
No, Mel. I think you covered it all.
Jim Meyer, President of operations and Sales
David, one thing I wanted to add. You mentioned about marketing expenses. We continue every year to spend significantly less than our competitor in marketing expenses, including in the 4th quarter where we were completely dominant with it. Every time we have done one of our campaigns, they have generally been around a content premium brand that drove its own marketing into it, independent of it. This year will be no different. NASCAR is an extremely dominant brand with lots of resources and databanks and other things that will be drawn on, no different than Howard was in the publicity component. So I want to stress that marketing expenses have always been carefully considered here and will be done again that way this year.
Next question comes from Bob Peck with Bear Stearns.
Hi this is for Bob. I guess bob might have gone out. A question on the prepayment increase that happened in 4th Q, was that mostly 1 year annual prepayment or was it multi-year?
You mean with respect to the cash flows from prepayments?
The cash flows from prepayments the $30 million that came in.
That would be consistent with the number of subscribers added as well as subscribers renewing from prior years in the quarter. I think, as you know, we’ve had a pretty consistent with the average prepays from our subscribers. They vary a little bit but they’re right around 9 months, based on a $12.95 standard. So each 4th quarter, because we get so many subscribers who sign up for the prepaid annual plan, cash flow for the 4th quarter gets pretty dramatic as the years go on because you have the accumulation of not only what we do in the current year, but the prior year’s renewals.
And did you see a different trend as far as subscribers that were coming in purely for Howard?
In terms of their payment length?
In terms of the payment length.
No, we did not.
And the third question I had a quick one was, in terms of video and telematic and enhanced services, how should we look at them in terms of potential revenue going forward?
Jim, do you want to speak to that?
Sure. On both of those, we’re evaluating our pricing and what the impact could be in our revenue projections. We don’t really have any fixed guidance for you yet because we’re still waiting on the case of telematics’ potential rollout with out OEM partners. In the case of video, I think that while we have looked at the costs of getting in the business, the costs of what a very attractive programming offer would be, we’re still working with our 2 OEM partners to evaluate the take rate. So I don’t really think that we can give you any guidance quite at this point yet.
Jim, a quick question on the products. The anecdotal evidence was that there were a lot that the S50 was in short supply around Christmas and even in January in a number of Howard Stern markets. What are you thinking of doing in terms of the live variable product that you are planning to come out with in summer to alleviate any shortage issues?
I think one of the reasons we were short is that S50 came later in the year than we would have liked in 2005. One of the reasons we’ve targeted the summer for our next generation of portable products is to make sure that it’s in adequate supply for the Christmas selling season. I will tell you, again, this stuff’s hard to forecast. And so, you know, I can’t guarantee you we’ll be right this time.
Our next question comes from Benjamin Swinburn with Morgan Stanley.
Thank you. Good morning guys. A question for Mel and then I’ve got a follow up for David. Mel, we’ve seen in the XM/GM relationship over the years some of the trends that have surprised people and obviously for Sirius there are some things that are out of your control in terms of your OEM partners delivering the vehicle growth that you expect and also then the sort of conversion ratio churn expectations that they deliver. What gives you confidence in your relationships with Ford and Chrysler that they can deliver first the gross car subscriber editions that you expect and also what are your expectations for churn out of the OEM channel long term conversion ratio? The reason I ask is that obviously GM has very attractive economics in terms of adding XM customers, probably the most attractive out there. To some extent, they’ve disappointed a little bit on how many of their customers are staying on after their free period and how many actual vehicles they’ve delivered to XM. So I wanted to get your take on what your expectations are for your partners.
So we’re very confident, obviously, in our 2006 guidance that we’ve given you. And part of that stems from the fact that we’re at the very early stages of ramping these things up as Jim in his opening comments talked about. So if, in fact, Detroit does not have as good a year as we would like them all to have, we’re still confident in the guidance that we’ve given you for 2006 that we can deliver it almost no matter what happens in Detroit, just because of the fact that we’re ramping up and increasing our penetration significantly. On the subject of churn for OEMs, I don’t think that we’re in a position of giving that yet and the same thing on take rates. We’re newer into this game. We talked about how much we’ve added in 2005. We added more subscribers, a multiple of more subscribers in 2005 from the OEM channel than we had prior to that. So we just don’t have the history. We know our content is…what makes somebody churn who has the product? Well, the content is something that would think about it. The other question is whether or not they really wanted satellite radio to begin with. That was part of our reasoning as to why our model of where they were paying for it and it was on the sticker of the car that the car is costing them more money because it has satellite radio, will be a factor. But, we are aware of what has happened with our competitor. We have the benefit of learning from what has happened with them to ensure that the same thing doesn’t happen to us or that we’re able to learn form it and it doesn’t happen quite in the same way. David, why don’t you add on to that and then I think there’s another question for you.
Okay. I think Mel covered the churn, long-term conversion ratio. Mel is exactly right that we’re only just now beginning to see the first of the Chrysler bundled subscribers come up, go through the renewal process. They’re very small numbers and it’s too early for us to begin to talk about. So, what was your second question Ben?
Did the account payable accrued expense to cash in the 4th quarter of $108, what specifically was that related to? And I think you said that we should not expect a big contribution in working capital from that line in ’06. Is that correct?
If you look back to the fourth quarter of ’04 I think you’ll see that number was $64 million and expanded by $40-$45 million going into the fourth quarter of ’05. it makes a lot of sense when you look at the growth in the gross adds of the business when you think that we have to produce those and when we do produce them that that’s when the subsidies come due. A lot of it has to do with the timing of production in both years. In ’04 and ’05 production came later than we had originally expected so, you know, instead of the production coming in the 3rd quarter, shipment in the 3rd quarter, payment due 45 days later, that we had a lot of production that shifted into the 4th quarter. So it’s sort of a time shift and in our guidance for this year we are presuming that we will get the production done in the 3rd quarter and therefore the payments to those suppliers will go out in the fourth quarter.
So this is expensing on equipment primarily that passes out the door later? Not programming.
Yeah, that’s exactly right.
Our next question comes from Lorraine Mancini, with Merrill Lynch.
A couple of questions. First of all for 2006 on seasonality of your subscriber additions do you expect that its going to be heavier toward the front end of the year because of Howard Stern still? I’m assuming that there’s some spillover and I know your competitor suggested that there’s a lot more spillover into January this year than last year. So can you talk a bit about that?
Let’s do one at a time since my memory is going as I get older. On that subject we think that Howard Stern is going to add subscribers every single day. Obviously the 20 years that he was with his prior employer, he created value for them every single year and we fully expect that to continue going forward. As people are going in to buy satellite radio, every single day they’re going to have a choice and one of the companies is going to have a programming offering that’s going to include Howard and we think that’s going to contribute. So the idea that it’s only going to affect 4th quarter or 1st quarter is lame. I think this is something that’s going to continue throughout the five years at least of his contract. And as we marshal the Howard audience to get them to be our sales people to sell it to their friends and other people, you’re going to see those numbers continuing. But I think the seasonality of the satellite radio business has been such, January has always been a very strong month at retail. A lot of people got gift cards and the like. So we certainly think that the first quarter will be strong. But you ought to think about the fact that for father’s day and graduation, people are going to be giving Sirius as a gift, in part because we have Howard stern.
And then, in terms of your advertising expectation, I know you said you had more on the books already this year than you had for all of last year. I’m assuming in your conversations with the advertisers you’ve talked about long term plans of satellite radio and their budgets. How do you think they’re accepting the product now as an advertising platform and where do you think they’re taking those budgets from? Is it coming from radio or is it incremental?
Okay, thanks. It’s obviously these levels are small at this point. So we told you that we finished last year at a little over $6 million and as of today we have well over $6 million on the books for 2006 and it are only 6 weeks or so into the year. So, we’re very optimistic, we’re very bullish. Our advertisers are interested in satellite radio. At all of the conferences now dealing with advertising, satellite radio is on there. We were represented last week at an advertising panel. The advertisers love the idea about it. They love the idea that there’s a targeted audience, they like the idea that it’s relatively inexpensive because of its early stages and we think that this category is going to become increasingly significant. We don’t think it’s hurting terrestrial radio ion any big way, because again the levels compared to the $20 billion that terrestrial radio’s getting, still remains low. But clearly there has been advertising money that has come from terrestrial radio. If you listen to Howard stern, you’ll hear an awful lot of the advertisers who were with him when he was in terrestrial radio. So I assume either those advertisers increased their budgets or maybe they didn’t increase their terrestrial radio budgets much and they’re giving us the additional revenue. But again, David pointed out that we’re looking at least toward our first milestone which is over the next couple of years to get to where it’s 10% of our revenue and then talk to you a little bit more about what we think the longer term plans are.
Our next question comes from April Horowitz with Hoeffer and Arnett.
Good morning. Quick question on the Q4 of ’06 free cash flow. Does that include payments for the Q3 subsidies? Will it still be positive after that?
Okay. And then I was wondering what’s the size of the prepayment? Is there a breakdown between the number of months in an OEM sub versus a retail sub? Is there a difference between those two?
We haven’t talked about a big breakdown publicly before. There are some differences. When you think about the weighting of things, the Chrysler 12 month bundled program has dominated the new adds in OEM until quite recently. So it would obviously skew longer. But as Ford comes in with the 6 months bundled subscriptions, that’s going to bring the weight of the OEM channel down a little bit. But I’d say there isn’t that much of a difference between the 2 channels by the time you’re all done.
And then going back to the advertising revenues for 2006 and 2007, can you give us any kind of color with respect to how much is the percentage of the total $600 million and the $1 billion that you’ve given out?
I think that what we’ve said is that we are looking to approach 10% of our total revenue in advertising.
10% in which year?
Probably closer to ’07. We’re going to keep approaching it right? So if you take a look at this year and if we have $600 million, you should assume that we will not have quite 10% of the $600 in 2006.
Our next question comes from Craig Moffet with Sanford C. Bernstein.
Good morning. Mel, I’m intrigued by something you mentioned before about a buy button coming on the new portable. If I read between the lines on that, is the RAA working as your partner in the design of new features for the new portables market? And could you update us on how those discussions are going and then separately if you could just update us on the inventory position and the channels more broadly than what you said before. We still hear about stock outs and things like that, especially in some of the east coast and Howard stern markets. Is that still the case and when does all of that get worked out?
I’m going to let Jim answer those questions for you.
Thank you Mel. Obviously we don’t ship products that we think are in violation of the laws. And so, clearly in the area of what is and isn’t allowed under the digital home recording act, it’s still up for debate, up for discussion. We have a lot of discussions with the music industry. We continue to have a lot of discussions with the music industry. Our putting a buy button in the product that we’ll introduce this summer is for consumer convenience. Our research tells us it’s something consumers want. They like the idea of being able to, if they hear something to instantly bookmark it and purchase it later and then be able to include it into a consolidated music collection. So that’s our driver for a buy button. In terms of product shortage I think in most cases, inventory is coming back up to stock, although we still continue to see very strong sales. I think in the few exceptions and particularly the Northeast, it’s been harder for us to get the stock through the distribution centers and out to the stores as quickly as we would like. We think we’re making real progress on that with one exception. As I mentioned, the replay was a very hot product and significantly outsold what we believed. By the way, it’s noteworthy that is was, with the exception of the S50, the most expensive product in our lineup. So that one we’re struggling to get back in stock.
Next, Lucas Binder with UBS.
Thank you. Could you talk a little bit on a couple of items and I’ll do them one at a time. Howard Stern, what’s the timing of getting the streaming product on your online service and is there going to be incremental costs in order to provide that?
We would like to be able to do that. We are very concerned about the overall backbone of the internet and it’s ability to do this. If you think about it, the two biggest events in the internet history for doing something live, we had the biggest one which was Howard’s last day in terrestrial radio, which yahoo covered. The concern from everybody that we’re speaking to is that if in fact we put Howard on live on the internet streaming, it would be very popular. We also believe we may find ourselves getting an awful lot of additional subscribers who may not be in a car or who may not have the same interest in the home product. But if, in fact it was offered on the internet and they were able to get it in their office or whatever, would be appealing. But we are not going to do it until we can get the technical issues all worked out so that we can be ensured of both the security and the ability to have a good listening experience. This is something that we would like to do, that Howard would like to do. We would also like to at least initially be able to do it at no increase in costs. We think we’d like to do it for our subscribers. You’re going to just have to stay tuned for when we make an announcement as to when it will start. But it will happen.
Thanks. Assuming it does happen or when it does. There’s no incremental cost to you having to pay Howard for that, right?
Correct. That’s right.
The other two would be on advertising. You talk a lot about the growth opportunity in advertising but it seems that the revenue share still favors as far as an incremental margin is concerned, subscriber growth over advertising. How do you weigh the two and do you see this as a separate opportunity for growing the business?
Yeah. I mean, in essence our model, which is a very desirable model because we have two streams of revenue, is principally a subscriber model. There were people I know when I started and I read whatever analyst reports were out there, there was very little mentioned about advertising a little bit over a year ago. And when you think about the number o listeners and the number of subscribers will ramp up significantly. So if you believe, as we do that in 2010, let’s call if 40 million subscribers to satellite radio and let’s call it a little over 2 listeners per subscription. So you’re now dealing with potentially 80 million people listening to satellite radio. And we think that advertisers obviously are going to be paying unbelievable amount of attention to something of that size. So we continue to focus on our subscription revenue. We have a separate department that is solely focused on the advertising side. We have today, I see we’re going to add 2 more sales people to our organization. We believe it’s important, we believe it’s incremental and we believe it’s very profitable additional revenue for us.
Great and lastly, BMW as one of your partners indicated, plans on putting HD radio in some of their vehicles. I guess to Jim, how does this impact your relationship with BMW, how does…are they able to put in HD radios that are also Sirius compatible?
Before Jim answers let me just point out. We have always said, by the way, that terrestrial radio is going to coexist alongside satellite radio. I think there will be obviously less and less listening to it but there is always going to be a terrestrial radio. And clearly, terrestrial radio should be making the move from analog to digital, which they’re going to do. It’s going to take them a significant amount of time but they should do it. And we believe that we will be there alongside of them everywhere, 10, 15 years from now.
I think that’s it. And as far as an incorporated product, they’re not a common platform today, I think is the best way to say it for BMW. By the way, BMW is the only OEM partner that we’re talking with right now that seems to have, the best I can tell, any plans on HD radio in the short term.
Our final question comes from Maurice McKinsey with SBR.
Thank you for taking the question. Just a few. The first is, can you discuss your subscriber demographic mix at year end? Can you also discuss in that context, Martha Stewart – her channel, listeners ratings for her channel and how helpful she’s been in bringing in women listeners in the quarter.
Our subscribers’ names that we get are principally men. So, whether or not that just a function that they’re the people who are going into best buy and radio shack and circuit city and they’re the ones whose name appears when they buy a car, but the majority of the subscribers are in male names. Again, we’ve talked about 2 listeners or a little over 2, 2.2 listeners per radio and we think that obviously will include women. We believe that there’s a great opportunity for us to promote more toward women. A lot of our music, obviously, appeals to that demographic and we believe that Martha and Cosmopolitan amongst some of our other offerings will be a large driver of getting more women to subscribe to satellite radio. We do not have, we have information but we have not given it out, it’s our own proprietary research that talks about why people subscribe and the reason they gave us for subscription. And Martha was a driver of that as well. I can tell you that Howard Stern, the NFL, our music and Martha were leading reasons why people have subscribed to Sirius in the 4th quarter. And again, we think that there is a great opportunity for us to expand. We also found subscribers came to us in the 4th quarter from all across the country. So this one was not just New York, LA and Chicago. But not only are those markets where Howard Stern did well, but there’s also more people living there than anyplace else. So, you know, you should also assume that we’re going to continue to focus not just on the big markets but on the markets that are terribly underserved with radio. So when you get into the more rural markets, you’ll find that there are less radio choices and therefore satellite radio reception is far superior to anything they could get and there are more choices for them. So, we think that we’re sort of at the very early innings of what will be a very extraordinarily big industry.
Thanks Mel. Is it too early to talk about the number of listeners or average number of listeners for any of those shows? For Howard Stern I know its only the first month, or for Martha Stewart?
I think the idea is that we are currently not engaging any audience measurement company to measure. And the main reason for it if you follow terrestrial radio, there’s a whole lot of dissatisfaction with Arbitron which is the company that does measure radio listening. And they’re looking to change their entire methodology because they believe that the diary method, which is what they have, is antiquated. So, we could tell you that on the first day Howard was on the air, there were 400,000 phone calls that were logged into our system that day. I can’t tell you how many different people it was, but there was just an awful lot of response. We also – I had a meeting with Martha Stewart last week and she is thrilled with the reaction that she has been getting. People are talking about it, the phones are ringing. We’re getting anecdotal information from the advertisers who are on Martha Stewart’s show and on Howard’s show. The renewal rate, again, it’s very early…a lot of the people bought it just for the first month, for example. And now we’re finding the renewal rate to be exceptional. And when we become comfortable with the measurement device other than the advertiser’s ability to get a return on their invested capital, if in fact it serves us well to have a syndicated ratings service measure, we’ll do it. But we think that we’re going to do just fine in advertising without it.
And just one last question with the volume of callers that you mentioned for Howard Stern, can you compare and contrast just the volume of subscribers in January vs. December, just qualitatively?
I think we’ve given you more transparency, more guidance than anybody could ask for and what we have said is that you know, we’re going to issue our first quarter results and we’ll tell you then what we did in the first quarter and we think that you’ll be very pleased because we really are starting off the year very strong.
Thanks everybody for you time today. The IR team is available to answer any questions through the close of the day.
That does conclude today’s conference; ladies and gentlemen you may disconnect your lines at this time.
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