Sirius XM Holdings Inc. (SIRI) Q1 2014 Earnings Report, Transcript and Summary

Good morning. And welcome to Sirius XM’s First Quarter 2013 Results Earnings Conference Call. Today’s conference is been recorded. A question and answer session will be conducted following the presentation. (Operator Instructions) At this time, I would like to turn the call over to Hooper Stevens, Vice President, Investor Relations and Finance. Mr. Stevens, please go ahead.

Thank you, Jennifer and good morning, everyone. Welcome to Sirius XM's first quarter earnings conference call. Today, Jim Meyer, our Chief Executive Officer, will be joined by David Frear, our Executive Vice President and Chief Financial Officer. At the conclusion of our prepared remarks, management will be glad to take your questions. We will also be joined by Scott Greenstein, our President and Chief Content Officer for the Q&A portion of the call. First, I would like to remind everyone that certain statements made during the call might be forward-looking statements as the term is defined in the Private Securities Litigation Reform Act of 1995. These and all forward-looking statements are based on management's current beliefs and expectations and necessarily depend upon assumptions, data 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. For more information about these risks and uncertainties, please view Sirius XM's SEC filings. We advise listeners not to rely unduly on forward-looking statements and disclaim any intent or obligation to update them. As we begin, I would like to advise our listeners that today's results will include discussions about both actual results and adjusted results. All discussions of adjusted operating results exclude the effects of stock-based compensation and certain purchase price accounting adjustments. With that, I will now hand the call over to Jim Meyer.

Thanks you Hooper. Good morning. And thank you for joining us today to discuss to what we think was a very strong first quarter and one that positions us to succeed and achieve record financial performance in 2014. For the ninth consecutive quarter we’ve grown revenue at double digits to a number that was just shy of $1 billion, up 11% year-over-year. Driven by the strong revenue growth and tight management of cash operating expenses which were up just 4%, adjusted EBITDA climbed 28% to 335% million, the highest level the company has ever achieved in a single quarter. An adjusted EBITDA margin of 33.5% was also a record, up over 400 basis points from 29.1% in last year’s first quarter. Free cash flow of $223 million was up 56% and represented a first quarter record and free cash flow per share was $0.036, up 64% from $0.022 in last year’s first quarter, as reduced our share count through buybacks over the past year. Net subscribers grew by 267,000 in the first quarter to an all time high of 25.8 million. Self-pay subscribers grew by a 173,000 in the first quarter also to an all time high of $21.3 million up 7% year-over-year. This first quarter subscriber growth was actually a bit above our internal forecast for the quarter and is consistent with our full year guidance. Let me iterate, we remain confident in achieving our full year subscriber growth target of approximately 1.25 million and furthermore, we see nothing in the next few years that should prevent us from continuing to grow our paid subscriber base toward 30 million. Our solid subscriber growth, even faster revenue growth and high contribution margins had produced dramatic growth in adjusted EBTIDA and free cash flow, exactly what you would expect from SiriusXM’s…

Thanks, Jim. Despite an unrelenting winter that restrained auto sales, SiriusXM turned in its best operating quarter ever and has restructured its balance sheet to continue delivering strong growth and free cash flow per share. Net additions of 267,000 were stronger than our expectations and we remain confident of achieving approximately quarter million net additions for 2014. Car sales through February were flat year-over-year but with better weather in March sales were up 7% over 2013, to bring the quarter SAR in at 15.66 million, up 3% over 2013 and the better quarter since the merger nearly six year ago. Vehicle penetration was up 3% to 70% car sales in the first quarter. We had our strongest first quarter ever for new car trail starts at more than $2.4 million and used car trail starts at an all-time quarterly record exceeding $1 million for the first time. Total conversions increased year-over-year, our best first quarter ever for conversion volume, very strong growth in the subsequent owner conversions and stable new car conversions offset a slight decline in the aftermarket business. Churn improved to 1.9% from 2% in the first quarter. Improvements in non-pay and other voluntary churn more than offset continuing growth in vehicle turnover among our subscribers. We finished with the record self-pay subscriber base of $21.3 million and total subscribers of more than 25.8 million. Revenue increased 11%, the quarter, driven by subscriber growth, ARPU growth and revenue from connected vehicles. Adjusted EBTIDA grew nearly 28% to a record $335 million and adjusted EBITDA margin jumped from 29.1% to 33.5%. The biggest single factor was the 11% drop in subscriber acquisition costs, as the growth in the OEM installations was than offset by a drop in unit cost. We picked up 3.1 points of margin on the improvement…

(Operator Instructions). And your first question comes from Brian Kraft from Evercore.

Hey good morning guys, a couple of questions. One on self-pay and net adds, I think early in the year, you had said that self-pay and total net adds would be relatively similar this year. I just want to see if you could update that, and now with the quarter behind us, if you still saw the year playing out that way. One last question on cost, with the OEMs shifting to 2.0 chipsets; will the SAC declines continue or are close chipsets more expensive -- so do we go through a period at some point in the next couple of years where SAC maybe flattens or goes back up before coming down again. And then also on programming, Jimmy talked a lot about the incremental programming enhancements that you’re making, which I think is great for the product, but can you continue to do that and also maintain that flattish programming cost outlook. Those were my two questions? Thank you.

I’ll take the first one in the third one and David will take the middle one on SAC. First of all, I thought we were clear, I just want to be clearer. Our guidance for self-pay net additions this year is 1.25 million. Our first quarter performance quite candidly was a little better than we had expected when we drew that plan. But I want to continue to see how the months unfold, but I’m confident in the 1.25 million.

We don’t see a difference between the two self-pay and the total nets. It’s just in inventory difference. We still think they both look like one and a quarter.

And then on the last point, there is no question that, through the merger and through the rationalization of our agreements in programming, we have been able to take a significant chunk out of our programming cost. I think, programming for us is -- it’s hard to say which one of your children do you love more, but it’s a very key asset. And so as we go forward, if we see opportunities where we can get a meaningful program that we believe gives us a competitive advantage we will take it. Okay, I think it’s the only thing I can comment. Scott, do you want to add.

Yes. One thing, Brian. The other thing that as the company has grown, the advantages that we offer our content partners in all walks of life from -- as you mentioned, music sales, ticket sales, everything else just becomes exponential as the company continues to grow. So while costs are always going to be an issue, alike in earlier years our benefits are very clear right now to a lot of our partners. So it’s helping obviously with the cost maintenance.

And on the chipset question there isn't anything about the rollout of the 2.0 chipsets going to drive the unit costs up?

Does it cause the declines or maybe flat line for a while at some point? Is that the right way to think about it?

I don’t -- there are so many different generations of radios that go into cars. We have some OEMs that are still selling radios from seven years ago. So I think you should think about unit cost as slowly declining over time.

And now, we’ll hear from Barton Crockett out of FBR Capital Markets.

I wanted to drill down a little bit more on the self-pay number. The net additions there were down 43%, I think year-over-year. They’d be about 14% of your full-year guidance, which is not a 42% decline. So I was wondering if you could explain why they were down so much this quarter, and why you see the trend looking so much different over the next few quarters?

So I think there is heavy seasonality to the flow of our business that our first quarter self-pay churn has always been a high point. We still have a lot of that Christmas effect from the early days and it’s migrated from people who had aftermarket radios, who went into OEM vehicles. Remember Howard started in January of ’06; a lot of people came on then and so the cycle dates are -- haven’t changed much over the years. So our first quarter has always been a high churn quarter as Jim said that it was ahead of our expectation. So we’re off to a faster start for the year. We probably, despite the fact it was above our expectations, it probably took a little bit of a hit from the slowing auto sales in the quarter, turnover of all kinds of vehicles slowed down, not just new vehicles but used vehicle sales were slower. So just a whole bunch of things, but as we look at it, we think it’s a great start to the year and we remain very confident on the guidance.

Okay great. And then If I could ask another question here. We’ve done some survey work that would say that a lot of Sirius subscribers, on our survey, 64% are using Pandora. Pandora is reporting that they’re seeing a big increase in people using their service in the car, as you know the integration with the car improves. What do you see about the Sirius subscribers using Pandora now? Are they more likely to cancel or is there any churn impact or not?

I have to tell you, I look at this one, this is maybe a question I only worry about every week or every day, right. And so, we go through a pretty thorough analysis, at least twice a month on reason codes for churn and exactly what’s going on there. And Barton I have to tell you, by and large for us, it hasn’t changed. The majority of the churn we see, and I said it publicly, and I’m going to see it again, are going back to FM radio, or going back to terrestrial radio. Obviously when you look at the Pandora listening numbers, they are currently increasing and that listenership has to be coming from somewhere. I think it’s coming from terrestrial radio. We’re not seeing a meaningful impact that I can see on our business today from streaming. That doesn’t mean we won’t in the future, but today we just don’t see it.

The other thing, Barton is that there’s a plenty of information out there from sort of music industry, from the radio industry, that would suggest that the pie of listening is actually expanding, all right, and so, there was a day when people used to walk around with transistor radios and they went away for a long time, and they’re effectively back with smart phones. And so you got more listening to the aggregate of satellite radio, AM/FM radio, Pandora-like services, Spotify-like services than you’ve seen before and we can’t at this point in time find the effect in our results.

Okay. And then if I could just squeeze in one other question; on the share repurchase potential and your leverage, if you guys were to move to your leverage target of 4x by the end of this year, you could free up between free cash flow and borrowing capacity over $3 billion to do share repurchase or other capital returns to shareholders. Could you talk about your appetite to do something at that level of magnitude, which could require looking at your repurchase authorization and adjusting that?

We have the program that we have. I don’t disagree with your math, that if we chose to use all of the leverage and all of the cash flow in that way, then it is certainly mathematically possible that we would do 3 billion. We have 1.7 billion remaining on our existing authorization. We care about how we use the shareholders’ money. We think we’ll be smart with how we do that once we get through that authorization, we’ll have a discussion with the board and consider what we might want to do in the future.

And now we’ll hear from James Marsh from Piper Jaffray.

Just a quick question on Agero here. I was hoping you could give us a little bit more granularity here. Obviously the rate of growth looks pretty impressive here but I was hoping you can talk a little bit about how you guys see the ultimate market size getting here and just who do you expect to pay for the services, is it OEM or is it consumers, you expect that to shift over time? Do you think this a business that can approach the size of your satellite business over time? Just trying to get kind of a big picture views on the market?

This is Jim. First of all I think we’ve given all the guidance that we’re going to give right now for what we see in the next three years, which I think is pretty far outlook. How do I see it? It’s a combination of both, James. I mean number one -- and it’s brand new and so we’re still following what each and every OEM wants to do. I think it will be a combination of what I call wholesale and retail, meaning that there will be certain features that some automakers builds into their cars and want in their cars for as long as that car is on the road and will pay for it upfront but there will be other automakers who want to offer certain services, but want them provided on a retail basis, as we do today with our audio service. So it’s going to be a mix and a blend. And frankly most of the players are still figuring out what they want to do and how they want to do it. I have been very careful in my comments and I will again. This is a march, not a sprint, okay. There is no -- I’ll be clear again there is absolutely no doubt in my mind where the automakers are going. Every one of them is evolving to a connected car and every one of them will offer connected vehicle services of some type. And frankly they all will have to remain competitive, okay. But the speed is unpredictable and for those of you that followed our Company for a long time, you know how long it takes to get technology seated in a new car and then how long it takes to run through the several evolutions as they move to a model year. So I’m really confident we’re well positioned. I’m confident in the guidance we’ve given you for the connected vehicle business this year and as growth potential over the next couple of years and we’re just going to keep our head down and keep working and we’ll give you an update when appropriate.

And now we’ll take a question from James Radcliffe out of Buckingham Research.

Two if I could. First of all, I know it’s a long term sort of question but how do you think about making the service available in vehicles that might be connected cars in terms of having a terrestrial wireless connection, but might actually not have satellite radio installed. So effectively moving toward being an app without the associated SAC cost of the satellite hardware. And secondly can you give a granularity on how self-pay beat your expectations? Was it the churn turned out to be lower or you had better conversion rates or better install mix? Thanks.

Jim will take the second one first.

Yeah. So self-pay, definitely better with a surprise on churn, I mean we expected more non-pay and other voluntary churn then we’ve saw in the quarter. And it was - we’re really excited about the improvements of those, especially given the higher car turnover we saw. So actually the, but for the improvements in non-paying voluntary churn, that car turnover might have pushed churn up and so really it was a very strong performance for churn and then it was nice to see the strong performance coming out of the conversion opportunities as well. So both new car conversions and subsequent owner conversions were at very strong levels in the quarter. So it’s sort of multiple front beat on our internal expectations.

And on your first question, I mean first, I think we get a little hung up on the transport from the delivery of service and I think what’s really important is the service. Okay? And so first and foremost, I think its content that’s going to matter more than anything else, as it has been for the last at least 10 years I’ve been here. That said, that said, number one, I personally -- we’re committed that customers can have our content any way they want it and if they want to just get it through an app, that’s fine with us. The vast majority of our customers prefer to get it today through built in satellite in a vehicle and I can tell you it’s, one of the reasons it’s because it’s really easy to use and very convenient for them. As time rules out, we’ll see which way they get it which way it goes. I do think James, you raise an important point that I think some of your colleagues don’t see as clearly and that is, I don’t really expect a major shift. I believe automakers will be deploying built in satellite broadcast technology for many, many, many, many years to come. But those that choose not to, if they ever did or vehicles in certain categories that choose not to, absolutely, we will offer our product to those customers through streaming. And by the way in those cases there will be no SAC or no revenue shares associated with that.

And now we’ll take a question from Ben Swinburne of Morgan Stanley.

This is Brian [indiscernible] for Ben. I have a couple of questions, if I may. Just a follow-up on the churn question earlier. You mentioned normally it’s a seasonally high quarter and you put in the price increase, but churn was down year-over-year. So it sounds like that beat your expectation. So is there any change to your retention practices or how you went about retaining subs to generate that result?

No there wasn’t. We did -- continue to do the same things we’ve been doing a long time.

Okay, and then it seems that self-pay growth adds, which is in a metric you report, but it seems to imply that they would have been down year-over-year, and I know in the fourth-quarter you mentioned there was a trend of customers trading in their cars earlier than you expected, which drove some reclassification. Was that a factor in the quarter and could you help us at all quantify that trend?

When we look at this we -- the vehicle migrations, sort of out of self-pay and into back-ended trials, whether they are paid or unpaid, was at a pretty high level. And so we were very pleased with the kind of net result for the quarter. And honestly it’s not a bad thing. I think about it relative to -- like the wireless industry, right, where people go in and swap out their phones. And for the most point part of the wireless, right that’s a same day or same hour transaction, where they swaps one for another. And in our distribution it’s over an extended period of time because they swap into something with a three month to 12 month trial depending on what brand they’re in before they are back into that self-pay universe. And so for the ones that are swapping into unpaid trials, which is most of the car manufacturers at this point, we count that as churn in the reported churn rate. But I think if you were to look at the effective rate through the migrations, we’re actually running solidly beneath the reported churn.

Okay, and next we’ll hear from Kannan Venkateshwar out of Barclays.

One question I had is from the used car side. You guys have been guiding us with the numbers for the last two or three years, but it looks like that number is growing at about 0.5 million a year, even though the base is growing. So from your perspective what gets that rate to accelerate from where it is, given the kind of opportunity that it has?

We’ve talked about this a good bit in various conferences over the last couple of years. When you look at car turnover profiles, and then you look at the new car installations, you certainly have to look at the average ownership and what the history of new cars has been. And we actually are in a little bit of a lull, if you roll back to what were the new car installations five and six years ago. They were sort of flattish going through the recession, even though our penetration rate was growing dramatically. So when they entered the recession, and there were 16 million cars being sold in the country, and then we sort of exited it and started to recover 10 million cars; our new car installations were about the same through that slide in auto sale, and then really began to ramp up with the recovery. And that same number of installations from sort of the 2008, 2009, 2010 period is what’s rolling over now, in the fact that we’re able to manifest the sharp increases that we are is really testimony to the great job that our team has done in building out the distribution infrastructure in the used car business. And as the volume start to ramp up, which we expect in the next couple of years, that will stand to benefit from that in much the same way that the business benefited from the recovery in new car sales after 2010.

Overall, I mean is there a possibility that over the next couple of years, because of this particular trend, the overall net add trend actually starts to accelerate again?

We will see.

And now we will move to a question from Mike Pace with JPMorgan

Just a couple of questions on capital structure. You recently provide security to the 5.25% note. Is that security in collateral generally the same as your revolver, and can you remind us what that collateral includes or does it exclude anything? And then is the rating initiatives were to lower those ratings back down to BB for whatever reason, do those covenants to come back or are they gone forever. And then I have one follow up.

Okay. So no, the covenants are gone forever. And the collateral package is the same between the two, the general assets of the company and it doesn’t exclude anything in particular.

Okay and then, David, you mentioned you still have four times total leverage target. You also mentioned considering the high yield market at some point in the future. When you think about those funding needs, would you consider issuing new secured bonds parallel with the 5.25%; and if so, how should we think about where you want secured leverage within that four times total leverage target?

No, tapping secured debt capacity isn’t high on our list of the things to do. It’s kind of like a rainy day fund. Things are good in the market like they are now that our interest in tapping the capacity is not all that great. Obviously we tapped for the sake of getting rid of the restricted payment limitations in the 5.25% and so that was in our mind a good trade for equity holders. Right now we always consider the cost of different types of debt when we go to issue, but I wouldn’t play additional secure debt high on my list of things to do this year.

And our next and final question will come from Jason Bazinet with Citi.

As you guys know there’s a lot of concern about what the connected or what sort of the Pandora threat means and players like it. I was just wondering have you guys ever done any work on your existing customer base to segment whey they subscribe to SIRI. In other words was it for the proprietary content? Is easier to use? Is it because there’s fewer ads? It is because there are on a limited -- wireless data plan, any sort of segmentation or maybe give us some color on what -- why people subscribe?

So, Jason this is Jim. I think number one, obviously we do that quite a bit, okay. And by the way the answer to your question from the point you listed is yes. I’m not inclined to share that data, because I don’t know what -- why that would be advantageous. What I will tell you is that breadth of content matters a lot. And that’s why we spend what we spend, okay. And that’s why we put the focus on it that we do. To answer the very first question; do we look at it? Yes, we survey it a lot. David you want to add anything or?

You know for -- we have the same product for a long time. And I think that over the history that -- the themes have been the same. People -- when people are going to pay to listen to the radio, they want something different and better than what they get in a free versions. And so one of those things is commercial free music. It’s been a core tenant of the company since the date of -- since before Scott, Jim and I got here and the diversity of the content we always thought was important. We felt it was important to be more than just music out there. And then to have specialized content that connects with people. We made investments in major brands -- the awareness and to track subscribers in the satellite radio. It’s clear that the investment in those - in that branded content has paid off over the years and has left us with a really unique product offering that a lot of people are willing to pay for. And yes, we continue to watch how tastes change and I think we’ve done a great job of keeping the content fresh and interesting to listening public.

And just one another to add to that. If you look at, well, not apples to oranges, we complement in the video area. When you look at lots of free video content all over the internet and everywhere, it doesn’t mean HBO or NetFlix or anything else, it doesn’t have premium content that people are paying for. So people can try lots of things for free as long as our content remains premium at the level it is. Lots of things are going on, but our model is solid.

Okay. Thank you.