Sirius XM Holdings Inc. (SIRI) Q2 2014 Earnings Report, Transcript and Summary

Good morning. And welcome to the Sirius XM’s second Quarter 2014 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.

Thanks, Susana and good morning, everyone. Welcome to Sirius XM’s second 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. Scott Greenstein, our President and Chief Content Officer will also be available 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 both discussions of actual and adjusted results. All discussions of adjusted operating results exclude the effects of stock-based compensation and certain purchase price accounting adjustments. I will now hand the call over to Jim Meyer.

Thanks, Hooper. Good morning. The team at Sirius XM delivered an outstanding second quarter that puts us on track to exceed our prior financial guidance for 2014. We grew revenue at 10% while holding our total cash operating expenses to just 1% growth, producing a gain in adjusted EBITDA of 31% versus last year second quarter to a record high, $370 million. We are raising our revenue forecast to approximately $4.1 billion and our adjusted EBITDA forecast to approximately $1.425 billion. Free cash flow expanded by 42% to $335 million which is the highest level ever produced by our company in a single quarter. On a per share basis, free cash flow jumped even faster, up 47% as we reduced the share count through our stock repurchase program. For the full year, we now expect approximately $1.1 billion of free cash flow. We’ve produced net subscriber additions of 475,000 including self-paying net additions of 380,000. These put our total subscriber base at 26.3 million and our self-pay subscriber base at 21.6 million. Both of which are record high. Our net additions in the second quarter were very consistent with our thinking of full year subscriber guidance. And importantly, as we think about our confidence in the back half of the year, the trial funnel is at a record high of 7.3 million which bodes well for both our new and second owner growth later this year. We have long emphasized at Sirius XM that business models matter. They’re not all created equally. Our scalable business model with high variable margins is unmatched in media. And it’s producing exactly the kind of stellar results we would expect. Exhibit A being our 35.7% adjusted EBITDA margin, easily the highest in the company’s history and up almost 6 points from last year’s second…

Thanks, Jim. Sirius XM had a very strong operational quarter and delivered outstanding financial results. As Jim mentioned, we are raising our financial guidance across the board. Net additions of 475,000 were stronger than our expectations and we remain confident of attaining our guidance for 2014 of approximately 1.25 million net additions. SAR was 16.5 million in the second quarter, 7% from the prior year. Vehicle penetration was nearly 71% of new car sales, up about two points versus last year’s second quarter. We had our strongest quarter ever for new car trial starts at more than 2.8 million and used car trial starts also set a record at nearly 1.2 million. Total trial conversions were also at record levels. Churn was 1.8% the second quarter, up slightly from last year’s second quarter number of 1.7%. Again, vehicle related turnover was the primary driver of increases in churn. We finished with a record self-pay subscriber base of 21.6 million and total subscribers of more than 26.3 million. Revenues increased 10% in the quarter, driven by subscriber growth, revenue from connected vehicle services and ARPU growth. Adjusted EBITDA grew nearly 31% to a record $370 million. And adjusted EBITDA margin jumped 570 basis points from 30% to 35.7%. Similar to the first quarter, the biggest single factor was the drop in subscriber acquisition cost down 18% as the growth in the OEM installations was more than offset by a drop in unit costs. We pick up 4.1 points of margins on the improvement in SAAC alone. Contribution margin improved to 70.9% primarily on improved OEM revenue share. And other fixed line items improved as a percentage of revenue over the prior year except for G&A which reflects much of the cost associated with connected vehicle services and increased legal fees. Free…

Thank you. (Operator instructions) And we’ll take our first question from Jessica Reif Cohen from Bank of America. Jessica Reif Cohen – Bank of America Merrill Lynch: Thank you. I have three quick ones. On the content costs, I mean, which were down, could you just remind us what major contracts are coming up in the next year or two and our expectations across can actually still come down further? And I just wanted some, if possible, could Jim some color on what you were saying about the West Coast investment?

Jim, you want to take the last first?

Sure. Sure. One of the things that I think we’ve learned here is that I don’t think we got to be what we consider to be the leader in country music without working real hard. And I think one of the ways that that was accomplished was by embedding our team in the Nashville area with both first class – what we think are first-class programming experts and first-class content experts and a studio presence there, and then built on that. And I think we’ve been pretty clear over the past couple of years that two area we wanted to invest in more are women’s programming and we want to do better in the West Coast drive time. And Scott and I have agreed that we are going to evolve, not revolution–evolve into a bigger presence on the West Coast in a variety of talent areas to supplement and develop programming for that particular audience, and for that matter programming from that area that we would like – that would appeal nationally certainly as well.

But, Jessica, you shouldn’t read the word “investments” indicate that we’re headed in a direction of committing capital that is kind of out of line with what our trends have been. I think it’s always in plan.

Yes, I think, as much as just having a handful of one or two key employees out there with the gap when Fallon left and some other things, there’s an enormous amount of talent in cycle and out of cycle out there on the promotion opportunities that, sure, they do come to New York and do it. It’s just going to give us a lot more content to be able to get some out there rather than as dependent as we are in New York.

So on your two other questions, the last of the pre-merger agreements that hasn’t yet come up for renewal is the NHL deal that it comes up at the end of this next season, so basically it runs through next year’s Stanley Cup. Other than that, we’ve already been through all the programming contracts at least once since the merger and many of them have been through more renewals than that. Directionally, Scott’s team has done an unbelievable job in taking programming cost from what were pro forma – for the two companies $400 million for 2007 down to something that’s right about $300 million level, maybe a little bit less right now. And I’ve just – I don’t see where you should expect cost to be declining in that kind of a way going forward. We think we’re at a good level. We’re still growing revenues while holding programming cost generally pretty firm now. And so we’re getting good margin absorption from it. Jessica Reif Cohen – Bank of America Merrill Lynch: So just one last question on the margin. So if programming cost is stable or kind of stable, but the contribution margin has gone up and you mentioned that Zac [ph] was part of it, I mean, the 40% long-term margin really does seem conservative. Any comments that you can make on that?

Well, yes, I mean, look, we worked really hard to get to where we are and we’re still sort of 4 point, 3 points away from getting to 40. So we – there’s still plenty of wood to chop here. Jessica Reif Cohen – Bank of America Merrill Lynch: Thank you.

And we’ll take our next question from Amy Young from Macquarie. Amy Young – Macquarie: Thanks. My question is on ARPU and near term drivers of ARPU. Can you talk about kind of your appetite for another price increase versus market segmentation; just some of the different puts and takes on ARPU and if you could talk about some of the retention cost as the business matures a little bit. Thanks.

Sure. I think that we are always looking at segmentation as a way to better efficiently manage the tradeoff between subscriber growth and price. And it continues to evolve and we continue to evolve as we get more engaged with our subscriber base and certainly more experienced with a bunch of different things we continue to try and gain results. I think probably the biggest factor that’s out there today is there’s no question that the new – the audience of people buying cars has swelled and with that has come a lower demographic that presents a little different challenge to us on – on the tradeoff that you asked about. What I will tell you is we’re testing a lot of things in that. We’re finding our way through that and we’re not going to – I can tell you we’re not going to have any kind of a knee-jerk reaction. We’re going to work our way through it and I’m confident we’ll maximize our objectives. In terms of price increases, we don’t have anything to say. I mean, we always look at areas where we think we can look for room to grow our margin but I don’t have anything to say on that today certainly. David, anything you want to add?

Just over the overtime media prices that – with the tendency to increase, I don’t think that we’ll be any different. There are lots of different ways to do it that we have quite an array of pricing plans with kind of structures and things like that. So we’ll keep an eye on pricing and continue to refine it. To your question on retention cost, it’s an area we spend an awful lot of time on. I mean, obviously, the churn rate in being able to influence the opposite side of it, how many people you keep is really important to the business. When you get this big, what seem like small churn rates are really big numbers in terms of people turning over. So we work hard and we actually allocate a lot of resources and I’ll borrow a word that Jim used earlier, investments, we invest heavily in retention strategies around customers and we try hard every day to keep them. Amy Young – Macquarie: Great. Thank you.

And we’ll take our next question from Ben Swinburne from Morgan Stanley. Ben Swinburne – Morgan Stanley: Thank you. Good morning. Two if I can; Jim, can you talk a little bit about your plans on the streaming side? I know it’s a product area you’re spending all the time on and investing in. How are you thinking about that product evolving it from here, how you position it? And then, I think, David, maybe you commented in your prepared remarks about 2 million used self-pay additions this year. Can you just put that number in context for us, how you think about that versus last year the sort of penetration of the opportunity and maybe how you think about in the context of your guidance for self-pay net ads this year? Thanks.

Yes, so, I’ll take streaming first. Ben, I think, first and foremost, I think I’ve been clear here about where our focus is on the business. Streaming to us just another protocol for transmission; and so we don’t actually see it as a separate business. It’s not a – we don’t believe that people make decisions on what they want to listen to just based on how it’s transmitted. In fact, we think that that means very little to them. How they make the decision of course is what’s the best value and what they get the most satisfaction for. For us, streaming provides some valuable outlets to solve some issues that are inherent with the technology of our net – of our satellite and broadcast network in that it both allows a much easier in-use consumption of our product. It allows much easier consumption of our product while you’re jogging or exercising or that kind of thing. And it certainly begins to allow us to do more kinds of two-way things that the IP connectivity allows. With that said, I have to say, I am comfortable where we are and the amount of our subscribers that stream our content. Our subscribers who do, as you know, pay and that’s something that we’ve built that way deliberately from day one. And we will continue to invest in our IP product to make sure that the IP product subset, I’ll reiterate the word “subset” of Sirius XM’s product, product offering is competitive with anything out there. David, do you want to take the question on used cars?

Yes. So, on the 2 million self-pay additions from the subsequent owner market, we talk about it early in the year when we gave our initial guidance. It’s up about 30% from last year’s level. We feel like we are right on track for that. And so it is incorporated in all of our guidance. I talked about the trial starts in my remarks, 2.8 million new car trial starts in the quarter and 1.2 million or almost 1.2 million used car trial starts. And so, you kind of look at that and at a roughly 4 million trial starts in the quarter that we’re looking at 30% of them being in the sort of the used car market. But the interesting thing is, is the length of growth that we’re going to find in this that eventually those subsequent owner or used car trial starts are going to exceed the new car trial starts. Ben Swinburne – Morgan Stanley: Okay.

And I think that’s an important thing for investors to keep in mind in the coming years that while we have a great sort of robust business coming off from new car production, we have a phenomenal opportunity available for the company for growth in the used car market as well. Ben Swinburne – Morgan Stanley: Thanks, guys.

And we’ll take our next question from Lee Cooperman from Omega Advisors. Lee Cooperman – Omega Advisors: Thank you, and congratulations. Excellent numbers, nice tone to the call. Just a simple question, I haven’t tried to figure it out. What is the actual fully diluted shares that spanning at the end of June, which is I guess is the most recent reported period?

Let’s see, the outstanding shares are fully diluted. Yes, they are 5.7 million and then I think there are 270 million in the money convert. And so roughly you’re trying to back up that 6 billion shares, just a few shares under that. Lee Cooperman – Omega Advisors: And the remaining that you’ve – prior authorization was completed or still in process. And I know you said, you want wrestle with the 2 billion. So what is the remaining authorization presently, just the 2 billion or something more?

So we don’t – we haven’t put that out quite yet. But we do have a little bit more than 2 billion available. Lee Cooperman – Omega Advisors: Very good. Okay, thank you very much. Congratulations again on your numbers.

Thank you, Lee.

And we’ll take our next question from Jim Goss from Barrington Research. James Goss – Barrington Research: Thank you. I’ve got a couple. First, given the growth in your subscriber base, are you starting to reach some critical mass in certain key demographics and certain markets that you might actually be able to have a little more traction in terms of advertising opportunities?

So Jim, as you know, advertising is about 2% or our – 2.5% of our revenue. I certainly don’t want it to go away. I hope our – if ever our advertising team is listening, I don’t want to say it doesn’t matter because it’s sound money. But our real focus is some traction. And as we see – as we gain footholds, I think country music is a great carrier. As we get stronger and stronger and we’re able to use both the leverage of our base of subscribers and our insight into what those subscribers want, it’s all about giving them a better product.

Yes Jim, and we continue to beat the growth in the national ad radio market. I think we’ve been showing that pretty consistently from a long period of time. And you’ll see it again this year. James Goss – Barrington Research: All right. A couple of other things. The Today tie-in I thought was a very interesting thing. Is this providing some sort of template for new partnerships that can be both promotional and co-marketing opportunities? And are you seeing impact on subscriber counts or what are your expectations in that regard?

On the Today Show, yes, that – we’ve had a long history with our partners of trying to make sure it was a two-way marketing street because our theory always was on most of these, and Today Show is probably the most glaring example of it. When they’re in the car, we’re sort of the dominant audio plays for their content. And often a lot of that may be TV content whether it’s CNBC or Fox or some of other partners. The Today Show really believes in that and has been as you point out a model example on how to do this. But all our deals have always had or attempted to have marketing component. I think with a blue chip brand like the Today Show setting that’s standard for that, I think you should expect more of that from our deals with partners or people that have marketing assets in the future.

And Jim, in terms of subscribers, we’re so big right now that frankly when we mill [ph] the ad things or drop things, it’s hard to gauge the immediate result of things. I will tell you, I personally believe that Today Show was very good for our business. And I think it’s something that will help us certainly with maintaining our subscriber base as helping to grow in the future. James Goss – Barrington Research: Right. And the last one little nit, the share of churn that is actually representing a shift to a new car, do you have any sense of how much of that in a way is maybe almost shouldn’t be carried in that metric?

There are about three different answers to that question. And I think the most conservative answer I can give you is that I think that our churn rate is probably overstated by not quite 10 basis points. James Goss – Barrington Research: Okay. Thanks very much.

And we’ll take our next question from Vijay Jayant from ISI Group. Vijay Jayant – ISI Group: I have two. I just want to get a handle on as you’ve sort of penetrated the consumer market, how many of your subscribers are really disconnecting and coming back as a new customer. I’m trying to really understand how much is the real growth for new customers rather than just sort of the funnel being re-upped every time from the same guys in the past. And second, if you sort of ran through a model that assume that you get to four times leverage by the end of 2014, given your $1.25 credit facility, is it fair to assume that you could buy back about $1.7 billion for the rest of the year? Thanks.

So on the last question, it is theoretically possible.

So let me take your first one for a minute. So I don’t know that I quite agree with you. I mean number one, a big chunk of new car buyers that we’re seeing we’ve never seen before, obviously that percent drops over time as we’re in the business longer and longer, our penetration stays in the mid 60s to the low 70s, eventually we’ll have seen a majority of the new car buyers. I’ll remind you in our new car funnel, there’s always new buyers coming to that funnel every year. Every year, x percent drops out, either they can’t drive anymore or unfortunately they passed away and they get replaced by younger people who assimilate to enough wealth to buy a new car. But the vast majority of the used car people we’re seeing we’ve never seen before. And I think there we certainly are seeing new members coming into our subscriber base without a question. And I think that’s the best I can answer that.

And one of the couple things, I mean in the – most of the trailers in the new car funnel represent non-subscribers. When you think about it, we converted for a long time less than half of the new car buyers and then people churn. So you have the people you didn’t convert or who churned off the service and the people who you haven’t seen before and when you add them all up, there’s more of those than there are people who subscribe to the service. So every quarter, we see more of non-subscribers in the new car trial funnels than we see subscribers. Then the second thing is that when you think just about the vehicle turnover among the existing base, we have more auto partners on unpaid trials than we have on paid trials. And so when somebody goes from the self-pay subscription to an unpaid trial subscription, we count them as churn in their auto versus subscriber base. So I think you’ve got two factors suggesting that we’re honestly a long way from just having the existing sort of subscriber base pop up the funnel.

Yes. Vijay Jayant – ISI Group: Very helpful. Thank you.

And we’ll take our next question from John Tinker from Maxim. John Tinker – Maxim Group: Thank you. Could you give us an update on how your targeted service to the Hispanic community is going?

Well, so I would say we’re still developing it. As you know, we ran a major promotion in a month in the second quarter in Houston that was 100% Hispanic focus. It involved a lot of talent. It involved a mix of car dealers and individual subscribers. I’d say it’s too early to be able to give you any kind of meaningful data there yet. John Tinker – Maxim Group: Thanks. Finally, as you go from being in 65 million to 120 million cars, what do you think you your total – what do you think could hit in terms of subscribers, in terms of the market size? And secondly, do you have any plans to access the subscribers who aren’t actually paying for service?

So we obviously are not – we don’t give any long-term guidance on where we think we can get in subscribers. I think you’ve touched on the real fundamental of our growth, which is I’m really confident that the amount of enabled cars in the next five years with the only exception being we don’t know what will happen to the economy in the United States, but we’re confident in what our incorporation rate will be. And you can do the math from there on how big the following gets, how efficient we are in yielding out of that funnel. And I think pretty quickly you can come up with your own longer term subscriber number. And remember, we’ll get another bite at all of those again six years down the road which is about the average length that someone’s keeping their car, right? So I think that one’s for you to figure out without our help. What was your second question again, I’m sorry? John Tinker – Maxim Group: As you build up this huge phase of cars with your radio end that aren’t paying you, do you have any plans to access that base in any other way?

Well, that’s a great question. That’s a great question and it’s certainly – do we have any plans today that we’re ready to announce? No. Are we actively looking at that? All the time. John Tinker – Maxim Group: Okay, thank you.

John, the only other thing I’d say on long-term subscriber growth is that we expect to build out the fleet to about 150 million vehicles in 10 years’ time. And between the new cars and the what is going to be consistently growing opportunity in the used car market, I think you’re going to see steady growth in subscribers for all the way through that period. John Tinker – Maxim Group: I hope so, thanks.

And we’ll take our next question from James Ratcliffe from Buckingham Research. James Ratcliffe – Buckingham Research: Hi. One more on the used market if I could. You’re clearly making progress on that front. And what share of used transactions at this point do you think you have visibility into and again with the 13,000 dealers and the like and how high can that get? What’s the sort of point where there’s just going to be leakage because there are transactions you can’t reasonably [ph] get to? Thanks.

Well, right now I would say that our share of the – I mean we don’t know for sure, right? But I think our share in terms of getting it recorded to us is that – of the used car transactions is pretty high. Our average fleet is only 3.8 years old and the cars that are turning over tend to be relatively newer, so they’re running through CPO programs or franchise dealers where we have very good reporting protocols. It’s really tough to go to hang a number on it. Thanks. James Ratcliffe – Buckingham Research: Thank you.

And we’ll take our next question from Barton Crockett from FBR Capital Markets. Barton Crockett – FBR Capital Markets: Okay, thanks for taking the question. A couple of things if I could. First, I was wondering if you could just update us on progress with Agero in terms of consumer uptake and automaker deployment plans. And I’m kind of curious, you guys had announced five-year kind of net traffic navigation relationships I think with Quest [ph] going forward. If you could talk about if that plays into your relationships with the automakers and how that could affect the income statement going forward.

Sure. I think the first sign of progress on Agero is we don’t use the name Agero anymore. It doesn’t exist here, okay? Which, as investors, you should feel good about because we fully integrated that organization into the Sirius XM organization and let our teams – one of the things where I’m really proud of that we’ve accomplished on a quick period of time is when our teams meet with our OEM partners today, there’s not one team coming in on audio and one team coming in on connected vehicle. It’s a fully blended sale. So the first part of your question, I’m really happy of where the integration has gone. And second, I’m very pleased with the stature it’s given us both in terms of its embedded technology and in particular, the access to those over 100 engineers that we can have working on our mid and long-term connected vehicle strategy. And second, there’s nothing like having a real working service when you go in to sell that you wanted to in the service business with OEMs. They’ve been shown so much short letter [ph], so much stuff that’s going to happen, it makes dealing with them a whole lot easier when you actually have a real service. And so I would say that’s the second part I’m really pleased with. The third part, where is it going? I think I was pretty clear in my remarks, it’s really moving around a lot right now. There’s a lot going on and I think it’s too early to answer your question where we’re going to fall up. But I will say I’m confident; in the end, we’re going to do really well here.

Thank you. Thanks, Barton. And thank you all for participating in the call.