Satellite Radio Playground

by Dennis “Cos” Costa

Sirius XM CEO, Mel Karmazin

In a earnings press release this morning, Sirius XM Radio (NASDAQ:SIRI) reported its first quarter (Q1) 2010 earnings and operations results. As previously announced, the company confirmed a total net addition of 171,441 new subscribers in the first quarter, compared to a net loss in Q1, 2009 of (404,422). This brings their total subscriber base to 18,944,199 as of March 31, 2010, an increase of 344,765 on a year-over-year basis.

During CEO Mel Karmazin’s opening statements, he spoke of other non-financial issues that have occurred since the first quarter’s closing date of March 31, 2010. He spoke of how pleased they are to have resolved the NASDAQ bid compliance issue on April 27, 2010, and how through organic growth in their stock price, they no longer were considering a reverse stock split. He also spoke about the company’s value in relation to other NASDAQ listed companies, and that they were valued higher than 92% of all companies listed. As a result of the company’s value and performance, they were entered into the NASDAQ Q50 Index last week. Sirius XM had been on the back-up list of this index, which is a benchmark for some of the world’s most up and coming growth companies, as described by NASDAQ. Mr. Karmazin also reported in the first quarter the company’s equity is one of the most liquid listings in the NASDAQ, and that in the first quarter of 2010 it was the most heavily traded stock on the NASDAQ exchange.

Mr. Karmazin also stated that the company was very excited about their management of customer churn at 2.0%, down from the preceding period in 2009, which was 2.2%. He said that customer satisfaction remained high despite the increase in fees that were instituted in 2009 for the internet access, multi-subscriber, and music royalty payments. As a result of customer satisfaction and the economy recovering, he reported that the company returned to record growth in subscribers, reaching 19.003M at the end April, 2010. This in itself would indicate that the company is far exceeding its expectations of adding over 500K subscribers this year. It is too early to tell, but I am looking for the company to revise this number up by a minimum of 200K subscribers to over 700K for the year. A very up-beat Mr. Karmazin simply reiterated his confidence in the company’s outlook, and maintained all guidance for 2010.

In the company’s press release of their earnings results, the headline was as follows:

Pro Forma Revenue of $670.6 Million, Up 11% Year Over Year – Record Pro Forma Adjusted Income From Operations, up 45% Year Over Year to $157.8 Million – Net Income Per Common Share of $0.01 Versus ($0.07) a Year Ago

Looking deeper into the report, while reporting positive year-over-year results, the surprise to most was that the company reported a negative free cash flow (FCF) of ($127.2M) for the quarter, an increase compared to the same quarter of 2009 of ($3.6M). The company’s explanation of this change in operating cash flow was as follows:

This increase was offset by changes in operating assets and liabilities as a result of the early repayment of approximately $61 million deferred in 2009 that was scheduled to be repaid, at 15% interest, in monthly installments from April 2010 through March 2011, a lump sum programming payment in the first quarter of 2010 that was paid over the course of the year in 2009 and the payment of 2009 bonuses in cash as opposed to stock in the prior year resulting in an increase in net cash used in operating activities of $104.6 million. In addition, capital expenditures in the first quarter of 2010 increased by $28 million over the prior quarter period primarily due to increased satellite spending.

While negative FCF is always concerning, the explanation seems to describe prudent cash management for the purpose of reducing future financing costs. Rather than spreading payments out and incurring interest and fees, impacting future quarters’ performance, the company is applying cash on hand to front-load these payments for 2010. In addition, these up-front payments account for the noticeable change in the Cash and Cash Equivalents account sequentially, from $383.5M as of December 31, 2009, to $268.5M as of March 31, 2010, or a net reduction of $115M. The company also paid capital expense of $28M, attributed to satellite spending. They also confirmed the launch of XM’s satellite, already built, scheduled for the fourth quarter of 2010, and the launch of Sirius’ sixth satellite at the end of 2011. David Frear said that this would complete their constellation build-outs for both companies, and will result in savings of over $100M in 2012, and into years beyond.

Looking at past practice for payments of expenses, most analysts were expecting Free Cash Flow to come in over $100M. When asked if this would impact the company’s projections for 2010 of over $500M, the company reassured investors and analysts on the call that they were confident that this number would track out over the year, and they are maintaining all guidance for this important metric.

The company noted that their OEM partners were experiencing a recovery, and were optimistic that this would continue. The industry reported on May 3, 2010 a Seasonally Adjusted Annual Rate (SAAR) of 11.19M for April, up from 9.2M a year ago. The used car programs are showing a lot of promise and are growing sequentially, resulting in gross additions. Although the volume is still relatively small compared to the overall new car business, Mr. Karmazin reiterated how important this market would become in the future, and was very optimistic.

Another surprise to most observers of the company’s metrics, was the significant reported rise in average revenue per user (ARPU) of  $11.48, from its same period a year ago of $10.48, a 9.5% increase. This would normally be celebrated, especially considering the cost of customer retention to manage a steady churn of 2%. Here again, it requires digging deeper to find the reason for the increase. What we find, is in this quarter the company included the Music Royalty Fee charge, that in the past was either not included, or not available because it did not exist. Removing the $47,947,000 in fees collected, puts this metric back into perspective. Sequentially, the ARPU would have decreased to $10.63, a decrease from the previous quarter’s $10.92, or 2.6%. It always pays to look a little deeper at the most obvious surprises in metric, non-GAAP numbers.

The key highlights from the results:

• Sirius XM is reporting solid numbers from continued growth, supported by a recovering auto industry. They reported a return to record subscriber numbers at the end of April of over 19M.
• Management is prudently utilizing its cash to reduce financing costs and fees, by prepaying expenses for the 2010. This resulted in its reported negative free cash flow for the first quarter, only to reap the rewards of these actions in future quarters.
• The company is also using its cash to make bonus payments to its employees, instead of common shares of stock, which is good for investors by eliminating the resultant dilution.
• The company is paying off near term debt, as evidenced by its announcement to prepay the 10% PIK Notes due 2011 on June 1, 2010.
• The company is taking advantage of the best debt profile in its history by restructuring its balance sheet and reducing interest cost.  In a year the company has progressed from a 15% secured debt condition, to a 9% average unsecured debt status.
• Given their debt profile, they will continue to reduce debt and interest expense in the coming quarters as is appropriate.

Finally, when asked about the status of the Howard Stern contract, Mel Karmazin said that there was nothing new to report, but when an announcement is made, it would be announced on Stern’s show.  If anyone wanted to know what was going on with Howard’s status, they would have to listen to him on his show. This sounded very optimistic, and bodes well for the “King Of All Media” being a content provider for some years to come. Stay tuned…

Position: Long SIRI

Contact the Author: denniscosta@satelliteradioplayground.com