Sirius XM Holdings Inc (SIRI) 2003 Q3 法說會逐字稿

Good morning. My name is Molly, and I will be your conference facilitator. At this time I would like to welcome everyone to the XM Satellite Radio third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press star then the number 2 on your telephone keypad. Thank you. I will now turn the call over to Joe Titlebaum, Executive Vice President and General Counsel. You may begin your conference.

Good morning. My name is Joe Titlebaum, General Counsel of XM Satellite Radio. Before we begin our prepared remarks, I would like to remind everyone that certain information on this call may contain forward-looking statements. Due to a number of factors, our actual results may differ materially from those projected in such forward-looking statements. Those factors include future demand for the company's service, the company's dependence on technology and third-party vendors and the potential need for additional financing, as well as other risks described in XM Satellite Radio Holdings, Inc., Form 8-K filed with the Securities and Exchange Commission on June 3, 2003, and the form S-3 filed on August 8, 2003.

Copies of these filings are available upon request from XM Radio's Investor Relations department. I will now turn the call over to Hugh Panero, President and CEO of XM Satellite Radio.

Thanks, Joe, and good morning, everyone. I'd like to thank all of you for joining us today to discuss our operational and business results for the third quarter of 2003. And as usual, on our call today is Joe, Joe Titlebaum; Gary Parsons, the Chairman; Joe Euteneuer, the Chief Financial Officer; and Steve Cook, who is probably a happy guy today, the Executive Vice President of sales and marketing, because of our subscriber achievements.

This morning I'd like to focus my remarks on XM's outstanding third quarter results and our expectations for a very successful fourth quarter. A quarter that will feature even greater OEM penetration and the always critical holiday selling season. Joe will then review the company's financial results for the quarter, and then we'll open up the lines and take your questions.

In late October, XM passed the one million subscriber mark in less than two years after the service was launched nationwide, a pretty historic event for XM Radio, its employees, its partners, its shareholders, many of whom are on the call today, and most importantly the listeners who have clearly demonstrated the broad appeal of our satellite radio service. We are all professional people here, and we spent about five, six years building this business, and we are really savoring this week, it's a special week for us, but we realize that we have to continue to be vigilant, but we don't want to let the moment pass without enjoying it.

On November 4th, just a couple of days ago, we celebrated our one million subscriber milestone with an open house here that was hosted by Quincy Jones. We had it at our broadcast facility here in D.C., and we had a number of artists from various Johnners that represent what XM is all about, that span jazz, blues, country, R & B, rock and comedy, people like Cassandra Wilson, and Shelby Lynn, and Kenny Wayne Sheppard, and the comedian Lewis Black, and other Grammy award winners. We also broadcast the event live on XM Satellite Radio, which we think it was an enormous success and we had a lot of feedback.

We also had a presentation to our, what we call the honorary million subscribers where we selected some audio that was submitted to us by about -- there were about 18,000 customers who were asked to tell us why they loved XM, and we picked out the best ones, and we put together an audio presentation that we -- and we honored these customers, and it was a pretty big moment because we wanted to share it with our subscriber base.

The achieving of the one million subscribers not only validates satellite radio but does something even more. It really just shows that as a service we are being accepted in the hearts and the headphones and the living rooms and the dashboards of America, and we are becoming an essential component of one's daily routine. I think what a lot of people do now is they get in their cars, and they listen to local radio, they find out the news, the weather and the traffic, then they switch over and they listen to XM Satellite Radio for the balance of their time in the car.

Consumers have adopted XM Satellite Radio faster than regular radio's did when it was launched, TV's, satellite, TV dishes, CD players, MP3 players, and digital video recorders. As a mass medium, we reached a million subscribers in less time than cable TV and on-line subscription services like Internet access, two of the nation's most successful subscribers businesses. This is a result of the fact that when many of these different services launched, there was some component of their business that was missing. Either dishes were too big or hardware was too expensive or they didn't have the right distribution or the right content. And our business tends to have all of those characteristics that came together at the right time.

I was actually amused that I think just yesterday TiVo announced that they had hit a million units after being around about five or so years. So if you think about the presence that TiVo has or awareness and you look at XM Satellite Radio and how quickly we did it, we've been quite successful. And what's also interesting is just as cable TV destroyed the myth that nobody would pay for television, we have destroyed actually two myths. One is that nobody would pay for radio and that radio had to be local to be successful.

Turning now to the third quarter results, during the quarter XM added a record 237,395 net-new subscribers, ending the period at 929,648 total subscribers, extending our leadership position in both the retail and the OEM markets for satellite radio. In fact, our third quarter confirmed that XM not only accounts for roughly 85% of the total satellite radio market to date but also continues to capture the dominant share of all new growth. Third quarter subscribers represent a 34% increase from the end of the second quarter of 2003 and more than four times the subscribers for the same period last year.

The subscriber momentum will accelerate during the fourth quarter with the anticipated addition of approximately 300,000 net-radio subscribers, or nearly as many subscribers as we added during all of 2002, and we'll end 2003 with over 1.2 million subscribers. I think that's a pretty significant achievement. With our diversified portfolio of products, XM's wide brand recognition, our award winning content, our broad retail distribution channels, and strong OEM partners, XM is positioned to compete again as one of the hottest new gift ideas for the upcoming 2003 holiday shopping season as it did last year.

In the product area, XM recently introduced two attractively priced new additions. The Delphi Roady and the XM Commander. To compliment our highly successful Delphi, SKYFi radio product line. Both additions have generated excitement among consumers and are energizing retailers and are available in select stores nationwide now. The Roady delivers outstanding performance in an easy to install package that weighs about five ounces. It's about 40% smaller than the previous portable satellite radio models. The Roady is the first complete satellite radio solution for the vehicle priced under $120 and it offers subscribers some pretty cool, unique features, including a new ultra-thin XM micro antenna, interchangeable face plates, customizable color screen display options, and a special feature called "tune select" that remembers and finds your favorite song when they play on any of the XM channels.

The XM Commander, at an MSRP below $160, is another important addition to XM's current product lineup, and it enables XM to work with all existing AM/FM car stereos, regardless of the make, the brand, or the year. It features a compact controller with a display screen, again the XM micro antenna, a full-function remote control and a very small hide-away tuner box. The Commander also offers subscribers state of the art functionality including a large dual-line display, it has 30 channel presets, the ability to preview channels before selecting, and the XM tune select feature as well.

The controller is sized and styled to integrate seamlessly into the dashboards of most vehicles including high-end luxury cars. It's important to note that the attractive retail price point of these products are not achieved by major hardware or chip set subsidization and the modest hardware subsidies on both the Roady and the XM Commander are in line with those experienced on the SKYFi and are consistent with XM's guidance on fat [ph] reduction.

With the introduction of the Roady and XM Commander we gained two outstanding product offerings. These products also enhance our ability to penetrate additional market segments including younger demographics and vehicles without tape decks. So for the people who have been on the call from the beginning of our launch, we started out with products that were priced in the range of $300 to $600, and now with these two new products and other products that we already have out in the marketplace, our products range in price from $49 to $200, with our boom box, with our SKYFi, at $169, with our Roady at $120, and we have our PC accessory product called the XM PCR at $49.

In preparation for the upcoming holiday shopping season, our partners have already manufactured, of these new products, we have about 100,000 Roady's and 18,000 XM Commander units. These products began shipping early last month and will be prominently displayed at a wide range of retailers during the holiday making them, as I mentioned earlier, great gift ideas.

Also, a common practice in the after-market and the OEM business is third-party companies that emerge to offer innovative products built around successful technologies or products like XM Satellite Radio. For example, when consumers wanted to listen to CD's in their car, a bunch of third-party companies started offering after-market CD changers that worked with the in-dash stereo systems in those cars. When people wanted a place to put their cell phones in the car, third-party companies again emerged and started offering docking stations and other accessories, so that those devices could work in the cars. At XM we want to encourage the development of these innovative third-party applications around the XM service, and we are now providing a new product to third-parties called XM Direct.

The XM Direct system enables a satellite-ready radio to tune into XM using the existing in-dash stereo controls. What we're doing is we're providing this product to new third-party distributors, one is called satellite radio direct, and what we contribute is a universal tuner module and antenna that works with any satellite radio, any satellite-ready radio. Satellite radios direct packages the XM direct tuner and a small antenna with digital cable adapters that are created by third-party engineering development companies and it's a packaged product for consumers. So now we have a very easy way to get into vehicles that have head units that are satellite-ready. Satellite radios direct packages the XM direct tuner and a small antenna with digital cable adapters that are created by third-party engineering development companies and is a package product for consumers. So now we have a very easy way to get into vehicles that have head units that are satellite-ready.

Satellite radios direct is offering XM direct to both consumers and automobile dealers. Auto dealers have years of experience selling products and services developed by third-party companies. You just have to look at the introduction of mobile video players and the lowjack system for locating stolen cars, and what XM direct gives the auto dealers an opportunity to offer XM radio to their customers, and they're all in the business of satisfying consumer demands because they want to have loyal customers. A further indicator of the sustained demand for XM product in general, ST Microelectronics, XM's exclusive manufacturer of our chip sets, recently announced that total shipments for XM chip sets have now exceeded 2 million units. ST expects to reach 3 million marks within a few months. Moreover ST has shipped working samples of our third-generation chip set which combines XM's two custom chip sets into one.

This third-generation chip set will facilitate additional innovative products in '04 and '05 due to its reduced size, lower power consumption, and improved manufacturing costs. And I think it's pretty clear that along with leading and subscribers, compared to other technologies, that we also are very competitive with regards to being a leader in developing cutting-edge products and technology as well for our service in our category.

In the retail marketplace Best Buy and Circuit City are driving our sales growth, and have each awarded XM their respective, "Vendor of the Year" awards in the mobile audio category. This is quite an honor from these retailers. It means that we obviously are contributing to their sales growth, which is obviously happening in a depressed audio segment, so we're a pretty important components of their business. And also Wal-Mart, the largest retailer, continues to ramp up the merchandising of XM products like SKYFi and Roady in its stores nationwide, particularly in its connection centers. And it's well positioned to become one of our major sales outlets over the next couple of months.

Now to the OEM market. XM views a strong OEM business to be an absolute necessity for the broad penetration of satellite radio into the consumer marketplace. Our OEM business was exceptionally strong during the third quarter, representing more than one-half of net adds and was boosted by promotions such as the GM-sponsored Cadillac summer jam which proved to be a big success. The trend is significant, especially when you consider that General Motors and Honda together expect to manufacture approximately one million XM factory-equipped vehicles during the '04 model year, which is already underway. As many of you know that the model year commences in September of '03 and then goes through '04. So these are not projections that we are looking forward to generate. We actually see these things happening right now.

Over the last year GM has made XM a big part of its vehicle selling strategy. The amazing speed of XM's roll-out into new GM cars is a clear reflection of their commitment to this category. And now Honda has joined GM in offering XM-factory-equipped vehicles to new car buyers. Moreover these two leading automobile manufacturers have invested significantly in educating their dealers and new car buyers as to the value and appeal of satellite radio.

Over the first nine months of 2003, GM highlighted XM's availability on popular GM vehicle models in a comprehensive marketing campaign that includes print, and radio, and TV advertising, direct mail, market incentives, and other special promotional events. As new '04 Honda and Acura vehicles continue to arrive at showrooms in the fourth quarter, we expect Honda to join GM in not only creating XM subscribers and broader XM awareness, but also in generating significant XM brand loyalty among consumers through a similar marketing effort.

This quarter has included many important events in the GM/XM relationship. In July, GM announced that half a million XM-equipped vehicles had been manufactured. Also in July, GM successfully added 19 new models to the XM portfolio, bringing the total number of GM 2004 models offering XM to 43, representing approximately 75% of the entire GM model lineup. GM and XM working collaboratively are building on these successes. We look forward to ending 2003 with over 400,000 GM-related XM subscribers and nearly ten-fold increase from the end of 2002. And further, GM's ramp to one million XM factory-installed production mark is expected by the end of the first quarter of 2004, or just about five months from now.

In September, Honda launched its 2004 model year cars, offering XM as a factory-installed standard feature on the RL and the TL from Acura, both of which are available today at Acura dealers across the country and providing XM Radio as a factory-installed feature on the EX trim level line of the Honda Accord. The EX is a popular choice, representing about one-third of total Accord production volume, and as you know the Accord is a pretty popular car. The results of the Honda launch have been extremely encouraging. The third quarter ended with more than 6,000 Honda subscribers, up from just 700 at the end of the second quarter. It is important to note that this growth from Honda subscribers primarily occurred in just one month, which was September. So we expect that number to grow as the roll-out continues. Building on this momentum, Honda expects to manufacture over 200,000 XM-equipped vehicles during the '04 model year.

Also during the quarter, Toyota made XM available on its Lexus LS430 as a dealer-installed option, making it the first Lexus model ever to be offered with a satellite radio option, and Toyota has now made XM available on each of its brands, the Toyota Seinna and Lexus. In addition, Infinity announced that it will offer XM to new car buyers as a factory or dealer-installed option on its entire vehicle lineup. We are encouraged by the steps taken by Toyota and Infinity and look forward to expanding our relationship with these leading manufacturers. And, finally, Nissan and Audi offer XM as an option on select '04 models as well.

Complimenting these OEM efforts, the Avis rental fleet completed its first full quarter of XM Radio nationwide availability and it's a significant source of positive consumer exposure and feedback to XM and its compelling content. In fact, XM and Avis just announced that beginning immediately XM service is going to be included at no additional costs to customers renting a luxury or premium Avis vehicle. As of September 30th, Avis had activated about 19,000 XM-equipped vehicles. And, of course, we encourage everyone to visit their local GM, Honda, Acura, Toyota, Nissan, Infinity, Audi and Avis franchise to test-drive XM, the next generation of radio.

In the financing area, XM continues to strengthen its balance sheet and improve its liquidity position. In September, as many of you know, we completed a common stock offering to Legg Mason and T. Rowe Price raising net proceeds of about $150 million, and Joe Euteneuer will discuss our liquidity position in greater detail in a moment. And, basically, as you can see we're well positioned with a diverse and attractively priced product line, expanded retail distribution, increased OEM penetration, compelling programming that listeners want and demand. I think our brand recognition in this category is exceptional, and we are ready for an outstanding fourth quarter of this year and an even better 2004.

What I'd like to do now is turn the call over to Joe who will discuss our recent financings and our financial results for the third quarter of 2003. Joe?

Thanks, Hugh. This was a solid quarter for XM Radio, as we reached the major milestone of one million subscribers. Behind the scenes, we also achieved other financial milestones that will create a significant shareholder value over time.

I'd like to discuss four topics this morning. Our progress in improving operating margins and containing costs, while continuing to grow the business rapidly. Our ability to reduce the cost of gaining each new subscriber, our substantial progress in reducing cash burn, and our fund-raising activities during the quarter, along with our efforts to opportunistically de-leverage our capital structure and to minimize future dilution.

Once again XM enjoyed a record quarter for subscriber additions, adding more than 237,000 net additions, and reaching 929,000 subscribers by quarter's end. We added more subscribers in the third quarter than we added in the first nine months of 2002. We are well on our way to exceeding 1.2 million subscribers by year-end. Driving this growth are improvements in our distribution channels, expanded product offerings, as well as sales and marketing support from XM's key manufacturing and distribution partners. While the growth rate of XM is very exciting, and clearly demonstrates the potential of satellite radio, we are equally excited by the improvements in our operational performance this quarter and the long-term prospects for XM radio.

Of these 929,000 subscribers, approximately 721,000 were after-market OEM and other subscribers. 189,000 were OEM promotional period subscribers, approximately 75% of whom are electing to continue their XM service post-promotion. And as Hugh mentioned earlier, another 19,000 were Avis Rental Car subscribers. In our press release we detail for you the RPU for each of these subscribers categories so that you may review the individual trends that make up our overall performance.

Our EBITDA loss, including a net one-time benefit of $4 million, was $64 million for third quarter of 2003 as compared to an EBITDA loss of $67 million in the third quarter of 2002. While there is a slight improvement in EBITDA loss, more dramatic indicators of XM's improving business performance can be found in our significant subscriber growth, rapidly declining CPGA cost, improved operating margins and stable fixed expense. XM continues to pursue it's managed growth strategy for 2003, focusing on efficient expansion of our subscriber base.

The most notable items of our operational performance include the following: This quarter revenue increased over 34% from the second quarter of 2003, to $27 million, nearly five times the revenue from the third quarter of 2002. This increase in revenue is primarily due to the subscriber growth in our after-market OEM and other subscriber category. The average monthly subscription revenue per subscriber, or RPU, for this category was $9.51 in the third quarter, versus $9.54 for the third quarter of 2002. Overall RPU was $8.84 in the third quarter of 2003. The reduction in overall RPU is driven largely by the growing number of new OEM promotional subscribers who typically receive one free month of XM service.

Also, our family plan subscriptions have grown to nearly 7% of our ending subscriber base. We believe these customers who pay $6.99 for each additional radio beyond the first subscription will be XM's most loyal and highest total revenue customers. Our subscribers continue to pay their subscriptions in advance. Paying on average five months in advance, an improvement from last quarter. In addition, we have started to see substantial customer interest in purchasing multiyear subscriptions at a discount from the $9.99 base rate. These accounts have more than doubled since last quarter to over 58,000 subscriptions at September 2003, and provide a significant liquidity benefit to XM.

XM's total operating expenses for the third quarter of 2003 increased by approximately $26 million, or 25%, to $127 million, as compared to the third quarter of 2002. Yet our additions increased over 2.5 times from the same period last year. This trend shows that although our expenses are up on a total dollar basis, our efficiency in gaining subscribers continues to improve dramatically.

Variable expenses include the cost of equipment sales, revenue share and royalties, customer care and billing, and advertising sales. These expenses were $19 million for the quarter ended September 30th, 2003, an increase of $13 million as compared to the $6 million for the quarter ended September 30th, 2002. This increase is directly a result of the growth in revenue and subscribers. The gross margin on our subscriber business, which includes revenue share and royalties, along with customer service costs, has improved to 39% in the third quarter of 2003, from the 34% in the second quarter of 2003, and the 28% in the first quarter of 2003. A trend we expect to continue.

Fixed expenses, which include satellite and terrestrial, broadcast and operations, programming and content, research and development, general and administrative, and marketing retention and support, declined to $25 million for the third quarter of 2003, compared to $35 million for the quarter ended September 30th, 2002. This quarter we reversed $8 million in non-cash compensation charges for warrants that are no longer applicable. Absent this one-time reversal, fixed expenses would have been $33 million, which is in line with our guidance. We expect fixed expenses to be stable at approximately $140 million for the full year 2003.

I would now like to comment on our continued improvement in the cost to gain a subscriber, which is best measured by cost per gross addition, or CPGA. CPGA is the fully loaded per-unit measurement of the cost to capture the next subscriber. CPGA includes not only subscriber acquisition costs, or SAC, but also advertising and marketing. CPGA is the best gauge to evaluate the cost effectiveness of gaining the next subscriber. CPGA for the third quarter was $127 per subscriber, as compared to $385 per subscriber in the third quarter of 2002, and $160 per subscriber in the second quarter of 2003. Our in-house product development efforts have resulted in a significant cost reduction on hardware, which are major drivers of our lower CPGA. Additionally, we have discipline in the discretionary use of media and advertising spending, as well as our use of product promotions and rebates.

Over the first nine months of the year, XM only spent $41 million on advertising and marketing, versus $73 million in the first nine months of 2002. This is a $32 million, or 44% reduction. XM's ability to reduce these costs, while at the same time accelerating subscriber growth, is due in a large part to the coordinated effort and support of our OEM partners and the strong word of mouth marketing provided by our existing XM subscribers. Obviously, the $127 CPGA for this quarter is a substantial reduction, and we are pleased how rapidly this metric has improved.

From this point forward, CPGA will improve at a more moderate rate and may fluctuate on a quarterly basis due to seasonality of the business, product mix, and distribution channel mix. We expect to see continued chip set, antenna, and component cost improvements coming out of our innovation center in Florida. Some of these improvements will reflect themselves in further reductions of CPGA, while others will be used to improve consumer price points and product configuration.

Subscriber acquisition costs are a subset of CPGA expenses and reflect manufacturing subsidy costs, distribution expenses, all promotions, and the negative margin on direct equipment sales. XM SAC for the third quarter of 2003 was a modest $76 per subscriber, as compared to $131 per subscriber for the same period last year, a 41% reduction in SAC in a year. XM has successfully reduced retail price points by aggressively driving down the cost of chip sets and the other components of our radios to minimize subsidy costs. Further, we have been effective over the past year in shifting the payment of subsidies from the time of manufacture to the time of activation, minimizing XM's risk on relative amounts of inventory at the various retail outlets.

Next I would like to comment on our significant progress in reducing our net cash burn. For the quarter ended September 30th, 2003, XM's negative operating cash flow was reduced nearly in half from the same period in 2002. From $86 million to under $45 million this quarter. The $45 million also represents a significant improvement from the net cash burn of $59 million in the second quarter of 2003. These results reflect the improvement in operations associated with the continued growth in subscriber revenues, ramping gross margins, stable fixed expenses, and reduced CPGA, along with the impact of deferred revenue which increased to $32 million as of September 30th, 2003, and noncash financing from GM of $19 million during the quarter.

In the financing area, I'd like to touch base on XM's liquidity position and highlight the fund-raising activities during the quarter. As of September 30th, 2003, XM had a total cash and short-term investments of $457 million, and an undrawn facility from GM of $96 million. Taken together, the total liquidity position of XM as of September 30th, 2003 is $553 million. We believe that we have adequate liquidity to execute on our business plan.

During the quarter, XM improved its balance sheet and removed significant risk from its business plan through the issuance of 11.3 million shares of its Class A common stock to Legg Mason and T. Rowe Price for net proceeds of approximately $150 million. The net proceeds from this offering will be used primarily to pay the construction of XM-4, which will be available as a backup to XM-3 in 2005. In addition to strengthening our liquidity position, XM converted to common stock approximately $96 million in face amount of maturity of its 10% senior secured discount convertible notes and its preferred stock in return for 12.9 million shares of common stock. As a result of these conversions, the company will avoid $45 million in future interest and dividends and the potential dilution of over 800,000 shares of common stock which otherwise would have been required for future interest or dividend payments.

These de-leveraging transactions provide a significant economic gain for the company. But for accounting purposes they result in a non-cash accounting charge of $4.4 million during the quarter which is reported in other expense and included in EBITDA. This noncash charge results primarily from the write-off of debt discounts and deferred financing fees. Of course, no one likes to occur these one-time accounting losses on the books, but the substantial positives that we gain in reducing our debt and a stronger balance sheet and reduced future dilution are well worth the effort. We may incur future accounting charges as we pursue opportunistic deleveraging of our balance sheet through the retirement or conversion of various securities.

Okay. In regards to guidance to the street, we plan on finishing 2003 with increasing momentum, which we will carry into 2004. We expect to exceed our guidance of 1.2 million subscribers by year-end 2003 and to beat our revenue guidance of $85 million while holding our EBITDA loss to our guidance of $295 million excluding the impact of deleveraging transactions. With regards to 2004 guidance, we are putting together final plans for 2004 which will include new product launches, new service offerings, and the pace of growth we want to achieve in both the OEM and retail distribution channels.

It is clear that we have the leading position in satellite-radio category and we will continue to grow the business in an economically responsible manner. We will announce final 2003 subscriber results the week of January 5th, 2004, and at that time we will also provide 2004 guidance on subscribers, revenue, EBITDA, and cash flow. But based on our experience to date, we expect to exceed the average analyst estimates for 2004 ending subscribers of approximately 2.5 million. Hugh?

Thanks, Joe. Well, many of you have been following the company know that this team has been here pretty much since the beginning, and I think what we've demonstrated is that we have in the past and we continue to execute our business plan. We're hitting all our major milestones to date, our subscribers continue to surge, we've hit the one million mark, we're on our way to exceeding 1.2 million at the end of the year, and we're expecting a successful 2004. We've got new products, like the Roady and the XM Commander and XM direct that have been introduced. They compliment our existing SKYFi line and we're expanding markets which we think will also fuel subscriber growth.

From every vantage point, whether you're talking about product, pricing, distribution channel, content, quality, we are superbly positioned for an outstanding holiday season, which, as you know, is a big part of our growth phase in any given year. Our subscriber growth has been achieved while we control cost, lower SAC and CPGA, and stabilize EBITDA, as well as keeping our fixed costs flat. And we continue to strengthen our balance sheet and improve our liquidity and mitigate financial risks.

In summary, since we're being reflective here because we hit this one million mark over this two-year period, is that we have, made some very good decisions, we have avoided very big mistakes. The smaller mistakes that we have made we have learned from, and we are, and as I said at the beginning, we're going to enjoy our hitting this million mark but we realize that the challenges that go forward in '04 and '05 and '06 are the same kinds of things that we faced in the past, and we're just going to be very vigilant and dedicated to responding to whatever issues come up and overcome them as we have in the past.

So with that, I'd like to open up the call for your questions and we will move forward.

At this time I would like to remind everyone, in order to ask a question please press star then the number 1 on your telephone keypad now. We'll pause for just a moment to compile the Q&A roster. Our first question comes from Robert peck from Bear Stearns.

Hey, guys, congratulations on a great quarter. Hugh, I wanted to know if you could maybe talk a little bit more about the XM Direct product. First of all, is it a clean install? Are there wires and stuff, or is it sort of hidden behind the dashboard? And what sort of option? What's the price of that option say versus a dealer going with a serious option? Are there any sort of legal issues attached to it? Can a BMW dealer install an XM Direct unit?

Well, Steve, why don't you answer the question.

The great thing about this product is if you think about it, any satellite-ready head unit out there can be hooked up with XM Radio. So what we're doing is providing the tuner box and a little micro antenna, and then there are third-party equipment manufacturers out there that are developing the connector cables so that a standard set-ready head unit can display all the song title and artist information. The great thing is, there are no wires in the vehicle. It looks just like a factory-installed vehicle, and with our new micro antenna that can be installed very discretely on the roof of the car, and it looks like a factory-installed solution.

Great. There's no sort of legal issue there, I guess, at all with going into manufacturers you don't have agreements with right now?

Third parties that provide various types of accessory products and, both the OEM and the aftermarket, and we are simply providing our technology with our XM Direct, which is an open operating system for people to enhance the category, move it forward, and basically respond to consumer demand.

Okay. Great. Joe, I was wondering if could you maybe tell us a little bit more about churn and gross adds. I notice on the call you said that CPGA number of $127 was per subscriber. Is it per subscriber or per gross add?

Per gross add.

Per gross add. Okay. And as far as backing it out, we were getting a churn sort of above 1.5 or so. I was curious if you could tell us what the churn was or the gross add and what we may be doing wrong.

Basically churn continues to be in the low 1%. Nothing has really changed there. Basically what you're doing, and when you go to do that calculation, you're getting the impact of the conversion rate associated with the OEM promotional Saabs, and when we report churn we're doing it on the aftermarket OEM and other category, which is the bulk of our self-paying subscribers.

Okay. And on that note, I guess it's about 721,000 OEM and retail subscribers. Can you give us the breakout on that?

We have not really chosen to break out our subscriber base between sort of after-market and OEM, but, I mean, as you know, the business was traditionally built on the aftermarket, but as the OEM category continues to grow, which it's now almost to a point of 50/50, and gross additions on a going forward basis, it will become more even over time.

Okay, great. As far as the OEM promotional subs, after they have their three months, of which I guess on average you get paid two of the three months, if they decide not to go forward that does that count as churn, then?

No, because basically what we've chosen to do is break out two categories of subscriber for you.

Right.

The OEM promotional subs we talk about the take rate, which right now for the quarter was around 75%, and therefore anyone who didn't take the service is in that sort of 25% that didn't convert over, and the churn rate, which is in the low 1%, is in the 721,000 subscribers which are all self-paying subscribers which they make the decision every month to continue to pay their bill or disconnect.

Okay. Is there an insurance update for us as well?

Just that the, as you probably have read, that the insurers are immersed into a bigger insurance issue with all of the various companies that have been impacted by the satellite anomaly, [Inaudible] Pan Am set, and we are part of that process and it kind of percolates along, and as things occur with it we'll let people know when it's appropriate.

Last question, and I'll let somebody else go. As far as the recent solar flares, we're asking all our satellite companies, have you seen any anomalies lease from that, and aside from that have you seen any further degradation on the 702's?

No, the degradation is what it is, and with the solar flares, a few were lit at our one million subscriber's party, but the ones that happen in space, were not events from a technical standpoint.

Thanks again, great quarter, guys.

Thanks, Bob.

Your next question comes from April Horace from Janco Partners.

Good morning. Nice quarter, guys. Couple more questions on the subscribers. Basically, I think you said 50% of this quarter's adds were OEM. If you're now seeing Honda start to ramp, where do you see that number trending in Q4 and in 2004?

Yeah, I'll take that, April. I think we're still expecting about the 50/50 trend, because, of course, in the fourth quarter, we get the big lift on the retail after-market side from the holiday selling season, and then going forward we've got some of the new products we've just introduced on the retail side, the Roady and the Commander, which are going to prop up that side of the business. So I think we're looking, even with the OEM expansion, at pretty much a 50/50 pace going forward.

And then at Honda, are they also going to be offering some sort of promotional period as well?

Yes, they do. They do the same sort of three months free for the subscribers.

And previously we thought that that number may trend upward on an RPU basis because of extending the promotional period. Is that going to happen going forward, to like more of 11 months, or is it going to hang more at that three-month level?

At this point, I mean, manufacturers may elect to offer different length promotional period but what we've seen thus far is most people settling in, primarily on the 90-day free trial promotion.

April, in the numbers we do have obviously the Cadillac summer jam promotion that was so successful for us, and you can see it in our equipment revenue and the change in the positive margin on equipment revenue, but other than that the majority of the OEM promotions that we have out there to date are the three-month promotions, and when you look at the RPU number you can see that as a result of Honda really stepping up in sort of the last month of the quarter, it is sort of suppressed from what you would think on a three-month promotion of 667 down a little lower because they had that one month free in the calculation.

Okay. And then can you give me a little more color as to what this warrant reversal, I mean, how did that come about, what triggered the reversal?

Yes. As part of our relationship with Sony, there was a warrant component that was provided to them but was only triggered if they had hit over, what was the number? A certain percentage. A certain percentage. And basically what occurred is since the SKYFi units and the Roady units that have come out subsequently, the original Sony plug-and-play device which we launched the business with, became a device that really wasn't as popular in the marketplace, it was priced too high, and at too high a subsidy, so it basically had faded from being one of the consumer options, and therefore, whatever the mechanism was that was to trigger the warrants obviously wasn't going to happen because that product was no longer available, thus the reversal.

Okay. And then I notice that the conversion rates back to the promotional subs went to 75% this quarter. Where do you see that trending going forward? Do you think that can go as high as 80 or 85%?

It's going to bounce. What we've seen is that it trends anywhere between 65 and 80%, April, and so a lot depends on the promotion that's being run in the period, but we expect it in the --

I think it depends on a lot of variables. It depends on what happens in the auto industry, it happens with financing of cars. And also to a certain extent it depends on the mix of particular vehicles, how many high-end vehicles and how many low-end vehicles. We do tend to get a little bit better conversion rate in the high-end vehicles than the less pricey vehicles. It's not an extraordinary difference, but that mix issue will impact you as well, too.

Okay. Great, thanks again.

Your next question comes from Marc Nabi from Merrill Lynch.

Hey, guys, how you doing?

Hey, Marc.

Couple of questions. I'll ask the subscriber aftermarket OEM question a different way, and, Joe or Hugh, whoever wants to maybe take a shot at it. If you take the 721,000 and then back out about 568,000 you did in the second quarter, you had about 153,000 net additions. What percent of those subscribers went from the promotional into the after-market OEM bucket? You see what I'm trying to figure out? I'm just trying to break it down further as best as I can.

Hey, Marc, we might actually have to take that calculation off line to really walk through it with you. Because obviously, I think we listed OEM promotional subs as like 116 or something in the second quarter.

Correct.

Roughly 75% of those, but you have to understand that that was just the full three-month period so how many came on in any particular month during that time frame, we probably need to go sit down and try to recalculate it backwards with you off line maybe.

All right. I see what you're saying. Then also, Hugh, you had made a comment about having about 120,000 of the Roady and other devices. Is that sufficient supply for the holiday, do you feel, I mean, normally one would think -- I thought the number would be higher. I'm just trying to get a better sense for what's appropriate during a holiday selling period.

Well, that's the manufactured number to date. They're continuing to crank those out, and what we're doing is, we've certainly got plenty of Roadies to supply all of the national retailers and we're starting to work to the regional's and the independents. So I think we feel really good about our supply at the major nationals and we're working hard to supply the regionals and independents as well.

Mark, that was just to simply give you a snap shot in time to show that it wasn't a trickling out. There's a large volume that's already in the inventory flow and then obviously thousands per day being manufactured on a daily basis.

Right, Gary, kind of what happened a year ago, remember you told me the SKYFi you said, you weren't getting enough supply, correct? There was actually equipment shortages.

We're in better shape with the Roady than the SKYFi last year. We're ahead of production pace, so I think we will be far better overall supply situation this fourth quarter.

The bottom line, of those two new products, there will be several hundred thousands in the marketplace by the fourth quarter and we just simply gave you what has been shipped to date because a lot of people, when you announce new product, they sound real good, but if none of them make it out to the marketplace, then it becomes suspect.

Great. The next question relates to Wal-Mart and maybe other distributors. When do they really start to aggressively come on board as far as selling the products? Is it really in August, September? You started to see them coming full force? Is it really going to be a fourth quarter event? And also, are there any new distribution agreements that are on the come like, for example, could Target be something out there that you would sell your wares in, and just want to get some thought on that.

Well, I mean, Steve can -- Steve will kick me if I say anything wrong. We are actually close to each other at this table here. But basically the Wal-Mart probably started off slower than we anticipated, and it's been building up in terms of getting the inventory. What we wanted to do was actually get the right products in the store, which included our Roady product. What we really see is them to be fully ramped in this fourth quarter, particularly at their connection centers and their other outlets.

With regards to other distribution outlets we are doing a test right now in Target, which is another environment like Wal-Mart, which can facilitate some of these devices that are require, let's say, less sales support because we've reached some sort of brand awareness, and the actual installation is fairly simple, so you could see that happening as we learn more about it, but I don't want to overhype the test that we're having.

No, I understand that. I was just trying to see if there had been more distribution outlets in there. Last question. Hugh or Gary or whoever, Steve, the Walkman version you've always talked about, when will that be available for consumers, in quantity, too, obviously?

Well, we're not providing any detail on that product right now. We're working on a variety of different technologies and components that will expand our presence to be wherever AM and FM is available, and as we move forward with that product and maybe even other products that we haven't talked about we'll let everybody know.

Okay. Thanks very much.

Your next question comes from Tom Watts from SG Cowen.

Congratulations, guys, on a great quarter.

Thanks, Tom.

Couple of detail questions. One, you have negative retention costs. Could you comment on that and where that comes from?

The negative retention, Tom is, the Sony warrant.

Okay. Just wanted to verify.

Yeah, it's just the reversal. It was basically a success-based warrant, and the measurement period was at the time we achieved a million subs, the success wasn't achieved, so therefore we had to reverse the charge.

And why in retention costs? Just out of curiosity.

Well, it was basically retention costs was just something we concluded in fixed. It was fixed charge going forward, and just a placement.

Great. And also, in terms of some details, just from your cash flow statement, could you give us cash flow from ops, investing and financing?

Well, that will be reported in our 10-Q that will get filed next week, so we haven't -- but as you see, in the cash statement that I gave you, we're talking about being around $45 million for the quarter.

Okay.

It's basically half of where it was last year, and it's down from about the $60 million of the second quarter.

Then on life sports, Serious has made a big deal about some of their life sports arrangements. Where are you on that? How important do you think that is?

Well, we've talked to all the sports league's. We actually carry right now all the kind of major events in terms of major league baseball. We do carry the NBA on our ESPN service. We carry the major college football bowl games, and we obviously have NASCAR, which is a hugely popular sports offering that we have. My feeling is, is that we'll evaluate it, but my feeling right now, as you know, hockey is a sport that has a certain amount of popularity, the NBA basketball, these things are all available on local radio stations, they're available in cable and direct TV packages in many cases, they take up an enormous amount of bandwidth when you're talking about putting on like hundreds of games during a week, and the fact is, when you really look at the car radio experience and the availability of sports and brand names, the question is which are the ones that you really feel are going to work in the context of your overall music offering, which is really what we feel kind of drives the offering. So I mean, basically to have a few hockey games is not something that right now we think sort of enhances the sale of our service at this point, but we'll evaluate the sports packages as we go forward, and we're talking with other league's as well.

Maybe on a broader question, what key buying factors do you see for the service out there? I was in a Best Buy over the weekend and they told me if I really liked music I should choose XM over Serious because they had more music channels. What are the key buying factors you're seeing in your market research?

Well, I think our market research shows that the key decisions is, well, first of all, it really depends on who's coming to the marketplace. Some people are driven to it because they just want to get more music and they want an alternative to radio, but after that I think when they're in the store I think what they're driven by is actually the hardware pricing. And I think a fairly significant portion just wants to know what the front-end cost of getting into this technology is. We're finding that there isn't a huge sensitivity to the monthly price, and then it goes to, the content that one is offering, which I think the music content really drives it.

So I think the reason why we've been successful, as I mentioned before, compared to any of these new services, is just that our -- since we've been able to drive down the price of the front-end costs and the hardware, we've made it very easy for people to sort of enter the business and become a subscriber, and without doing it in a way that's sort of burning cash, that is reflected when you have very high CPGA's, or high SAC, and I think as long as we can continue to do that, what will happen is that the shift will be even more a focus on content, which we're working on. So for example, we're going to have an 18-hour exclusive series with Quincy Jones telling the history of contemporary music. We have more live events. I think that's what's going to drive the business going forward.

The final question, where does Radio Shack stand in distribution of satellite radio, and are they a prospect that would be inviting?

Yeah, we've talked to Radio Shack in the past, and we do have a relationship with their franchise dealers in the smaller markets, and we'll continue to evaluate them as a possible source of distribution. It's all got to work into our economic profile, though. As Joe has mentioned, we've been very focused on managed growth and profitable growth, and we'll continue that.

Actually, let me amplify that a little bit for Steve, because I've been disciplining myself not to dive in on this thing, but I tell you, when we look at the results for this quarter, I mean, I'm spectacularly happy about it because we all knew that the growth was going to be there, and it came through really solid. But cutting the cash burn in half and just driving, frankly, CPGA costs down to the level that I think we've guided the street for, for next year at this time, are really significant achievements that I credit the management team, quite frankly for keeping a tight hand on the tiller and making sure -- on the tiller and on the till, so we're making sure we're very disciplined in the pricing promotions and how we drive forward. We want this to not only be a wildly successful offering, we want it to be a highly profitable company and service, and I think that takes strong discipline, management to do it, and we're well on the way to doing that.

I agree, and it's very exciting you plan to exceed 2.5 million subs next year and hit your cash flow targets. Thanks a lot.

Thanks.

Your next question comes from Ty Carmichael from Gotic [ph] Capital Management.

Hi. Congrats on a good quarter. I did want to just try to understand two trends. One would be, and simplifying them a little bit. One would be your RPU trend. It looked like if you kind of back in the numbers, close to 30% of the reported net sub adds, if you take the difference between promotional OEM subscribers at the end of the second quarter versus third quarter, so 30% of your net sub adds came from the promotional subs, then if you take the change in Avis, for the rental cars, then you take the implied change in the family plan, if they represented a 7% of the period ending subs close to 50% of subs came on board paying less than the current RPU. And, going forward, just to understand how that is going to, for modeling purposes, and understanding top line and cash flows, how that's going to trend, what, is your expectation for those percentages of your net sub adds going forward? Is that something we should work off of at the end of the third quarter and kind of carry that as steady, or is that going to change?

Think of it as component pieces. Right now, the bulk of the 721,000 subscribers out there are at the average of $9.51. What one of the things that will overall, the one piece that you missed was the multi-year plan discounts. We are getting increasing penetration of people willing to sign up for, two years and three year subscriptions at an average of about a 17% discount that is another contributor to sort of taking down the average RPU. So I think what you're going to see as the family plan going into the fourth quarter and multi-year plans sort of take us down a little bit, you will see the growth continuing to come back up as people spin off the OEM promotional plan.

Maybe if I could ask it another simple way. Going forward, of your net sub adds what percentage would you expect those to be, say just for next year, coming from promotional OEM, the rental plan, the rental avenue, and the family plan, just in aggregate, what percentage, roughly, would that be?

I think what you see, the percentage will go up slightly over the next two quarters, Ty, going into next year for the promotional subs, then it'll start leveling off because we will have finally achieved sort of like a saturation of production on a normal basis coming out of GM and getting Honda wrapped up.

And it's also true that as the base grows, the percentage of the promotional sub adds will become a smaller and smaller percentage. So that should start to work in our favor.

And then just on the churn calculation, if you just took, based on the implied gross sub adds, which you calculate from your CPGA which you give us, and you can back into, then you have the aggregate cost, you can back into gross sub adds, if you took the gross sub adds and then you took the difference between the gross sub adds then the reported net sub adds that gives you your kind of what could be defined as disconnects, or subscribers that stopped being on the platform, and if you took that and you divided that by your average subscriber base, which you can back into based on your RPU numbers and then your reported revenues, it looks like that number, whatever you want to call it, went up in the third quarter to north of 1.7% versus the second quarter, which was about 1.2%. And just forgetting what we're calling it, what would you expect that percentage to be going forward, roughly?

Well, as we've always said, we continue to believe that churn will stay in the low 1% range over time as we grow our subscribers in 2004 and 2005 you will see a slight increase in the churn rate, but for now it's been relatively stable.

I think that was your definition of churn, and I understand that. I'm just trying to understand, based on -- because I don't think you define churn the way I do, if you just take gross sub adds.

You're picking up --.

Just that number, forget about what we call it, what would that number, based on your expectations for the conversion rate, et cetera, et cetera, from promotional subs to paying subs, what would that number be, on that calculation, if it's called 1.7% in the third quarter, is that number going to go higher or lower going forward?

Well, once you see full saturation of the OEM promotional category then it should actually stabilize to going down, because you'll have then sort of this recurring in and out, assuming that the take rate stays at a constant level.

Ty, you've got two totally separate type things, very radically different "churn" if you called it that, and by trying to blend the two together, it makes their model difficult to calculate because you have to then know exactly how many promotional period percent of the total. So that's the reason we've broken it out separately because it's much easier to say, gosh, you've got essentially a 25% churn one time off of the promotional subs that come in, but then after that, they fall in line with everybody else, sort of a little over 1%.

I guess what I'm trying to get at is just a better understanding of what your cost of growth going to be in aggregate going forward, because there is a cost to bring on those promotional subs that ultimately disconnect, right?

The simple way to look at that is just look at our cost per gross add.

Yeah, but to figure out what your gross adds are going to be going forward you have to have some sense as to what the aggregate churn would be.

The way to look at it, Ty, if our cost per gross add is $127 today --

The gross add number takes into account your disconnects from promotional subs, right?

Actually, Ty, if even if you bulked it slightly, even if you moved it out from that and said your cost per gross add was $140, or something like that to, offset what you're saying, you're still getting a phenomenal pay back situation on it.

Do it the other way, Ty. If you want to take churn into effect, do it on a net-add basis.

That's what I'm trying to understand from you guys, if you took it that way, just trying to get away from the semantics, just trying to understand.

The cost per gross add for the period was $127. If you wanted to do it on a net-add basis, which includes effective churn that would take it up to $151, but it's still well below anything you've ever seen.

I'll follow up, because I think there's a little bit of a disconnect. Thanks.

Your next question comes from Ben Altman from Skyway Research.

Congratulation, guys. It's a great quarter.

Thanks a lot.

Interested in looking forward here. I want to ask two questions. The first one is, introducing the third-generation chip set into the OEM tuners, what do you think the cost savings will be and compared to the current separate tuner approach, and will this cost structure justify universal integration throughout the OEM product lines?

Let me just address it. What we have done on any of the chip set improvements, and then candidly, on a cost basis overall, a lot of the CPGA improvements and hardware improvements overall have taken place in the tuner section and in the antenna section almost more than in the regular chip set section. So it's a number of different items, not purely just the third-generation chip set that is driving that, and we flow all of the new antenna, tuner, and chip sets into various of the products generally whenever they are positioned for an upgrade or it's a time for model change.

They tend to, by the way, since you happen to have mentioned the OEM channel, the OEM channel tends to adopt those latest and newest chip sets slightly slower than what the after-market does because, as you're aware of the very long engineering lead times associated with the OEM market, it takes them a long time to validate each new technology improvement, and so that tends to flow in several quarters after it's first available in the after-market retail. So, we flow those into the retail products first, and you'll see those improvements basically continuing throughout '04 as we move forward, and that's why when we talked about future improvements in CPGA, even though we think they'll be more moderate going forward in the future, we will see them continuing as we in fact flow in these new devices.

Fantastic. I have one other question. As far as potential revenue implications, I want to go over a few other sources. Somewhat are speculative, granted. First, the Canadian market, then streaming data advertising, as I see you're posting data across the information screens now. Weather services, XM branded content products, such as, perhaps your own branded albums, et cetera, and XM branded hardware sales, which I think have been missed on this conference call for the most part. I'm very interested in the equipment revenues thus far, and I wondered if you could comment on some of those, if you would.

We really don't like commenting on them until we're actually ready to do anything. I actually have plans to cut my own album soon. I'm not quite sure if you want it. But when we're ready to talk about some of those other revenue sources, we'll appropriately articulate it in the various forms that we need to do that.

All of those sound like wonderful ideas, but, as I say, we always try to be pretty conservative and only getting ready to talk about things when they're pretty imminent. Now we did in fact, obviously file with our Q, the last Q, the entry into Canada from a regulatory standpoint. The reason we announced that was the fact that we essentially legally had to since we were filing with the Canadian government through our partner, our Canadian Satellite Radio. That regulatory process continues underway in Canada. It's moving very favorably, but we'll just have to wait to get updates as the regulatory approval process plays its way out.

Fantastic. Again, great job, I appreciate your time.

Thank you.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers. Mr. Panero, are there any closing remarks?

Well, just simply that, I think we're a company that has the wind at our back right now, and we are growing rapidly, we have all the characteristics of a mass market phenomenon. We are looking forward to the holiday Christmas season, we've got a roll out with OEMs, we have new products going into the aftermarket, we're basically bringing down our SAC and CPGA costs, and we're actually, as I said before, we're savoring this moment but we're not diluted by what we've accomplished so far in that we still have to be focused on what we have to do tomorrow, and the day after, and into next year. For those shareholders who have been with us for a long time, I want to thank you. And for those people who are newer, welcome along for the ride, and we're building a pretty fun and interesting business here, so thank you very much.

Thank you for participating in today's teleconference. You may now disconnect.