Sirius XM Holdings Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; unaudited. Unless stated otherwise, dollar amounts are U.S. dollars. Financial statement amounts below are rounded to millions.
Business context and reporting period
Sirius XM provides subscription satellite and internet radio, advertising, and connected-vehicle services. At quarter-end it reported 32.2 million subscribers, including 27.0 million self-pay and 5.2 million paid promotional subscribers. Liberty Media beneficially owned approximately 69% of common shares; Sirius XM identified itself as a controlled company.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $1,379.6m | $1,277.6m | $4,021.2m | $3,714.2m |
| Operating income | $434.0m | $392.2m | $1,244.2m | $1,102.6m |
| Net income | $275.7m | $193.9m | $684.9m | $541.3m |
| Adjusted EBITDA | $550.6m | $491.9m | $1,574.3m | $1,401.0m |
| Free cash flow | $433.8m | $356.5m | $1,099.5m | $1,079.7m |
- Q3 revenue increased 8%; nine-month revenue increased 8%. Subscriber revenue rose 6% and 7%, respectively, on subscriber growth and higher average revenue per subscriber (ARPU). Advertising revenue grew 21% in Q3 and 18% year to date.
- Operating margin was approximately 31.5% in Q3 versus 30.7% a year earlier, and 30.9% for the nine months versus 29.7%. Net margin was approximately 20.0% and 17.0%, respectively, compared with 15.2% and 14.6% in the prior periods.
- Q3 and nine-month diluted EPS were $0.06 and $0.14, versus $0.04 and $0.11. Nine-month weighted-average diluted shares declined 5% year over year.
- Nine-month operating cash flow was $1,313.8m, up from $1,216.1m. Capital expenditures were $206.7m, versus $132.2m. Reported free cash flow, a company-defined non-GAAP measure, rose 2% for the nine months; it excludes acquisitions, strategic investments and related-party loans.
- Cash at September 30 was $73.6m, down from $213.9m at year-end 2016. Debt carrying value was $6,741.3m, including $290m drawn on the $1.75bn revolving facility; $1.46bn remained available. Total liabilities exceeded total assets, and stockholders’ deficit was $1,050.1m. The company reported compliance with debt covenants, including the facility’s 5.0-to-1.0 leverage limit.
- Declared dividends were $0.010 per share in Q3. The board subsequently declared $0.011 per share, and management said it expected regular quarterly dividends totaling $0.044 per share annually. The $10bn repurchase authorization had $1,039.1m remaining at quarter-end.
Material changes versus prior comparable periods
- Net income growth exceeded operating-income growth, in part because Q3 2017 included $68.7m of unrealized gain on the Pandora investment. Other income totaled $87.0m for Q3 and $83.9m for the nine months, versus $2.4m and $15.7m in 2016. The gain is noncash and valuation-sensitive.
- Operating expenses rose 7% in Q3 and 6% year to date. Higher royalties, programming, sales and marketing, engineering, and depreciation partly offset revenue growth. Nine-month depreciation and amortization rose 14%.
- Subscriber net additions slowed to 119,000 in Q3 from 345,000, and to 821,000 for the nine months from 1.397m. Self-pay subscribers grew 6% year over year, while paid promotional subscribers fell 5%. Average self-pay monthly churn remained 1.9% in Q3 and 1.8% year to date; ARPU increased 3% in both comparisons.
- Investing cash outflow rose substantially, reflecting the $480m Pandora investment, $130.8m loan to Sirius XM Canada, $132.2m additional investment in related-party ownership, the $107.7m Automatic acquisition, and higher capital spending.
- In July, Sirius XM issued $2.5bn of notes due 2022 and 2027 and redeemed $1.5bn of older notes. The redemptions generated a $43.7m loss on extinguishment of debt; nine-month interest expense increased 2%.
Outlook, commentary, risks and unusual items
- Management expected subscriber, advertising, equipment and other revenue to grow, while anticipating higher costs in areas including royalties, programming, marketing, engineering and streaming. These are directional statements, not specific consolidated earnings guidance. The filing estimated a 2017 adjusted effective tax rate of approximately 34%.
- The Copyright Royalty Board’s September 2017 ruling upheld Sirius XM’s interpretation of exclusions for pre-1972 recordings but found its Premier-package upcharge exclusion improper. The company disputed the claim and planned to defend itself. It estimated a reasonably possible additional loss of $0–$85m, plus interest or late fees, and had not accrued this additional amount because it did not consider the loss probable.
- A separate CRB proceeding was expected to set satellite-radio sound-recording royalty rates for 2018–2022, with a final ruling expected by December 15, 2017. Management warned that proposals from SoundExchange could materially increase royalties.
- Strategic transactions included the Automatic acquisition, the Sirius XM Canada recapitalization (70% equity interest but 33% voting interest; accounted for under the equity method), and the Pandora preferred-stock investment. The Pandora investment carried a 6% cumulative dividend if declared, a redemption option from 2022, and fair-value exposure; a 10% lower Pandora share price was estimated to reduce its value by approximately $23.7m.
- Other notable risks include substantial indebtedness, reliance on automakers and subscriber retention, satellite or systems disruption, competition, regulation and litigation. The company said there had been no material changes to previously reported risk factors. Its 2017 revenue-recognition adoption was expected to reduce reported subscription revenue by less than 3%, with corresponding expense reductions and no expected net-income or adjusted EBITDA impact.
Important facts for investors to verify
- Whether subscriber net additions and promotional-subscription trends improve, and whether churn and ARPU remain favorable.
- The final CRB royalty-rate decision and further proceedings, damages exposure and potential interest or late fees in the SoundExchange matter.
- The sustainability of earnings growth excluding the Pandora fair-value gain, and the investment’s subsequent valuation and redemption terms.
- Debt, interest costs, refinancing and capital returns relative to cash generation, especially given low cash balances and significant contractual commitments.
- Performance and returns from Pandora, Sirius XM Canada and Automatic, including related-party arrangements and the impact of the Canada investment’s limited voting control.