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Getting Sirius About Earnings

Daniel Jones
October 27, 2013

Before the market opened on Oct. 24, Sirius XM Radio (NASDAQ: SIRI) reported its third quarter earnings. Analysts expected the company to report revenue of $970.37 million and earnings per share of $0.02. However, Sirius XM Radio disappointed on both fronts. Revenue came in at $962 million, and earnings per share only hit $0.01.

Revenue and income shortfall but strong growth nonetheless
Initially, this might appear to be extremely adverse news worthy of a market sell-off. Investors seemed to take it rather well, however, pushing the company's shares down by only 1.5% as of the time of this writing. Probably the greatest reason why the market didn't punish the company more after this shortfall was because it still handily beat its results from the same quarter a year ago.

Compared to the third quarter of 2012, revenue grew by 10.9% from $867.4 million to the $962 million Sirius XM Radio reported this quarter. This growth stemmed from the addition of 513,000 subscribers, net of all cancellations. In all, this brings the company's subscriber base to 25.6 million. In addition to adding to Sirius XM Radio's revenue, the larger subscriber base resulted in the company's operating income increasing by 22.8% from $231.7 million to $284.5 million.

Despite the increase, net income for the quarter fell by 15.4% from $74.5 million in the third quarter of last year to $63 million this quarter. The reason behind the substantial disparity in the company's net income when placed next to its operating income was a $61.2 million income tax expense for this quarter when it had a $20.1 million income tax benefit booked the year before.

Looking at the company's free cash flow, we see that it experienced a 25.6% rise from $195.2 million to $245 million this quarter. The primary driver for this increase was a 37.5% increase in the company's income from operations from $219.81 million to $302.24 million. This was partially offset by the company increasing its spending on property and equipment by 124.6% from $24.6 million to $55.26 million.

Subscriber Quality
Irrespective of what some might say, the company's significant increases in all of its metrics (with the exception of net income) are a positive sign for shareholders. However, the big question that should be asked is whether these increases can be chalked up to low-quality subscribers trying out the service or high-quality ones that will likely maintain their subscriptions.

To examine this, we should look at the number of deactivated subscriptions for the most recent quarter in comparison with the same quarter a year ago, as percentages of total subscribers for these respective periods. By doing this for the current quarter, we find out that Sirius XM Radio saw deactivated subscribers total 8% of subscriptions. This is actually down from 8.5% a year ago. Comparing these two metrics over the first nine months of this year versus last year, we see a similar decline to 23.6% from 23.9%. In essence, this suggests that the quality of subscribers is improving.

Some pressing concerns
Although the company performed well this quarter (albeit below expectations), the numbers it's posting are very attractive. However, there are some things to be cognizant about. First and foremost is that the company's current ratio (its current assets divided by its current liabilities) declined to 0.74 this quarter, which compares to 0.79 in the same quarter a year ago. What this means is that for every dollar in liabilities due within the current reporting period, it has only $0.74 in assets that can be easily converted into cash with which to pay said liabilities.

In most situations, this low of a ratio (and getting lower) would be a significant sign of liquidity concerns. However, when we look at the company's balance sheet, we should remove the company's current portion of deferred revenue because it is not an actual charge per se but, rather, an obligation to provide a good or service. The only time that this might be a big concern would be in the event that the company was on the verge of insolvency, which I don't think is likely any time soon.

After removing this liability from each fiscal quarter, we find that the company has a current ratio of 1.73 today vs. 2.18 last year. Such a substantial decline is disconcerting to say the least, but the level where it is now is still quite healthy. It's probably not a concern at this point in time. It should be noted that when comparing Sirius XM Radio to its closest competitor Pandora Media </