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EchoStar Communications (NASDAQ:DISH)

Q2 2006 Earnings Conference Call

August 10, 2006 12:00 pm ET

Executives

Jason Kiser - Treasurer

David Moskowitz - SVP, General Counsel

Carl Vogel - Vice Chairman

Dave Rayner - EVP, CFO

Analysts

Jeff Wlodarczak - Wachovia

Doug Mitchelson - Deutsche Bank

Tuna Amobi - Standard & Poor's

Kathy Styponias - Prudential

Vijay Bhayani - Lehman Brothers

Doug Shapiro - Banc of America Securities

Lale Topcuoglu - Goldman Sachs

Aryeh Bourkoff - UBS

Bryan Kraft - Credit Suisse

Thomas Eagan - Oppenheimer & Company

Operator

At this time I would like to welcome everyone to the EchoStar second quarter 2006 earnings conference call. (Operator Instructions) At this time I would like to turn the call over to Mr. Jeff Kiser, Treasurer of EchoStar Communications. Sir, you may begin your conference.

Jason Kiser

Thank you, operator. Well, thanks for joining us. My name is Jason Kiser and I'm the Treasurer here at EchoStar; and I'm joined today by Carl Vogel, our Vice Chairman; David Moskowitz, our Executive Vice President and General Counsel; and David Rayner our CFO. Absent today is our CEO, Charlie Ergen who had a longstanding family commitment and couldn't make the call.

Let me give you a quick recap of the financial performance for the quarter and then we'll open it up for some Q&A at the end. Before we get started, as most of you know, we do need to do our Safe Harbor disclosure. So for that I'll turn it over to David.

David Moskowitz

Good morning, everyone. Let me add my thanks to you all for joining us this morning. As you know, we do invite media to participate in a listen-only mode on our calls so we ask that the media not identify participants and their firms in your reports. We also don't allow audio-taping of the conference call and we ask that you please respect that.

All statements we make during the call that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks, uncertainties, and other factors that could cause our actual results to be materially different from historical results or from any future results expressed or implied by the forward-looking statements.

I'm not going to go through a list of all the factors that could cause our actual results to differ from our historical results or the forward-looking statements. Instead, I'd ask you to take a look at the front of our 10-Q for a list of these factors. In addition, we may face other risks described from time to time in other reports we file with the SEC.

All cautionary statements that we make during the call should be understood as being applicable to any forward-looking statements we make wherever they appear. You should of course carefully consider the risks described in our reports and shouldn't place undue reliance on any forward-looking statements that we do make. We don't assume any responsibility for updating our forward-looking statements made.

Also note that during the call, we will refer to certain non-GAAP measures which are reconciled in our 10-Q or on our Investor Relations website. With that out of the way, I turn it back over to Jason.

Jason Kiser

Thanks, David. Let's take a look at the quarter. Total revenue for the quarter was $2.46 billion, an increase of 7% over last quarter, and 17% higher than the same period a year ago. Continued subscriber growth and higher average revenue per subscriber were the primary drivers of the increase. From an EBITDA perspective, we generated $613 million during the quarter an increase of $28 million over last quarter and $58 million higher than the same period a year ago. Net income for the quarter came in at $169 million an increase of $21 million over last quarter, but $687 million lower than the same period a year ago. We should note that the net income for Q2 of last year included $593 million of a tax valuation allowance reversal.

Basic earnings per share for the quarter was $0.38 compared to $0.33 last quarter and $1.89 for the same period last year. During the quarter, free cash flow was $208 million. This represents $123 million decrease from the last quarter, but $151 million higher than the same period a year ago. The decrease from the prior quarter resulted from a decrease in cash flow from operations due to working capital changes and a slight increase in purchases of property and equipment.

Let's look at the DISH Network specifically. During the quarter we added 195,000 net new customers. This represents almost 61% of the incremental growth in the DBS industry for the quarter. We ended the quarter with 12,460,000 subscribers. Churn for the quarter was 1.7% compared to 1.57% in Q1 and 1.69% for the same period a year ago. The increase from Q1 and from the same period last year was driven by increased competition in Q1 price increases.

During the quarter our average revenue per subscriber was $62.71, an increase of $2.72 per sub over the first quarter and an increase of $4.18 from the same period a year ago. The year-over-year increase in ARPU was driven by several items. We had price increases in February, we had higher equipment rental fees resulting from increased penetration of our lease program and increased availability of local channels in both standard and high definition helped to increase ARPU as well. Lastly, we continue to see increases in advanced set-top box households which show up as increased ARPU from additional fees we received.

Subscriber-related margins decreased 65 basis points from Q1, and increased about 15 basis points from Q2 of last year. A slight increase in costs associated with our in-home service and call center operations accounted for the decrease from Q1.

Previously we had included certain benefits from our lease program in our SAC calculation. Starting this quarter, our SAC calculation will no longer include these benefits. Instead these benefits will be separately discussed and all prior period SAC amounts have been revised to conform to the current calculation.

During the second quarter, subscriber acquisition costs plus equipment capitalized under our new subscriber lease program decreased 2% or $14 per add from Q1. For the quarter we averaged approximately $683 per gross addition compared to $697 for Q1 and $692 for the same period a year ago.

The decrease in SAC from first quarter and from Q2 of last year was primarily driven by several factors. First we experienced reduced hardware costs per receiver. We also had fewer receivers per installation due to the use of more dual tuner receivers. Lastly, we were able to redeploy more equipment returned by disconnecting lease subscribers.

Separately, the benefit of payments we received in connection with the equipment not returned to us from disconnected lease subscribers and returned equipment that is made available for sale, rather than being redeployed, was $30 million for Q2, compared to $26 million in Q1 and $21 million for the same period last year.

Let's take a quick look at the balance sheet. At the end of the quarter we had approximately $7 billion of debt. We also ended the quarter with cash and marketable securities of $2.7 billion which excludes $106 million of restricted cash. On a total debt per subscriber basis we ended the quarter at $561 per subscriber, on a net debt basis, debt drops to $342 per sub.

Capital expenditures in the quarter were $313 million, with about $240 million of that amount going for all capitalized lease equipment and remaining $73 million for satellites and general corporate CapEx.

That's everything on the numbers so with that, Operator, I think we will open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions)Your first question comes from the line of Jeff Wlodarczak - Wachovia.

Jeff Wlodarczak - Wachovia

Hi, guys, it's Jeff Wlodarczak. No Charlie. So I guess you guys can't comment on Ergen's $3 billion in synergies commentary, so I won't go there.

If I could focus on the quarter, obviously very strong. The subscriber-related cost line was flat with last year. You had a pretty big improvement in the first quarter. Is there anything one-time going on there? Should I expect improvement?

Also, on the converting the network signal customers, are you doing it right now? What are the prospects of pushing that back and then how much dislocation in churn and ARPU do you see in the third quarter? Thanks.

Carl Vogel

Let me start. I wasn't there either so I can't comment on the synergy comments. With respect to subscriber-related costs, Dave can talk about the details, but as I think we've disclosed in the past, we had the transition to Echo 10 and we had the transition to single dish, and we've seen increased costs in a lot of our customer service areas as a result of that.

I think whether or not we're going to see improvement in the third quarter, we don't really talk about that on a forward-looking basis, but I can tell you that we are focused on our customer care and our customer delivery and our DISH Network services areas.

So, what happened in the second quarter is we had some of the effects of the elements I discussed.

With respect to distant, we are in the midst of settlement discussions with the broadcasters so I don't want to talk too much about those details, but I'll Let David fill you in on what we can talk about.

David Moskowitz

Sure, hi, Jeff. As those of you who have followed us for a long time are aware, this is litigation that's been going on for eight-and-a-half years I think now, and over the course of those years, we've managed to settle with hundreds of stations and station groups -- ABC, NBC, CBS -- lots of large station groups and a number of small stations around the country totaling hundreds of stations. We are anxious to try to reach a settlement with the remaining broadcasters and we're very focused on trying to do that.

Of course, a big piece of that is outside our control in that there's been a lot of history that's developed over the years and whether the broadcasters can get over that history remains to be seen. We hope so, but we're not going to obviously spend any time talking publicly about settlement, because I don't think that is conducive to furthering that process.

With respect to converting distant in the quarter, as we said in the Q, we do think it's likely that we'll start that process with respect to some subscribers in the third quarter, and we indicated that our average ARPU per distant network subscriber is less than $5 and we have less than 1 million distant subs. We're not going to get into greater detail because obviously it's very highly competitively sensitive information, but hopefully that gives you some feel for the outside potential exposure.

I don't believe that all of our subscribers who are converted, if that becomes necessary, would leave our service and we certainly have a number of pieces that we have in place to try to make any necessary transition as easy as possible and minimize the disruption of it. But certainly, there will be significant disruption if hundreds of thousands of customers lose the distant network channels that they rely on.

I think Congress is fairly acutely aware of the issue and we're hopeful that we can resolve with this with the broadcasters so that there isn't an unnecessary disruption.

Certainly, over the years, if you go back to the court case, as far back as 2003 the Court said that EchoStar is doing it right now; and that was back in 2003 and we haven't changed our procedure since then. So what we're talking about is a subset of our distant network customers who might lose service, but for this decision by the Court of Appeals overruling the District Court and concluding we can't offer distant to anyone.

So we think that logical, calm heads should prevail and that we ought to be able to resolve this with the broadcasters to avoid disruption to the customers, but there certainly can be no assurance that we'll be able to accomplish that.

Jeff Wlodarczak - Wachovia

Okay, thank you.

Carl Vogel

Yes, I think just to add one thing to what David said, with respect to the settlement, we're really looking for three things:

  1. That we're on a level competitive playing field so that we can continue to be a viable competitor in the market.
  2. We want a consumer focus and have as consumer-friendly a solution as possible.
  3. As David mentioned we're going to do everything we can to minimize the impacts of churn. In many of these markets we're already providing local into local services and we would certainly encourage such distant customers to convert to that platform if need be.

So I think we've got a good plan and as David indicated, our primary focus is to come to a settlement with the broadcasters, to be very consumer friendly and in a manner that's as least disruptive as possible.

Jeff Wlodarczak - Wachovia

Thank you.

Operator

Your next question comes from Doug Mitchelson - Deutsche Bank.

Doug Mitchelson - Deutsche Bank

Thank you very much. A couple questions for Jeff Kiser, or perhaps the other gentlemen present. First, any further details that you can provide us on the anomaly noted in the 10-Q for EchoStar 12?

Jason Kiser

Sure. It's really just repeating what is in the 10-Q, but we have experienced an anomaly on the satellite. It has slightly impacted the amount of capacity that we can utilize, but not in a significant manner. While we don't have an expectation that there will be a significant impact on a commercial operation of satellite in the future, the thing is 22,000 miles up in the sky and you can't call a repairman, so we just have to hope, and for those who are religious, pray that each of our satellites continues to function properly in the sky.

Doug Mitchelson - Deutsche Bank

I mean when you acquired that satellite, did you get insurance or other financial protection related to performance?

Jason Kiser

We don't carry commercial insurance on any of our satellites. We took a look at the commercial, I'm sorry, did you want to--?

Carl Vogel

In orbit.

Jason Kiser

We constantly evaluate and re-evaluate commercial insurance, but several years ago, the satellite insurance industry really got fairly skittish and they started putting in place pretty significant limitations on the insurance in terms of deductibles and percentages of the spacecraft which had to malfunction before you could get paid on it and of course, you can never insure the real value of that satellite, which is the revenue stream which is produced from it.

The only way that you can really insure that is by having adequate back up capacity in space so that if you lose one of those assets, you can replace it. That's really what we've tried to do is invest in the satellites we have in space which is probably other than Indosat, may be more satellites than anybody else out there. I don't know for sure but I think we've got probably 12 owned satellites plus an additional three or four leased satellites up there. So our philosophy is to try to insure the revenue stream and you can't do that through commercial insurance. You can only do that through having additional assets in space and that's where our focus has been.

Doug Mitchelson - Deutsche Bank

In that regard your 10-K had noted some '06 commitments for a satellite that you're going to be launching over the next two years. The first half of the year doesn't look like satellite capital spending was very high. Can you give us a sense of what might be hitting the second half as it relates to satellite spending?

Carl Vogel

Yes. We've got a number of satellites currently under construction, under contract. Some of those are certainly designated for additional services, for satellite replacements, additional capacity. So we're pretty comfortable with the construction schedule and the number of satellites we have under development right now.

But in terms of specific dollar amounts that we'll be spending, the Q discloses total satellite commitments that we have, that is approximately at the end of June $2.7 billion over future life. So as I said, we're pretty comfortable with the capacity that we have in the pipeline.

Doug Mitchelson - Deutsche Bank

The comments that you made before talk about transitioning to EchoStar 10 having an impact on costs. Can you give us any more detail on how it's impacting cost in the quarter? I thought with EchoStar 10 going up you wouldn't have as many SuperDISH installs, but you talked about transitioning might be costing more – any sense of the cost impact?

Carl Vogel

Right. Without getting into specific dollar amounts let me try and describe the kinds of activity that we had around Echo 10 and specifically also the two dish solution, moving customers from two dish to one dish. Obviously with Echo 10 we had a lot of channels, movement off of pre-existing satellites onto Echo 10, realignment across the country in terms of where customers were receiving their signals, primarily local but there were some other national signals that were also impacted.

That required -- one, it required us to in some case replace dishes or LNB's to make sure that we had the dishes peak properly to receive the Echo 10 signal. Obviously there were phone calls and truck rolls associated with all of that.

So that in general is the kind of activity that we had, really tweaking existing equipment and in some cases replacing equipment and just dealing with the overall movement of channels from satellite to satellite.

Jason Kiser

But you're right, Doug. There were benefits as well, obviously, and one of the benefits was that we don't do SuperDISH installations anymore and those were more costly both from a hardware and an installation perspective so there was an offsetting benefit there.

Carl Vogel

Absolutely. That's a benefit we'll see more going forward than we would have seen in any given quarter but certainly there are benefits that we'll reap off of that.

Doug Mitchelson - Deutsche Bank

Last question because I'm taking up a lot of time here. Just any update you can give us on wireless both in terms of your thoughts behind the AWS auction and the existing spectrum that you already own? Thanks.

David Moskowitz

Well, with respect to auctions as a result of the rules from the FCC, we can't talk much about the auctions. As we've said in the past, we continue to look at various broadband alternatives and we will continue to pursue those as we go forward, but I can't speak to any specifics regarding the auctions.

Doug Mitchelson - Deutsche Bank

Well, maybe can you answer the question, do you think it's important to have a broadband wireless solution as you look forward in the competitive environment?

David Moskowitz

We think that that could add value to our platform and are certainly interested that. I think we're doing pretty well right now given our revenue growth and both generating free cash flow and EBITDA, but it's certainly something that we look at. Is it a must have? I would say no. Is it something that we're continuing to look at? I would say yes.

Doug Mitchelson - Deutsche Bank

Thank you very much.

Operator

Your next question comes from Tuna Amobi - Standard & Poor's.

Tuna Amobi - Standard & Poor’s

First question for Carl. Can you give us an idea of the kind of content initiatives that you currently are exploring and where you see the greatest opportunities: broadband, video, mobility, stuff like that? I'll have another question for David.

Carl Vogel

I'm not going to get into the specifics of what content initiatives that we may be looking at. I think we have said on prior calls that our goal is to be the best video provider that we can be and have applications that are fixed, mobile, and portable and we're heading down those various paths. To the extent we complete initiatives we'll certainly make those announcements.

We made a handful of those announcements this past quarter, nothing particularly large, but we think we've got a platform that's national that is extremely interesting to content providers. We are interested creating brand extensions. We are certainly looking at everything that comes across our transom, and as I said, we're looking at ways that we can implement our platform on more of a mobile and portable basis.

But in terms of specific initiatives, I'm not really at liberty to comment on specifics but you can see the kinds of things that we've done in the past and those are the kinds of things that we're going to do going forward and that is to just enhance the experience for DISH Network customers across multiple platforms.

Tuna Amobi - Standard & Poor’s

So as you pursue all of these alternatives, what's your overriding strategy? For example, some of the steps that you have taken recently? As I think about what you're doing and I compare it to DirecTV, it seems to me -- and perhaps, correct me if I'm wrong -- that they have been a little bit more articulate in laying out what their content strategy is, the kind of things they're looking to do.

I'm not saying that you guys are not doing that, but I'm just trying to understand in the broader scheme what kind of commitment do you see in this space down the road, what kind of resources have you guys earmarked for these kinds of things?

Dave Rayner

Well, in terms of strategy, I think as I said, our strategy is to make the DISH Network experience the most broad and robust experience that we can from a video standpoint to our customers. I don't know what initiatives you're particularly referring to with respect to DirecTV.

Tuna Amobi - Standard & Poor’s

They have done some things in broadband video, music, stuff like that, online offerings and so on.

Dave Rayner

My understanding is most of that has come through the News Corp. relationship versus the DirecTV relationship, and we continue to look at ways, again, to the extent we have a broadband platform, we'll make more announcements as we get further along that path.

I wouldn't assume that our silence means that we're not actively pursuing things that can enhance our experience and be competitive in the marketplace. Again, it’s an extension of what we can do off of our set top box platform and it's things where we can provide interesting content that enhances the existing experience. But I'm not going to get into the specifics in terms of where our interest may lie with streaming media, music, chat, any of those.

Tuna Amobi - Standard & Poor’s

While we're still on the subject, how is the Pocket DISH going?

Dave Rayner

Pocket DISH is in it's early stages. It's an add-on product to our existing DVR. I would say it's going okay. Not great. We have not put a tremendous amount of marketing behind it. We have focused on other initiatives that are evident in the market, principally HD and DVR and we think the economic return is substantially better there.

We're working with the folks from ARCHOS to bring in some advanced features to make the user interface a little bit more practical and usable. Until we've got that done, we've kind of held back on the marketing.

I would say it's a product that adds value to the customers that want some element of portability. We think there are future enhancements like Wi-Fi applications, et cetera that are important and once we get a little further along I think you'll see us be a little bit more active in the marketplace with that product.

Tuna Amobi - Standard & Poor’s

That's helpful and one question for David. On the TiVo litigation, it seems like there's been some developments in the last three months since we had the last call. In your own assessment, are you more comfortable with this situation on that litigation, as compared to the comments that you made about three months ago. It seems like the bench trial has happened and there's still a couple of outstanding issues. I'm just trying to get a sense of your own evaluation of your own claims in that litigation compared to where you stood three months ago.

David Moskowitz

Sure, Tom. I still believe that this is going to be a long process through the court system, and I continue to believe that at the end of the day, we'll be successful in overturning the Eastern District of Texas jury verdict where plaintiffs I think are 15-0 at this point -- so they have never met a patent that isn't infringed. I think we’ll be successful in getting that overturned.

Obviously, the odds of a Court of Appeals overturning a lower court are not great, but we still feel confident about that. So we're going to continue to fight this and I still believe that at the end of the day we'll be successful. We did have the bench trial, there hasn't been any decision out of the court yet.

In fact, the only significant development was TiVo did appeal the Court of Appeals ruling finding that the lower court’ decision to exclude the opinion we received of non-infringement was wrongful. TiVo tried to appeal that to the full Court of Appeals and the full Court of Appeals said no. The Court of Appeals made the right decision. We do believe that that's a significant development in that the jury was prevented from hearing that we got an opinion of non-infringement and actually, TiVo was allowed to argue something that simply wasn't true, that being that we never even got an opinion when they knew we did.

So we do think that's significant and we think there are a number of other reasons why this will ultimately be reversed and we haven't changed our confidence factor. Whether that will happen with the judge remains to be seen, but it's probably not terribly likely. But if it doesn't happen with the judge, we do feel it will occur at the Court of Appeals level.

Obviously we're doing other things to put ourselves in a position to try to minimize any exposure, including working on potential work arounds.

Tuna Amobi - Standard & Poor’s

That was my next question. What are those specific things that you're doing on the contingency plan? Can you be more specific just in case the position doesn't work out the way that you're hoping it will.

David Moskowitz

Well, we are spending some engineering resources to try to develop workarounds which would make our products non-infringing even under the analysis that the District Court gave, and we've made good progress in that regard, but we're not finished with that development. And until that development is completed and implemented and a court concludes that yes, indeed, it is a valid workaround, we can't say we've got one. But we're certainly doing all of the things that we can prudently to look at this from every angle we can.

Tuna Amobi - Standard & Poor’s

Are you still shipping DVR's with those two software patents that were found to be infringed or did you suspend any shipments as a result?

David Moskowitz

No, we haven't suspended any shipments. There isn't any injunction that has issued. We are hopeful that the Court will not issue an injunction and that if it does, it will stay the applicability of that injunction. We believe that if the District Court does issue an injunction and doesn't stay it, that the Court of Appeals is likely to stay any injunction. But of course as I said, we are also pursuing alternatives including workarounds to take a look at all possibilities.

Tuna Amobi - Standard & Poor’s

That's very helpful. Thank you very much.

David Moskowitz

You bet.

Operator

Your next question comes from Kathy Styponias - Prudential.

Kathy Styponias - Prudential

My question is in regard to local HD offerings. I think you've announced that you plan on being in 50 markets. Could you just remind us of the timeframe? Could you update us on your thinking about going in markets north of size 50? I think at one point, Charlie had said that it wasn't economically feasible or certainly wouldn't be unless there was sharing of backhaul with DirecTV. Just wondering what the status is of that? Whether you can go at it alone or whether that still remains to be true and what size market you plan to sort of top out at? Thanks.

Dave Rayner

Sure, Kathy. We are in 26 markets with HD channels today and we've announced that we will be in an additional three markets to get up to 29 by the end of the year. We haven't announced any specific markets beyond that where we will go, although we do expect that we'll go into some additional markets with HD.

But as you pointed out, we do look at it a bit differently than DirecTV in that right now when we evaluate it, we don't see the economic feasibility in going into 200 markets in HD. We just don't know how you get there. We'll continue to evaluate it and if the numbers start to change and make sense for us to go into a greater number of markets, then we'll take a look at what those markets should be. The numbers could change because we share backhaul or capacity or because the content becomes more compelling or for any other number of reasons. I think Carl probably is the best guy to address those sorts of things.

Carl Vogel

Yes, I think David has hit on a key point. We haven't seen an economic model that justifies going beyond markets 50 but we continue to look at alternatives and would approach alternatives with, as Charlie has said in the past, sharing a backhaul or capacity but we have not formulated or come down on a plan that makes any sense for us to certainly make any firm announcement about what our plans are going to be, beyond the 29 markets by year end.

Dave Rayner

I would say EchoStar offers more HD programming today than any other platform out there, and we're excited by that. We continue to be an HD leader and Carl has the teams people working very hard on continuing to obtain HD content and obviously the economic advantage in a point to millions of multi-points environment of satellite as the platform to deliver HD content to the home becomes more acute, and so we're excited by HD and we certainly got a lot of content and we think the prospects are good moving forward.

Kathy Styponias - Prudential

Thank you.

Operator

Your next question comes from Vijay Bhayani - Lehman Brothers.

Vijay Bhayani - Lehman Brothers

Thanks, SCS on their call, stated that the roll of the NC 15 was being changed by some modification. David, is there anything you can share, is it HD? What's the delay for that modification? That's my first question.

David Moskowitz

Well, our satellites in process, I think a lot of satellites from being built by a lot of companies for a lot of people are being delayed these days. There are delays in the manufacturing process, there have been a number of launch issues, particularly with the Russian space agency which not only makes the proton, but supplies parts for several other programs as well.

We're not going to comment on the details of what we're doing with respect to any particular spacecraft, but we do continually look at what the best and highest use of our capacity is and when delays in production or launch schedules occur, we re-evaluate and if there are things that we can change that we think in light of changed circumstances will make us better competitors, then we try to take advantages of those and make them opportunities.

Vijay Bhayani - Lehman Brothers

Given you have probably the most elaborate HD offering in the market right now and the numbers seem to suggest that there's sort of a move to higher end customers. Can you give any context on is that showing up numbers, is it mattering from a differentiation perspective, having that HD offering? Is it too early to call that yet?

Carl Vogel

Well, I think it's a little too early to call, but I think we have certainly focused on trying to get as much national content as possible. I think as David indicated, we've got an extremely rich offering, I think we have somewhere around 28 or 29 channels, they are the best brands we believe in the space, including ESPN and TNT and others.

We like what people like Mark Cuban are doing at HDNet in terms of making more and more investments in the content. I think we are pleased with the initial results but there is still a lot more work to do. I think if you look at our promotions, we've got a significant rebate program for customers that buy HD, making it very, very affordable to enter the category from a content perspective. Where you are seeing the impact of that is essentially in the increasing ARPU. This quarter, year-over-year I think our ARPU increased around 7% and I would attribute a portion of that to the increased HD penetration and certainly increased content as well as rate increases and certain DVR fees. That is essentially where I think you're going to see the impact in the near term.

Vijay Bhayani - Lehman Brothers

Thank you.

Carl Vogel

Thank you.

Operator

Your next question comes from Doug Shapiro - Banc of America Securities.

Doug Shapiro - Banc of America Securities

Yes, hi. I was just wondering if you can talk about whether you think you're benefiting from DirecTV's efforts to screen out lower credit quality subs and whether you have seen any difference in the composition of the quality of your gross adds, however you define that?

Carl Vogel

I don't think we've seen much of an impact frankly from what DirecTV has done on their credit quality, and I don't think it's had much of an impact on our subscriber mix either. I think as I said to Vijay, I think we're pleased with our gross adds, we're reasonably pleased with our net adds. Our churn level is about the same in the second quarter as it's been the past three to four years, and our revenue per customer is increasing, so I don't think we've seen much impact from the actions of DirecTV at this point.

Doug Shapiro - Banc of America Securities

Okay. Thank you.

Operator

Your next question comes from Lale Topcuoglu - Goldman Sachs.

Lale Topcuoglu - Goldman Sachs

Hi, guys. A few questions. Jason, can we get a little bit of clarity on what was the thought behind the accounting change and the way you report SAC?

Secondly, when we look at the subscriber-related expenses they were a little bit up from the first quarter when you compared it to last year. Should we attribute more of that increase to the upgrade in the retention spending?

Thirdly, you have made the news in terms of your prepaid plan. How is that plan going? Are you seeing a lot of customer attraction with that plan and can you give us a little bit of a flavor what kind of returns you're getting?

Finally , and this is the humorous one. Given that Charlie is not present on this call, as you know, a lot of us actually attribute a lot of value to his comments and don't take this as being disrespectful to your comments, should we expect him on the call next week and next time? The reason why I'm asking is that way we can shut down the speculation that the Company is up for sale and Charlie is moving himself away from the Company. Thanks.

Carl Vogel

Well, let me take the last one first, and we don't take it personally because God knows there's only one Charlie Ergen -- thank God.

In terms of attributing his comments, Charlie, as Jason indicated had a longstanding family vacation and like all of us he's getting older, so his kids have to return to school a little earlier than they might otherwise have when they were younger. So I wouldn't read too much into that, but I will say that Charlie said at the beginning of this year he isn't going to spend as much time on these quarterly conference calls. I wouldn't take that as any indication of any lack of interest in the business by our Chairman. He is, in my judgment, fully engaged. As he said on prior calls, he sees many, many opportunities that he hasn't seen in a long time. I've seen engaged and I've seen disengaged, and this guy is totally engaged.

I'll let Jason and Dave respond to the SAC and sub related, and I'll respond to prepaid.

You know, prepaid is a good idea that we haven't implemented to the extent that we would like, frankly. When look at our adds, The vast, vast, vast majority are continuing to be our post-paid business. Part of it was we had to get the systems in place to support that prepaid effort. But I would characterize our prepaid effort to date as immaterial, somewhat disappointing, but it's an area that we continue to look at. But it has really no impact of any great degree in any of our financial metrics. Dave, I don't know if you want to comment on that?

Dave Rayner

No.

Carl Vogel

It was very, very small.

Dave Rayner

In regards to SAC and the way that we've changed the disclosure on SAC, as those of you who have followed us for awhile know, we continuously evaluate how we're disclosing information. As we looked at SAC we decided that we should display it a little bit different. All the same information is there. We're just putting it into some different buckets that hopefully you find if not more informational, at least equally as informative. So there's nothing really behind it other than the decision to try and display it a different way that hopefully you guys find more useful.

In regards to sub-related expenses as we talked earlier in the second quarter, we did see an impact from implementing Echo 10 and the two dish resolution, so I'm not going to go through that again, but we did see an impact there.

Regarding retention costs, there was not a material change in retention costs on a per sub basis. Obviously in total dollars as the business grows, the dollars do increase but on a per sub basis, there really wasn't a material change from the first quarter into the second quarter. We did see a slight increase as we're rolling out more HD and as customers want more HD, obviously we're upgrading some customers; DVR penetration continues to increase, and so there is a slight impact there, but as I said, not a very material impact on a per customer basis.

Lale Topcuoglu - Goldman Sachs

Thank you, I appreciate it.

Operator

Your next question comes from Aryeh Bourkoff - UBS.

Aryeh Bourkoff - UBS

Thanks, Carl, I'm not going to ask you to compare whether this Chairman was more engaging than your last Chairman.

Carl Vogel

No comment.

Aryeh Bourkoff - UBS

The opportunities you mentioned, obviously that Charlie sees in the business and very engaged can you maybe articulate some of the opportunities or really maybe talk about why given those opportunities the Company didn't buy back any stock in the quarter? And maybe revisit that issue in terms of how you assess whether or not you want to buy back stock?

The second question is on the auction I know you really can't comment on what's going to happen with the auction, but in terms of the joint bids, the joint venture I guess wireless DVS between you and DirecTV, is there a mechanism where one of you guys could take over the partnership? Let's just say that you're more interested the spectrum than DirecTV or vice versa? Are you tied together during the whole process or can you end up sort of taking it over or vice versa? Thanks.

Carl Vogel

Charlie, Jason can speak to the buyback, but in terms of the opportunities, one thing about Charlie, this is his only business. In other situations I've been involved in there's plenty of other businesses and so as a result of that, Charlie is the CEO and those of you that have followed the calls over the past ten years, as I think Charlie's strength is as much in strategy as it is in operations and that's just a different situation.

So I wouldn't characterize it one way or the other in terms of engagement, but Charlie, this is a business that we started from scratch. It's a business that has exceeded many expectations. In terms of opportunities, we're looking at things that could allow us to replicate what we accomplished over the past ten years in DISH Network. As we've said on calls in the past, it's trying to make our business the best video business as possible and there's portable and mobile applications to that so we're certainly looking at those kinds of areas.

We have talked about broadband opportunities. We continue to look at those areas as an area that we think may make some sense going forward. We continue to keep our eyes and ears open in terms of what international opportunities may present themselves.

Overall, our goal is to take the operating infrastructure that we've created over ten years, the satellite platform that David mentioned is quite robust over the U.S, The technical technology platform that we've created in ETC in terms of making cost effective set-top boxes and consumer devices and put that together in a place where we can then hopefully replicate the success that we've enjoyed at DISH Network. That's essentially the kinds of things that we're doing.

In terms of the auction, I can't speak to anymore than I've already described our relationship with wireless DBS and with the process just because of the requirements of the auction process by the FCC and I'll let Jason speak to the buyback.

Jason Kiser

Carl actually gave most of the answers to the buyback and it hasn't changed from the 800 other times we've been asked the question, but all of the different opportunities that are presenting themselves to us and we see as potential things that we would be interested in doing going forward, those all get evaluated equally at the same time that we're looking at doing anything in the capital structure. Whether it's looking at the different pieces of debt, whether it's looking at buying back stock, whether it's looking at issuing new things.

The opportunities out there all require or could require different levels of capital under all kinds of different scenarios. So, it's something that we're looking at every day. We're looking at every piece of it every day.

The issue I think is that from our perspective, we're just not sure when or if or to what extent any of these opportunities might come. They could come all together, they could come at different times, so really we're just keeping our optionality open on how we best use our capital.

Aryeh Bourkoff - UBS

Just one further question. The AT&T partnership that you have, obviously has gotten more solidified with the Home Zone rollout. Can you talk about some of the progress on the AT&T partnership during the quarter? Is it getting reinvigorated with the new deal and maybe just give us the number of subscriber numbers? Thanks.

Carl Vogel

Well, I think the AT&T partnership is extremely important to EchoStar and we have spent a lot of time, money, and effort to get the Home Zone product to the place that it is and we're very encouraged by their support of that product and we're very encouraged by their interest in that product. I think it is a good consumer product. I think our AT&T relationship is good. I think reworking the deal so it made more sense for both parties made a lot of sense. We consider AT&T a very valued partner and somebody that we can do things with going forward.

So we are putting our engineering resources behind that. We're putting our content resources behind that. We're working together to try and get I think better promotions and better execution and I think we're going down the right path not only with AT&T, but all of our telco partners.

Aryeh Bourkoff - UBS

Thank you.

Carl Vogel

Thank you.

Operator

Your next question comes from Bryan Kraft - Credit Suisse.

Bryan Kraft - Credit Suisse

Thank you. Just want to follow-up on an earlier question. Can you elaborate on why the economics of HD might not make sense in smaller markets? I mean what are all the up front costs that you do need to incur to launch a market?

Secondly, can you also talk about how you expect SAC or gross add to trend in the second half of the year notwithstanding the change in the definition?

Carl Vogel

I'll start with the economics of HD. I think it starts with satellite capacity, it starts with additional bandwidth, it includes backhaul costs from fiber to get the signal to our uplink facilities, it requires additional equipment. To the extent there is limited HD set penetration in certain markets beyond the top 40 or 50, the economics degrade proportionally.

So we continue to look at how those opportunities may present themselves. We are totally focused on HD as evidenced by what we've done with national services, but again, it's just to the extent that satellite costs come down which we don't see and to the extent that fiber costs come down which may occur, to the extent that we could share backhauls with others, that's always a possibility to the extent MPEG 4 four set-top box costs come down; all of those things are factors that weigh on our decisions to enter markets.

But we're in the very early stages of our MPEG 4 rollout and we haven't seen the chipset reduction that we would like, but we think we will over time. As those things converge in terms of greater demand, more content, lower set-top boxes, reasonable backhaul costs, we'll look at entering those markets and attempting to be a presence and an option for consumers.

Dave Rayner

In regards to SAC direction without commenting specifically on what we expect out of SAC, but general trends, a lot of it overlaps what Carl just said. Certainly, our lease penetration continues to increase, the redeployment of those boxes is going to be a benefit to SAC. As we discussed earlier, the elimination of SuperDISH both on the equipment and on the installation side will have a positive impact on SAC.

But offsetting that, to the extent that we have greater HD penetration, that's a new generation of box, the MPEG 4 boxes which are more expensive, obviously we don't have a large percentage of redeployed capabilities out of those boxes yet. We will see that over time, but they are more expensive boxes today. So to the extent that we see increased HD penetration, it's going to have a negative impact on SAC going forward.

Jason Kiser

I think we'll take one more question.

Operator

And your final question comes from Thomas Eagan with Oppenheimer & Company.

Thomas Eagan - Oppenheimer & Co.

Thanks. Two essentially follow-up questions. First wondering if you could talk a little bit about any dialogue, if any, you started with BellSouth now that they are going to be purchased by AT&T?

Secondly , DirecTV said on their call that they are able to drop the cost of their base box by about $20 before they add any additional features. I'm wondering what you're seeing in terms of the drop, if any, on the cost of the base box? Thanks.

Carl Vogel

Well with respect to BellSouth, we're not going to make any comments regarding that relationship. In terms of the cost of the base box I don't have the details, but having been around the industry a little while, I can tell you that nobody can make boxes cheaper than EchoStar, best I can tell. Because we're working off our own reference design. We use third-party contract manufacturers, there's no manufacturing profit in the middle, and I think we're going to be very, very competitive on whatever our box costs are. So I don't know if anybody else here has any idea on the cost of our base box, but I think we are extremely competitive in terms of the cost of our product.

Dave Rayner

I would agree, and you go over life cycle on any box the first box you deploy is the most expensive one you're ever going to buy; chipset costs come down, manufacturing efficiencies come into play, and over time, the box does decline. You reach a point some time in the life cycle that you're as low as you're ever going to be.

Carl Vogel

Tom did I miss something? Were you talking about MPEG 4, though? Did I misunderstand?

Thomas Eagan - Oppenheimer & Co.

No, wasn't. It's fine.

Dave Rayner

So I think any box cost goes through a life cycle and it's true on any consumer electronic product.

Thomas Eagan - Oppenheimer & Co.

Right. Is there a point in time say six months after the closure of the BellSouth deal, is there a point in time legally where you're allowed to speak to BellSouth?

Carl Vogel

I'm just not going to comment on that, Tom.

Thomas Eagan - Oppenheimer & Co.

Right. Okay, I understand. Thank you.

Carl Vogel

All right thank you, and thank you all for joining us and notwithstanding that we didn't have our headlining act here in Mr. Ergen, we hopefully answered your questions and we'll see what we can do next quarter. Thanks for joining.

Operator

This concludes today's EchoStar second quarter 2006 earnings conference call. You may now disconnect.

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Source: EchoStar Q2 2006 Earnings Conference Call Transcript (DISH)

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