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Executives

Greg Maffei - President and Chief Executive Officer

Chris Shean - Controller

Mike George - Chief Executive Officer of QVC

Bill Meyers - President and Chief Operating Officer of Starz

Bob Clasen - Chief Executive Officer of Starz

Dan O’Connell - Chief Financial Officer of QVC

Glenn Curtis - Executive Vice President, Chief Financial Officer of Starz

Analysts

Jason Bazinet - Citigroup

Doug Mitchelson - Deutsche Bank North America

David Gober - Morgan Stanley

Jeffrey Wlodarczak - Hudson Square Research

Douglas Anmuth - Barclays Capital

Bridget Washa - J.P. Morgan

James Ratcliffe - Barclays Capital

Matthew Harrigan - Wunderlich Securities

Murray Arenson - Janco Partners

Liberty Media (LCAPA) Q2 2009 Earnings Call August 7, 2009 11:00 AM ET

Operator

Good day and welcome to the Liberty Media Corporation quarterly earnings conference call. Today's call is being recorded.

This presentation includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about financial guidance, business strategies, market potential, future financial performance, new service and product launches, and other matters that are not historical facts. These forward-looking statements involve many risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements.

These forward-looking statements speak only as of the date of this presentation and Liberty Media expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein to reflect any change in Liberty Media's expectations with regard thereto or any change in events, conditions or circumstances under which any such statement is based.

On today's call we will discuss certain non-GAAP financial measures, including adjusted OIBDA. The required definitions and reconciliations, preliminary note and schedules one through three can be found at the end of this presentation.

At this time for opening remarks and introductions I would like to turn the call over to the President and Chief Executive Officer, Mr. Greg Maffei. Please go ahead, sir.

Greg Maffei

Thank you, Operator and good morning to all of you and thank you for joining us and for your continued interest in Liberty Media. Today we’ll discuss the performance in Q2 of the company the operating results of our largest consolidated subsidiaries. Speaking this morning on the call with me we’ve got Liberty Controller Chris Shean, who will discuss the attributed business' financial results and the liquidity picture for each of the trackers; QVC's CEO Mike George; Starz President and COO Bill Meyers; and an assortment of other Liberty, QVC, and Starz executives who are all available to answer your questions.

During the quarter, we continued to see quite strong operating results at Starz and at our e-commerce companies and you will hear more about that from both Chris and from Bill. And importantly we saw improving results at QVC, our largest controlled subsidiary and you will hear more about that from Mike George.

Here at corporate we strengthened the balance sheet considerably, retiring about $1.94 billion face of debt on a corporate wide basis. That included about $750 million of bank debt at QVC and retirement of certain maturities, straight debt and other purchases in the marketplace. All together, we brought that debt in at a discount to face of about $275 million. I think you should expect you will see more debt retirement coming in the quarters ahead.

Our public equity portfolio grew in the quarter nicely about over $2 billion. That was paced by gains in DIRECTV, almost $1 billion; Expedia of over $400 million; the IT spin companies, a substantial gain; and of course SIRIUS XM, which grew over $200 million in the quarter. Since we struck the SIRIUS XM deal back in February/March, we’re over $1.3 billion.

I note, of course, none of those fish are in the boat yet so we are not counting on them but it is nice to see them marked well.

At Liberty Entertainment, as I mentioned, Starz Entertainment had very good results, nice revenue and very strong adjusted OIBDA growth. We continue to make progress on our DIRECTV transaction. With the IRS, we are awaiting a response on our private letter ruling but are confident. At the FCC, it looks like the transaction will be considered pro forma and with the SEC, we expect to re-file with a completed proxy in mid-August and expect to vote in early October.

I note that during the quarter, driven by the share repurchase at DIRECTV, the Liberty interests exceeded [our rates] almost 56%.

At Liberty Interactive, as I mentioned QVC had very strong sequential domestic revenue and adjusted OIBDA growth and the adjusted OIBDA margin increased. The e-commerce companies grew in revenue and adjusted OIBDA in part due to some [inaudible] and importantly, lead by our Treasurer, Dave Flowers, we extended the QVC debt maturity through 2014 and took a lot of pressure off the balance sheet at QVC.

At Liberty Capital, Starz Media revenue and adjusted OIBDA both improved over last year and we continue to make progress on the debt structure, as I noted.

A couple of other things before I turn it over to Chris, we established the media for liberty award to talk about economic freedom and we added a new independent board member, Ian Gilchrist, late of Citibank, and we are happy to have Ian aboard.

So Chris, let me have you start by talking about the lift in financial results.

Chris Shean

Thanks, Greg. Liberty Interactive Group’s revenue decreased 1% to $1.9 billion while adjusted OIBDA increased slightly to $412 million for the quarter. QVC, the primary driver of the results amongst the Liberty Interactive attributed businesses, continues to operate at a challenging retail environment and QVC's total revenue decreased 4% to $1.7 billion while adjusted OIBDA decreased 4% to $373 million.

The e-commerce group of companies at Liberty Interactive, which include provide commerce, Backcountry.com, bodybuilding.com, and By Seasons again posted positive financial results. In total, the e-commerce group experienced revenue growth of 31% in the second quarter and adjusted OIBDA grew 56%. The increase in revenue for the quarter was driven by organic growth at all the e-commerce companies, combined with two small fold-in acquisitions made in 2008, which contributed $26 million in revenue during the second quarter.

Included in organic growth for the quarter is about $5 million of commissions earned when customers sign up for a third-party online discount program, which is slightly different than the standard revenue stream that these businesses have.

The increase in adjusted OIBDA was primarily driven by revenue growth as discussed above.

During the second quarter, QVC amended their bank credit facilities and extended maturities through 2014. Concurrently, QVC retired $750 million of loans at par and cancelled another $19 million of un-funded commitments at no cost. The remaining $4.48 billion outstanding principal will mature in six tranches between June 2010 and March 2014.

Cash used to retire the $750 million of loans came from a combination of $250 million of cash from QVC and $500 million in the form of inter-group loans of $250 million from each of the entertainment group and the capital group to the interactive group. The inter-group loans are secured by various public stocks attributed to the interactive group, accrue interest quarterly at a rate of LIBOR plus 500 basis points, and are due in June of 2010.

Additionally, QVC modified their revenue recognition policy through an FOB destination model this quarter. This model was considered more appropriate given QVC's history of providing replacements for goods damaged in transit. As a result of this modification, there has been an immaterial one-time adjustment decreasing revenue by $21 million and adjusted OIBDA by $8 million.

Excluding this adjustment, consolidated revenue would have decreased 3% and adjusted OIBDA would have decreased by 2%.

And with that, I will hand it over to Mike George for additional detailed comments on QVC.

Mike George

Thank you, Chris. We were very pleased with our Q2 results, which represented a significant improvement over the trend of the last few quarters. We see these results as a positive sign that our actions are paying off, even as underlying consumer spending remains weak.

In the U.S., net revenue fell 2%, a strong improvement from the negative 9% to 12% trend of the prior three quarters. And we were particularly encouraged by the continued strong growth in QVC.com, which was up over 10% from last year.

As in recent quarters, we saw strong growth in computers and consumer electronics and to a lesser extent, in beauty and handbags. The kitchen and floorcare and fashion jewelry businesses also showed some very nice gains over past trend. And while the apparel business remained soft, the declines have moderated from prior quarters and we increasingly feel that we have real upside in that category as well.

In contrast, the fine jewelry business remains very difficult as it has been for several quarters.

We also saw a significant reduction in return rates in the U.S. from 20% in Q2 of last year to 17% this Q2, driven by product mix and other initiatives we are pursuing.

U.S. adjusted OIBDA declined 3% in the quarter and was down only 1% prior to the revenue recognition adjustment that Chris mentioned. This is a significant improvement from the double-digit declines we experienced in prior quarters. Product margins were down about 60 basis points due primarily to a shift in mix away from higher margin categories and to a lesser extent, increased markdown use in apparel and jewelry as we strive to keep our inventories clean.

Bad debt expense was up 39 basis points. That’s about half of the increase that we experienced in Q1. Our cue card bad debt write-off rate was 7.5%, up from 6.7% in the prior quarter. These results reflect a moderation of the increases we’ve seen for several months and our write-off rates remain well below those of other card issuers as we continue to manage credit conservatively.

These declines were largely offset by significant improvements in our cost structure, including greater productivity in our distribution and call centers and lower freight costs as we implemented several initiatives to optimize our freight network. And we continue to tightly manage inventory with our overall inventory level in the U.S. down 10% from last year.

Turning to the U.K., we saw our sales up 1% in local currency, reversing the negative trend we experienced in Q1. We saw gains in fashion, beauty, and computers offset by some weakness in jewelry and consumer electronics. Adjusted OIBDA was down 1% in local currency, driven by a decline in initial gross margin due in part to the impact of foreign exchange movements. This decline was partially offset by a significant improvement in our fixed cost structure as several cost management initiatives began yielding results.

We successfully managed down our inventory levels in the quarter with ending inventory 15% below year-end levels, although inventory remains about 5% over the same time period last year.

In Germany, net revenue increased 1% in local currency, our fourth consecutive quarterly increase. This largely reflects the success of our strategy to double the beauty and health business, which grew nearly 70% in the quarter, coupled with increases in our footwear and home businesses. These gains were partially offset by continued weakness in jewelry and apparel where we continue to pull back air time to fund these other up-trending categories.

Adjusted OIBDA in Germany was up a strong 12% in local currency, driven by a lower obsolescence rate and improvements in our cost structure. These gains were somewhat offset by a reduction in initial product margin as we cleared out poor performing jewelry items. While we have some more clean-up to do in apparel, we feel that our inventory in Germany is in the best shape we’ve seen in years. Total inventory levels declined 10% over last year and are now at their lowest level since 2006.

In Japan, net revenue was down 3% in local currency. This is the first negative sales result we’ve posted in Japan in several quarters. As I mentioned on the last call, consumer spending in Japan is significantly challenged, impacting our results in the quarter. That said, we continue to take aggressive actions to drive sales. Our fashion and jewelry businesses remain strong and we believe we have real opportunity to improve our home and health and beauty businesses, which can provide upside to the recent trend.

Adjusted OIBDA in Japan was down 4%, largely in line with the revenue decline. We achieved meaningful improvements in our fixed cost structure, offset by the higher cost of television carriage as our sales decline created negative leverage on contracts that charge a fixed fee per subscriber.

Wrapping up, as I mentioned at the outset, we are very encouraged by these results and gratified that our actions are beginning to take hold, offsetting to some degree what continues to be a very weak retail environment in all markets we operate in.

We are seeing the positive results of our ongoing efforts to shift sales into higher performing categories, reduce inventory levels, manage down return rates, and cut expenses.

At the same time, we are continuing to invest in the business, taking advantage of the current crisis to out-innovate the competition. We’re developing new Internet and -- Internet, CRM, and broadcast management platforms which will roll out over the next six to 12 months.

We are continuing to expand our presence in the high definition tier in the U.S. with QVC HD now available in over 15 million homes in the U.S., a significant lead over any other shopping channel.

We continue to add new features to our mobile platform and we are on track with Italy, which will be our fifth market, and scheduled to launch in the fall of next year.

And most importantly, we continue to invest in elevating the shopping experience, offering truly distinctive products and programming to our customers as we strive to make QVC the premiere retail destination. For example, in Q2 we premiered [inaudible] jewelry directly from Istanbul, took our viewers to the Aspen food and wine festival and the Yankee Stadium inaugural season, launched runway designer [Carmen Mark Bolvo’s] home collection, Cindy Crawford’s beauty line, Elisabeth Hasselbeck apparel, and featured the CEW insiders’ choice beauty finalists. And our customers responded strongly to a number of great TSVs in the quarter, ranging from [Duni & Bourke] handbags to a best of Bobbi Brown beauty collection, Dell XPS notebooks, and Sharp Aquos high definition TVs.

Our efforts to redefine the shopping experience were perhaps best exemplified by the recent Wall Street Journal story featuring our new partnership with Isaac Mizrahi. We will be broadcasting several hours of programming monthly with Isaac live from his design studios in New York as we build a lifestyle brand around him, which we expect to become one of our top five brands.

This is creating a great deal of interest in the industry and among customers and non-customers and shines a spotlight on our efforts to move our brand forward and gain market share.

And with that, I will turn it back to Chris.

Chris Shean

Let’s move on to Liberty Entertainment. Revenue grew 2% in the second quarter to $367 million while adjusted OIBDA increased 44% to $89 million. The increase in revenue was primarily driven by the results of Starz Entertainment. The increase in adjusted OIBDA was due to positive results of Starz Entertainment partially offset by expenses related to the proposed split-off of the businesses, Liberty Entertainment, LEI. Now Bill Meyers will comment on the events of Starz Entertainment and Media.

Bill Meyers

Thank you, Chris. Starz had another strong quarter. Starz Entertainment revenue increased 8% to $296 million and adjusted OIBDA increased 54% to $105 million versus the same period of the prior year. The increase in revenue resulted from an increase in rates and the growth in the average number of subscription units. The higher adjusted OIBDA resulted from the increased revenue and a decrease in operating expenses. The operating expense decrease was due to lower licensing fees for films, somewhat offset by increased expenses for original programming and lower sales and marketing expenses. Versus the first quarter of 2009, Starz subscription units declined 3% and Encore subscription units declined by 1%. This decline in subscriber levels resulted from several factors. Many of our affiliates initiated rate increases in the first half of [the year], from both basic and premium tiers even as the economy caused consumers to tighten their belts. The pace of new home construction has declined sharply, which has lowered new connections for both basic and premium services and during the second quarter, we did not have access to national marketing campaigns with several of our affiliates.

We are currently working with our affiliates on several marketing campaigns to sign up new subs and retain existing subscribers. However, given the current economic conditions, we cannot predict whether or not we will experience further subscriber erosion.

We continue to work to increase the value of Starz's products for our affiliates and consumers. In the past year, we have added such features as more high definition channels and additional on-demand and HD on-demand programming.

An indication that our products can become even more valuable to our affiliates and consumers came this quarter when Comcast announced the trail of a service that will allow existing Comcast Starz subscribers to access Starz's movies and originals over the Internet.

During the quarter, we reached new multi-year affiliation agreements with DIRECTV and DISH Network, two of our largest affiliates. We continue to ramp up our original programming, which allows us to establish a unique identity with our audiences, gives us a library of proprietary programming to which we have unlimited rights, provides a new source of income from syndication, home video, Internet, and other distribution platforms.

In the second quarter, we started production on Spartacus, our new action adventure, hour long dramatic series from Sam Raimi and Rob Tapper that will air on Starz early next year and to which we will hold all rights, international and domestic.

The trailer of Spartacus was well-received at ComicCon and the Television Critics Association tour last month. To depict the world of Roman gladiators, Spartacus employs the cinematic techniques used in the movie 300 and represents a significant departure from any programming ever seen before on television, on either premium or ad-supported channels.

We started production on the second season of Crash, a co-production with Lionsgate, that will air on Starz this fall. The home video version of the first season will street next month, distributed in the U.S. by our sister company, Anchor Bay Entertainment.

We greenlit a second season of party down, the critically acclaimed half hour comedy series and announced that we will air a new half-hour comedy early next year titled failure to fly from two accomplished writer/producers, Eric Shaffer and Jill Franklin.

On the Starz media side, revenue increased by 58% versus the same period in the prior year to $90 million. OIBDA improved from a negative $19 million a year ago to a positive $17 million. The increase in revenue was largely attributable to a $25 million increase in revenue from sales of Starz Media programming to television networks, including $10 million in license fees from the exhibition of Overture Films onto Starz Entertainment networks as we continue to execute on our audience aggregation strategy, under which we produce our own programming and distribute it through multiple platforms.

The improvement in OIBDA resulted from the increased revenue and the timing of film releases by Overture.

The results for Starz Media may vary widely from quarter to quarter, depending largely on the schedule of theatrical releases. For example, with 5 Overture films slated for the release during the remainder of the year versus only one film released in the first half, we can expect an increase in P&A costs in the coming months.

The Overture release, Sunshine Cleaning, finished its theatrical run in the quarter as the highest grossing independent film so far this year. The next Overture film, Paper Heart, opened this week and will be followed in the next two months by Pandorum with Dennis Quaid and Ben Foster; the newest Michael Moore film titled Capitalism: A Love Story; Law-abiding Citizen with Gerard Butler and Jamie Foxx; and The Men Who Stare at Ghosts with George Clooney.

Despite the improved revenue and adjusted OIBDA for the quarter, the general economic conditions have impacted the overall theatrical and home video industries, including our businesses, resulting in lower-than-projected revenue for many of our individual productions. We expect these businesses to continue to face challenges until the overall economy improves.

Now I will hand it back to Chris.

Chris Shean

Thanks, Bill. Just to provide some top line numbers for Liberty Capital, during the quarter its revenue increased 14% to $199 million while adjusted OIBDA deficit decreased by $44 million for the quarter.

The increase in revenue was principally due to the previously mentioned increase in television revenue from Overture Films. The decrease in adjusted OIBDA deficit was due primarily to the difference in theatrical and home video revenue and related expenses associated with the films released by Overture Films.

Now with all that said, we will turn the call back over to Greg for some concluding remarks.

Greg Maffei

Thanks, Chris and thank you to Mike and Bill for the updates on your respective businesses. To conclude, I would note our priorities include at Liberty Entertainment, focusing on completing the split-off of LEI and the merger with DIRECTV and then reclassifying the new tracker Liberty Starz. At Liberty Interactive, we hope to continue to improve the operating performance at QVC as you saw this quarter and continue the strong performance at our e-commerce companies. And at Liberty Capital, we hope to continue to evaluate opportunities for cash on the books. We have done some buy-backs, as you’ve seen. We’ve had some good investment opportunities like SIRIUS XM and we continue to look at stock buy-backs.

Candidly, the markets today are not as appealing in terms of opportunities in the number as when we did the SIRIUS XM transaction but nonetheless, we think there are some and we will be hopefully executing on them.

In addition, we look to rationalize some of our investments in non-strategic assets, non-strategic third-party investments.

So stay tuned for the coming quarters ahead and thank you for listening and with that, Operator, I’d like to open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Jason Bazinet of Citi.

Jason Bazinet - Citigroup

I have a quick question on Liberty Capital. When I do my back-of-the-envelope calculation, it seems like the valuation makes sense if you don’t include any equity for the Sirius stake that you have and it seems to not make sense if you include it, and so I was just wondering --

Greg Maffei

-- say, Jason, when I’m not sure I agree with the premise of your question because I might think that there’s value in Liberty Capital even without the SIRIUS XM equity attribution, but go ahead with that point. Sorry.

Jason Bazinet - Citigroup

And so my question is can you just sort of help investors sort of understand how you might help Sirius to the extent they need financing and how valuable that asset and our NOLs are to you if it does go bankrupt? In other words, it’s not -- it seems to me the market should be included and I’m a little mystified why they aren’t because I guess my hypothesis, you sort of have an incentive to sort of make sure that Sirius remains a viable entity. Any comments would be helpful. Thanks.

Greg Maffei

Sure. I think when we struck the SIRIUS XM deal, Dave Flower our Treasurer said to me this is either a bottom or -- because you don’t put senior debt in at a $1 billion valuation and get 40% of the equity, or we’re just -- you know, it’s a fraud and we’ve just missed it. And we’re obviously convinced that was a bottom and the result of SIRIUS XM since have seen to demonstrate that. I believe at the time they were talking about 300 of EBITDA and the market didn’t believe it. Then they talked about 350 of EBITDA as they reported Q1. Now they reported Q2 and they have raised their numbers I believe to 400 of EBITDA and frankly, I don’t think I am underselling Mel here when I tell you I think they are going to significantly exceed 400 million of EBITDA. So I am very comfortable that our debt there is money good and that the equity valuation, while one can argue about how aggressive it is on a multiple basis, you’d be hard pressed to find a [stale] media company out there growing at the rates that this company is growing this year and I believe will grow over the next couple or three years without much improvement if any in the auto market.

Cost savings around content, around OEM deals, around the merger and production and operating costs are driving that growth and will and as our Chairman likes to say, if the auto market comes back stronger than we are anticipating, forget cash for clunkers but over the next couple of years, that’s a lucky strike extra.

So I am very comfortable talking about things like what might happen in a bankruptcy and how we might be able to capture the NOLs -- those are all ideas that we might have had back in February and March but those are very distant ideas today and we are talking about how much this equity is worth.

So I think this is a great business. They are unfortunately refinancing -- did refinance and I suspect will refinance more of the senior debt that we bought. The good news, they will take our money off the table and validate the equity story and lower their cost of capital. The bad news is we were getting very high rates of interest paid to us on that senior debt and we will no longer be collecting that. So we have mixed motivations on that.

Jason Bazinet - Citigroup

Understood. Very helpful. Thank you.

Operator

Our next question will come from Doug Mitchelson of Deutsche Bank.

Doug Mitchelson - Deutsche Bank

Thanks very much. Just a few detail questions -- one, Greg, are you able to tell us what the cash balance was between Starz and LEI it was at quarter end and tying out to what was on the balance sheet?

Greg Maffei

Sorry, Doug, let me make sure I understand this -- you’re saying what was in Liberty Entertainment, how much will end up at Liberty Starz and how much will end up at LEI?

Doug Mitchelson - Deutsche Bank

Yes, in aggregate --

[Multiple Speakers]

Greg Maffei

Okay, let me let my able folks in the room do some calculating, make sure we get that right for you. We’ll come back to that one. Keep going.

Doug Mitchelson - Deutsche Bank

The second one, you talked about selling shares at Sprint and [Moat]. Is that done? Are you fully sold out of those positions and what does that do with regard to the impact on the derivatives you have and the borrowing and any potential tax liability there would be helpful.

Greg Maffei

I don’t think we’re disclosing whether we’ve sold those out just because we don’t want to create any overhand in the marketplace on that but it’s safe to say we are at the right price. We’re happy to be sellers of those assets and we don’t believe it has any impact on the underlying derivatives in our tax position.

Doug Mitchelson - Deutsche Bank

And then you talked about an interest in repurchasing more of your debt over the coming quarters. Is the thought there -- could you be anymore specific? Is this an LCAPA specific event since that seems to be where it is sourced in terms of open market purchases or tenders or any additional details there?

Greg Maffei

Well, if you look at the debt we have post a spin merge with DIRECTV, there will be no debt at Liberty Starz -- it only has cash and excluding the fees debt at LCAPA because when I talk about the fees, I am talking about the Sprint callers which are offset by the Sprint borrowing. That’s really neutral.

You know, we have those exchangeables which we’re trading at a discount and at the right time and place, we valuating our investment opportunities in Liberty Capital, we’ll look at whether we’ll purchase third party investments or we’re purchasing debt or equity, which of those three is the most attractive. So that’s certainly possible.

Liberty Interactive is a little tougher. It does not have -- while it has a great cash flow generating source in QVC and it has a substantial amount of free cash flow, much of that is going to be devoted to paying down QVC bank debt. There is certainly the restricted payments that can come up and cover interest and the like but how much free cash flow we have to repurchase straight debt, which has been attributed to Liberty Interactive is a little less flexible, so I think where -- our most likely first case is to look at the stuff at LCAPA.

Doug Mitchelson - Deutsche Bank

And then the last question would be on the Starz renewal -- can you just remind us which major Starz renewals are left? And I guess one of the concerns is that renewals won't go well and that will hamper Starz's top line growth. How do renewals with DISH and DIRECTV -- I guess DIRECTV we know -- how did the renewal with DISH go and what’s your anticipation for the remaining, would be helpful. Thanks.

Greg Maffei

I’ll just get one thing -- I mean, in scale, the partners that matter the most are DIRECTV first and foremost. That deal is done, renewed for four years. Then Comcast. By scale, Time Warner Cable, though it is the third largest, have never been a particularly strong contributor to premiums -- not just Starz's premiums, anybody’s premiums. So they are well down the list in terms of impact on us and so DISH and Comcast, having done DIRECT, are the big ones and I’ll let Bill comment on this.

Bill Meyers

So Comcast, we are in discussions with them right now. We are pretty much in agreement and we are just trying to get that deal papered so we’re getting pretty close. The other deals that are coming up over the next several months are Cox and Time Warner and we have already had preliminary discussions with Cox on what makes sense for them and how they can use our product in a broader sense and those discussions seem to be moving forward in a very positive way.

Other than that, as Greg said, our biggest affiliates are behind us, you know, multiple years --

Greg Maffei

And just to tap around that, we did an extension with Cablevision last year and the telcos who are -- [inaudible] -- who are both, you know, they are not enormous today but over hits because of how their growth is and frankly where the rates are, they -- they are both behind us too for a period, so we feel very good about the overall relationship with distributors and where we sit.

Doug Mitchelson - Deutsche Bank

Is it fair to say if we aggregate all those deals that we should still expect core rate increases in the CPI plus range?

Bill Meyers

Well, clearly all those deals have CPI. We continue to add more product, so yes, our goal is to continue to maintain our rate by the addition of incremental product for those folks.

Doug Mitchelson - Deutsche Bank

All right, that’s helpful. Any answer on the cash or should I just --

Greg Maffei

Yes, back from the home office --

Chris Shean

Got the answer for you -- Starz has $175 million of cash at quarter end. The remaining 443 is corporate and call it other. Of that, 30 is on the RSNs and 30 would go with LEI -- 30 of the corporate cash would go to LEI in the spend, leaving 383 back at Liberty Starz tracker corporate.

Doug Mitchelson - Deutsche Bank

So that’s 548 --

Greg Maffei

That excludes the 250 loan.

Chris Shean

Yeah, that excludes the short-term loan that was made across the group of 250, so there’s a -- call that a placeholder for temporarily.

Greg Maffei

One of the things worth noting, Doug, is we have the financing that was struck to purchase an incremental 78 million shares at Liberty Entertainment that has a collar structure and a loan against it and we are paying down ratably on that at a small clip -- at the close of the deal we’ll be reimbursed for that by DIRECTV but the balance in the interim is being paid down by Liberty Entertainment.

Doug Mitchelson - Deutsche Bank

Okay, so if I do all the calculations right including the 250 loan to [inaudible], it sounds like there’s $800 million of cash at quarter end at Starz?

Chris Shean

If you value the loan as -- treat the loan as cash, yes.

Doug Mitchelson - Deutsche Bank

Great. Thanks for all the help.

Operator

Our next question will come from Ben Swinburne of Morgan Stanley.

David Gober - Morgan Stanley

It is actually Dave Gober. I had a couple for Mike on the QVC business. Obviously a major improvement in the trajectory there and you talked a lot about the cost side but I just wanted to dig a little bit deeper, particularly on the domestic business into the demand side and I’m trying to figure out -- it seemed like both the -- there was an improvement in both units and price but could you drill down a little bit into what the -- whether there was a change in the number of customers or just spending per customers -- I mean, I guess what drove the improvement in demand and what drove the particularly relative to the broader retail market, which did not seem to improve all that much?

Mike George

I would say it was more spend per customer than necessarily significantly increasing the customer base, so I think what we saw this quarter is we continued to have a very loyal customer who sticks with us. She is clearly more selective in her purchasing than she has been in the past but she is making trade-offs among a multitude of retail outlets, so I think we manage to inspire her a little bit and gained some market share versus the broader retail market. And so for us, to me, it’s really beginning to see -- I think the dividends of things we’ve been working on for the last 18 months, which is to really keep upgrading the quality of our assortments, upgrading the programming, bringing in new brands, and so I just think there was enough newness in the quarter, enough compelling programming and marketing that we were able to push through and get a higher share of her spend. And we are very excited about what we have teed up for the back half. I think that will be stronger still in terms of the quality of the programming and the assortments. We’ll see how the customer responds but we are certainly very excited about it. I generally think it’s the best lineup we’ve ever had.

So we just feel good that we think our initiatives are coming together and presenting a more exciting storefront to the customer and she seems to be responding.

David Gober - Morgan Stanley

Great, and then just a follow-up on the gross margin side, it looked like there was a pretty significant improvement from 1Q. HSN had talked a little bit about the fact that they saw an improvement in gross margins because of lower shipping and shipping costs, primarily because of the declining gas prices. Did you guys also see that in the quarter or was it -- was the gross margin improvement more due to mix shift?

Mike George

For us, it was primarily -- it wasn’t -- the mix issues have continued to be a negative drag on gross margins, so for us it was a combination of a few things. We definitely saw improved freight costs. Given the nature of our contracts, I wouldn’t put that primarily on gas pricing but we did a number of things to better optimize our freight net worth. We really did some creative initiatives that will have long-term benefits in terms of how we distribute our product. That was part of it and part of it was our warehousing costs are part of gross margin and we saw a very nice increase in the productivity in the warehouse. I think we’ve done a much job of variable-izing our labor costs and tying it more tightly to our shipments, along with other initiatives in warehouse.

And then part of the improvement reflects the decline in the churn rates and in the relative margins on returns versus the stuff that went out the door and just the mix between returns and original shipments also helped lift product margins.

David Gober - Morgan Stanley

Great, and I just had one follow-up on Doug’s question on Starz in terms of the renewals there -- any read through or any change in the structure of most of those deals? I mean, in the past there’s been a mix of fixed rate agreements versus variable. Has that changed in any of the negotiations or do you foresee that changing going forward? Or should the mix be relatively consistent going forward?

Greg Maffei

For the deals we’ve just completed, they basically have stayed pretty much the same so I don’t project that that mix is going to change significantly. I mean --

Greg Maffei

The only thing I would say is if it’s not a change in those deals but frankly the consignment companies have had faster growth than the fixed companies, so in that sense there’s a mix change -- not in the structure of the deals.

Bill Meyers

From a structure perspective, we don’t see them moving that much but we are really doing well. If you actually dug in and can see the details of our numbers, we are doing very well with our consignment customers today and we are seeing some softness in the number, it happens to be in some of our fixed rate deals, which our deal structure is protecting us and mitigating some of that risk.

David Gober - Morgan Stanley

Makes sense. Great, thanks, guys.

Operator

Our next question will come from Jeffrey Wlodarczak of Hudson Square Research.

Jeffrey Wlodarczak - Hudson Square Research

Two questions for Greg -- first on the potential swap of Starz Media and Liberty Starz, is the intention to do that fairly quickly after the LEI DTT merger closes? And that’s an internal swap so I assume there’s no tax ratifications.

And then second, any color you can give us on a potential transaction with Time Warner involving AOL and how that could theatrically be structured. Thanks.

Greg Maffei

On the first one, we have no current plans to move Starz Media out of Liberty Capital. I think it was noted by Bill -- we have a very consistent growth pattern of earnings which is a -- should appeal to a publics security at Starz Entertainment. Starz Media has -- is in a start-up phase and has a very bumpy pattern, depending on how much P&A and what’s released and the like and it sits today inside Liberty Capital, which is really an asset company, not an earnings driven company, not an EBITDA growth story the way that we believe Liberty Starz is.

So I think one of the questions is how is it best configured and over the long-term, how do we grow that business at Starz Media and then at some point, does it make sense to combine more with Starz Entertainment. But I don’t think that stands today as the right strategy.

Secondly, we have a lot of basis in that to actually -- how we structure that, we might actually not want to have it be a tax free deal. We’ll see what time holds.

On an AOL deal, as I think I was asked before, we have a productive relationship with Time Warner. We’ve already done one 355 exchange with them. We hold a bunch, around $800 million of TWX stock today. If there were an asset that were attractive that they were a seller of, we would certainly want to look. AOL could be that but could be something else too. AOL in particular might have some tax attributes -- they are attractive as well as being an interesting story.

Jeffrey Wlodarczak - Hudson Square Research

Thanks. If I could ask one follow-up -- as much as you can, can you shed any light on the delay in getting the LEI DTV proxy approved to the SEC? Because I think you were supposed to get approval by today or you have to drop in new numbers -- [I think that’s the case].

Greg Maffei

There are two things there. One is just negotiating with them about the structure of the transaction. At some point, the numbers go stale. So the time passed when working through the proxy we did go to the stale numbers and needed to drop the new ones in, so that is -- there are in effect two sets of delays, right? It took longer to get the discussion done with them and then once it took longer, kicked into needing new numbers.

Plus it’s as complicated as there’s two proxy statements that are having to get processed through the SEC.

Jeffrey Wlodarczak - Hudson Square Research

Thanks very much.

Operator

Our next question will come from Douglas Anmuth from Barclays Capital.

Douglas Anmuth - Barclays Capital

Thanks for taking the question. A couple of things for Mike -- first I just wanted to follow-up on the return rate, which I think at 17.3% was the lowest it’s been in several quarters. Can you talk more about the key drivers here beyond just the sales mix? You mentioned some other initiatives here and I’m curious about the sustainability going forward.

And then also, if you could comment on the linearity of the quarter in the U.S. and the international markets and perhaps what you are seeing here early in 3Q? Thanks.

Mike George

Sure. On the return rates, I would say that the mix was a large driver, as we shift mix more to electronics, beauty, home categories, which all have a much lower return rate than jewelry. We are also very focused on a corporate wide initiative to continue to strengthen product satisfaction and quality. We think it’s already quite high but we are trying to take it another level beyond that and there’s a variety of initiatives in that, everything from working on apparel sizing and education to improving jewelry, quality, a number of things I won't go through all the details but we do think that will yield benefits over time.

Now I’d also tell you that to some extent, the [green] improvement in this quarter is a little overstated versus sort of what the underlying business because as you know, part of the way you do returns is you are trying to estimate what returns are going to be going forward, since people have months to return the items and you are making estimates. And so a little bit of this is also kind of just a truing up of estimates, I think somewhat exaggerated to the degree of improvement. But nonetheless, we do think the improvement is real and we would expect to see continued improvements in returns going forward as we look at the mix of business as well as these quality initiatives, our expectation is we will see good [guys] in returns going forward.

In terms of commenting on Q3, we don’t -- you know, our policy is not to comment on in-quarter results. Obviously we saw in most markets very healthy sequential improvements between Q2 and Q1, so we feel good about the momentum. We feel good about the product mix and of course we are also coming into much easier comparisons and that obviously helps on the margin, to be comparing against softer numbers in the back half of last year.

Douglas Anmuth - Barclays Capital

Okay, great. Thank you.

Operator

Our next question will come from Bridget Washa of J.P. Morgan.

Bridget Washa - J.P. Morgan

A quick question on Liberty Interactive -- earlier you said most of the growth was coming from existing customers spend more, which I believe has been a trend over the last couple of years. At some point though you are going to need to seed the funnel with new customers and now it seems like you have great opportunities with so many businesses having gone bankrupt. What are you doing to drive new customer acquisition growth?

And then the second question is I know you said earlier that you were pushing back many of the costs associated with QVC Italy into 2010. Can you give us anymore detail about when you expect to recognize costs and about how much? Thank you.

Mike George

On the new customer front, we do think we have a lot of opportunities to grow the customer base. And as we’ve discussed in prior calls and meetings, we focus less on the absolute count of new customers and more focused on quality of customers, so we are kind of very surgical right now about looking at those businesses, those categories that tend to attract new customers that are highly profitable customers who are likely to be loyal to QVC and continue to invest in those kinds of businesses and continue to invest in creative marketing initiatives, platform initiatives to reach them.

So for example, this major partnership with Isaac Mizrahi who has a very devoted following, who had extraordinary success when he decided to go to Target and make his aspirational products available there. He obviously exited Target a while back. We think there’s a whole lot of folks that know Isaac and will be excited about the things he is going to do for us which we think are truly breakthrough and we see that as a great way to get new customers.

We are launching a very exciting accessories product line with Rachel Zoe in September. She has a very hot reality series on Bravo. She’s one of the leading stylists in the country. We think that that Bravo audience will be excited to see what we are up to.

I’ll give you a real, kind of immediate example but it just reflects the kinds of things we are trying to do -- on Sunday, if you tune into VH1, you will see a simulcast of QVC on VH1 as we lead the market in launching the remastered Beatles catalog, as well as Beatles for Rock Band. Really exciting, really fun, I think we’ll get a lot of new customers on our channel but we’ll get a whole VH1 audience that probably isn’t buying at QVC right now to see what we are up to.

We are really focused on social media, continue to do more and more with Facebook and Twitter in particular and we think that’s extending the word of mouth. And so for us, it’s about having the kinds of categories that appeal to new customers, whether that’s entertainment or beauty and it’s about being creative about how to get our word out on other platforms, whether it’s the VH1 example or social networks and we have a number of initiatives like that in the works.

Greg Maffei

I would add -- I think that those are all excellent initiatives. In addition, we have had a case where every few years we had been introducing an international, new international subsidiary and there’s been a delay. Italy will kick in, Mike’s going to talk about the costs but in effect adding a new younger mix of business, not necessarily -- I know you were focused probably on within each business but adding a new one is a good growth perspective on new customers as well because you want to have ones which have not yet reached scale entering into the funnel and so we talked about Italy. Obviously we’ve also talked about trying [new things] in places like China. I think that’s going to be an important part of the initiative for growth going forward at QVC.

Mike George

And on the Italy launch, we are beginning to ramp up. We expect that most of the costs, as you mentioned, will start to kick in next year. We’ll have modest costs throughout this year as we begin to add staff and build out the facility and so forth. But they will be immaterial in the scheme of things.

I don’t know that we are prepared right now to talk about a next year number. You can certainly get insight by looking at the year one launch in Japan, which is our most recent market and what kind of EBITDA or what kind of expense hit we took in year one. And I would tell you that we don’t expect it to be all that meaningful on the total EBITDA base of the company, so we don’t see it as something that’s going to have a material impact on the total EBITDA delivered in 2010.

Bridget Washa - J.P. Morgan

Great. Thank you so much.

Operator

Our next question will come from James Ratcliffe of Barclays Capital.

James Ratcliffe - Barclays Capital

A couple of questions -- first of all on -- looking forward to 2010 for Starz, given what you’ve been seeing in terms of box office performance from your studio providers, any read on what we are likely to see in terms of programming cost growth? And secondly just are -- should we still be assuming that you will have to pay out cash taxes when the Sprint hedges mature?

Bill Meyers

Well, 2010 is a little hard to look at right now because we still have a lot of titles that haven’t been released, so it’s hard for me to give you kind of a view of that is. We need to wait a couple of more months to just see where we’re at on those.

Greg Maffei

And as you know, James, it’s not only the scale of the titles, it’s the number of the titles and so if certain things ship during the quarter, Q3 or slip past Q4 into 2010 will impact, so there’s a bunch of variables.

Bill Meyers

So it’s a little bit early right now to kind of have a view of that.

Greg Maffei

And on the Sprint collar, our hope is that we would defer that tax.

James Ratcliffe - Barclays Capital

Right. Thank you.

Greg Maffei

That’s our expectation.

James Ratcliffe - Barclays Capital

Your expectation?

Greg Maffei

Yes.

James Ratcliffe - Barclays Capital

Okay, thanks.

Operator

Our next question will come from Matthew Harrigan of Wunderlich Securities.

Matthew Harrigan - Wunderlich Securities

Good morning. First of all, as far as Overture goes, you’ve really got a lot of open playing field now, given everything that has happened in the private equity side, the film financing, et cetera. I know the exhibitors are clamoring for more product. Is that something that just makes Chris [McGurk’s] like a little bit easier or is that something that is really funneling into your business plan at this point, given that there’s a bit of a gap there.

And then secondly on the GSN and fun technology side, I mean, those businesses are subject to a lot of the network effects that Michael [Zisner] likes to talk about and they really helped your e-commerce businesses. I know that you are trying to graft on to QVC. Can you talk a little bit about those businesses? I mean, it seems like they are -- or GSM, it seems like it is going to get a little bit lost over DIRECTV, I mean -- and in hindsight, is that something that you almost regret moving over there, given that it has a pretty nice growth opportunity to -- that and fun?

Greg Maffei

Sure. So on Overture, I think obviously there are a bunch of factors you noted. The changes in the film financing market and the like which help any entrant in the film business. There are also a bunch of factors to make the film business harder these days and probably the most prominent of which is the decline of DVD, particularly anything where you have library if it doesn’t hit it initially out of the blocks closer to the day-in-date drop, it’s really not hanging well. And a lot of things that have gone on structurally in the channel -- the absence of bins at Walmart and the like, all those things have reduced the DVD market post the initial drop.

When you look at that market overall, Overture has got a bunch of advantages because of Starz and where it is playing and it’s got a bunch of challenges and I think you’ve seen that candidly in the first year’s release as you try and get up to scale. It hasn’t necessarily delivered on as much as we would like. On the other hand, it has had some successes and I think if we look at the lineup ahead, there is reason to be optimistic.

I would also say we have a plant there in terms of our Anchor Bay distribution, our theatrical distribution at Overture, and the ability to take in the pay slot at Starz, which is probably under-utilized and one of our goals in 2010 will be put more product through there. One way or another, not necessarily all of which is ours but which we can partner with and probably take less risk of it, fulfill potential in the plant.

At GSN Fun, we are very sad to see it go because it’s a great business. It certainly had its challenges on the GSN side and the overall advertising market right now. Ratings are pretty good. They’ve done some really innovative stuff, David Goldsville and his team, on the programming side and that’s just getting up to speed but they are still exposed to the overall ad market, you know, general ad market and they have a lot of DR, which may be a little less vulnerable but they still have challenges.

On the Internet side, they have grown considerably and will and we love that business and what they are doing and I think they are right to note the potential for network effects. The hope would be and the expectation would be since our shareholders will be a significant majority percentage of the -- and in fact the majority of the shares at DIRECTV that DIRECTV can take that asset and drive it even further than we could using some of its distribution strength.

Matthew Harrigan - Wunderlich Securities

Thank you.

Operator

Our final question will come from Murray Arenson of Janco Partners.

Murray Arenson - Janco Partners

Thanks. I wanted to follow-up a little bit on what Matt was asking on the production side -- if you could talk a little bit more maybe with respect to the original series and give us the context for what budgets look like there and timing of that. I am particularly interested in the Spartacus piece, since that sounds like kind of movie product quality.

And then secondly if Greg, you could just offer some more color on the tax sharing payments that were referenced relative to Liberty Capital?

Greg Maffei

Let me if I could talk a little bit about the original series first and let Bill and anyone else fill in -- I think one of the things that has had some beginning critical success with Crash, the back half of Crash, how it did through the back half of its first season and how Party Down has done is we’ve had some critical success but have not actually driven as much audience yet as we would like. And this is a learning process and it is a process that took HBO probably 10 years. We hope not to be quite as long in the learning style but I think Spartacus in particular is going to have impact and someone described it as Gladiator meets 300, but you might be able to throw in meets Caligula. It’s going to be very graphic in a lot of fashion, both violence and sex and I think it’s going to open a lot of eyes. There are a lot of Lucy Lawless fans who are going to be very excited to see the series just for that.

And I think it will have impact and it’s a great learning experience and I think it will be very well-received. And those original series are an important part of creating the right mix of movies and originals at Starz, which I give credit to the team for doing.

Do you want to comment on the cost side, or anything else?

Bill Meyers

I think your point that Spartacus looks a lot more like movie kind of quality, clearly we have pushed ourselves to take account of a product that we really like and a story that we really like and put the best product on the screen and Rob Tappert and Sam Raimi are great at that. You know, the cost of that is kind of on -- you know, consistent with what you would see with a lot of original dramas on kind of that $2 million to $3 million an episode type of world. And we are very pleased with that product. As Greg said, it is getting a lot of publicity right now and notoriety. Lucy Lawless has a great following. At ComicCon, we couldn’t keep enough -- we didn’t have enough room as she was there and we think it’s a great story. And that’s what we have been trying to do is put really high quality stories with the best product we can put on the screen for the money and really drive customers. And it’s -- you know, we’ve come a long ways in two years. I’m with Greg -- I hope it’s not a 10-year, 12-year event but we are very pleased with it and it’s coming out in January, so --

Greg Maffei

The e-water cooler buzz about Spartacus is enormous.

Bill Meyers

And not just domestically -- it’s also international. I mean, we had several of the big broadcasters in the international market who already are interested in buying it just off the trailer, so we know we have the right story and it’s something that you have not seen on TV before and we are very pleased with it.

Greg Maffei

And obviously you must be a Lucy Lawless fan, asking that. Maybe you could help me understand exactly the nature of the tax question LCAPA because I am not sure I followed you.

Murray Arenson - Janco Partners

Well, I was just referencing in the press release the tax sharing payments between the -- the inter-group tax sharing payments?

Chris Shean

I can handle this -- Liberty Capital of course is the provider of tax shelter to the other two groups who generate taxable income, and for the six months the interactive group paid $138 million to capital and the entertainment group paid $117 million. So a total of $255 million of cash going back to capital for their tax shelter.

Greg Maffei

So in effect, rather than pay the U.S. government, the shelter is created by Capital, Interactive and Entertainment pay Capital and any future liability becomes Capital’s.

Murray Arenson - Janco Partners

Understood. Excellent. Thank you.

Greg Maffei

Thank you very much for joining us this morning and again for your continued interest in Liberty and thank you to all the participants.

Operator

This concludes today’s Liberty Media Corporation quarterly earnings conference call. Thank you for attending. Have a nice day.

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Source: Liberty Media Q2 2009 Earnings Call Transcript
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