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DIRECTV Group, Inc. (NASDAQ:DTV)

Q2 2007 Earnings Call

August 9, 2007 2:00 pm ET

Executives

Jonathan Rubin - Investor Relations

Chase Carey - President, Chief Executive Officer, Director

Michael W. Palkovic - Chief Financial Officer, Executive Vice President

Bruce B. Churchill - Executive Vice President; President, DIRECTV Latin America

Analysts

Vijay Jayant - Lehman Brothers

Jonathan Chaplan - JP Morgan

Anthony Noto - Goldman Sachs

Spencer Wang - Bear Stearns

Qaisar Hasan - Buckingham Research

Ben Swinburne - Morgan Stanley

Jason Bazinet - CitiGroup

Doug Mitchelson - Deutsche Bank

Steve Mather - Sanders Morris Harris

Tom Eagan - Oppenheimer

Tuna Amobi - Standard & Poor’s

Presentation

Operator

Good afternoon, ladies and gentlemen. My name is Pam and I will be your conference operator today. At this time, I would like to welcome everyone to the DIRECTV second quarter 2007 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Jonathan Rubin, Vice President of Investor Relations. Sir, you may begin your conference.

Jonathan Rubin

Thank you, Operator and thanks, everyone for joining us. With me on the call today are Chase Carey, our President and CEO; Mike Palkovic, CFO; Bruce Churchill, President of DIRECTV Latin America; and Larry Hunter, our General Counsel.

In a moment, I’ll hand the call over to Chase and Mike for some introductory remarks but first I am obligated to read to you the following: on this call, we make statements that may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors that could cause actual results to be materially different from those expressed or implied by the relevant forward-looking statements.

Factors that could cause actual results to differ materially are described in each of the DIRECTV Group’s and DIRECTV U.S.’ annual reports on Form 10-K, quarterly reports on Form 10-Q and our other filings with the SEC, which are available at www.sec.gov.

Additionally, in accordance with the SEC’s Regulation G that requires companies reporting non-GAAP financial measures to reconcile these measures to the most directly comparable GAAP measure, we provide schedules for the non-GAAP measures. These reconciliation schedules are attached to our earnings release and are posted on our website at directv.com.

With that, I am pleased to introduce Chase.

Chase Carey

Thanks, John. Good day and thanks for being on the call. I thought our second quarter was a solid one. We displayed continued strength in some key areas like gross sub adds and ARPU growth and began to make some real progress in key areas like churn and service costs. That progress really was not apparent in the Q2 results but I think really will become more visible in the next quarter or two.

One trend I would like to spend a minute on and note for Q2 was an increased demand for advanced products, essentially DVRs, HD and HD DVRs, and this is really true among both new and existing subscribers. I guess to give you a little color on that trend, if you take the number of new customers taking an advance product in Q207, it was more than 70% greater than those that were taking it Q206.

Probably two other advanced product trends I’d note first, while overall advanced product demand was strong, it was particularly strong for the HD DVR, again just to give you a sense of it -- the number of existing customers upgrading to an HD DVR in Q207 was up almost four-fold versus a year ago.

The second thing I would like to note is that what we are finding is that more households are taking more than one advanced product. I think as DVRs and HD become a more mainstream product, we are seeing an increasing trend for households to look for more than one in a home.

We do view this advanced product growth as positive, as we generate incremental revenue, as we said. We have lowered churn and really, probably as important as anything, better customers with a renewed commitment to DIRECTV and we do really look at it as a value-creating investment in our customers.

We continue to be successful in driving down the cost of that investment. Between now and year end, the HD DVR box cost will decrease about $100 per box. The HD box cost will reduce about $50 per box before year end, and then in the first half of 2008, we’ll take another step down in those box costs. So it’s an investment and it’s an investment we are continuing to manage and it is certainly again, we think very much an important value-creating investment for us.

Regarding our reported Q2 results, I thought our revenue and operating profit were solid. As I noted a minute ago, ARPU growth was strong in the second quarter. This was helped a bit by a big pay-per-view fight in May. It was largely attributed to fundamental strengths like the advanced product penetration.

Our strong gross adds showed our continued competitive success in the marketplace. We were up year-on-year in terms of gross adds and I think it showed the continued and in some ways growing strength of our ability to compete in the marketplace with the DIRECTV proposition.

I don’t think we made enough progress in key areas like churn in Q2, but our month-to-month results do show real progress, as I said up front, and I believe this progress will become more visible as we go forward.

Retention and upgrade spending was down significantly from the first quarter of ’07, yet still up materially from a year ago, Q206. This year-on-year increase is due entirely to increased demand for advanced products, as well as MPEG-2 swaps, which were up about $20 million from a year ago.

Before turning the call over to Mike to give you a bit more detailed comments on the quarter, I want to quickly mention or touch on our Latin American business, which we thought really had a very strong quarter. In fact, the net subscriber additions in the second quarter were greater than in the U.S. The strong subscriber growth was driven by a 72% increase in gross adds to 260,000 and a large reduction in monthly churn from 1.46% last year to 1.38% this year.

Most of this improvement came from Brazil, where we are reaping the benefits from the merger with Sky Brazil. We did also get some really solid subscriber growth from other countries like Venezuela and Colombia.

Including Mexico, we now have over 4.4 million subscribers in the region, the Latin America region as a whole. Revenues and operating profit before depreciation and amortization were also very strong, due again first and foremost to the Sky Brazil merger and then region-wide subscriber growth.

Finally, cash flow before interest and taxes is about $80 million for the first half of the year in Latin America, tracking better than planned, primarily due to strong operating results.

With that, I would like to turn it over to Mike and I’ll come back and make a few comments looking forward to the rest of the year.

Michael W. Palkovic

Thanks, Chase. As you just heard, the rapid growth in consumer demand for HD and DVR services is having a material impact on both our top line and bottom line results. We are getting the desired economic benefits from these advanced services in terms of better ARPU, margin and churn, but at the same time we are also investing additional dollars to upgrade our customers’ homes.

These benefits are particularly evident when looking at DIRECTV U.S. revenues, which increased 12% to over $3.7 billion. Much of this increase was due to strong ARPU growth of 6.8% to $76.43, representing one of our best growth rates in years.

In addition to the usual ARPU growth we get from annual price increases, we are also getting a strong contribution from the rapid increase in HD and DVR sales. For example, in the second quarter we added about 50% more new HD and/or DVR subscribers than a year ago and unlike some companies in our industry, we are continuing to see strong growth in ad sales, which were up 30% over last year.

The same holds true in terms of subscribers, where the improvements in gross subscriber additions and churn reflect favorably on both our competitive strength in the marketplace and higher advanced product sales. We now have well over 5 million HD and/or DVR subscribers, about 35% of our base. In the second quarter, around 40% of our gross adds purchased advanced services.

Also contributing to the increase in gross adds was the continued strong performance from our direct sales group, which attained a 30% increase in gross adds compared to the prior year, representing around 40% of our total gross adds in the second quarter.

In addition to the strong advanced products and direct sales, our telco partners also had solid numbers in the quarter.

In terms of our monthly churn rate of 1.58%, although we are pleased to see that our overall churn continues to decline despite the increasingly competitive environment, we had expected a faster reduction in churn. Fortunately, voluntary churn is meeting our expectations. However, involuntary churn remains too high. To address this, we are implementing several new initiatives. Some of these were made in the second quarter and we are already starting to see some of those benefits.

As we’ve said in the past, fine-tuning our credit policies is an ongoing process and you can expect to see even more changes in the future as we strive to further reduce the number of low quality subscribers on our platform.

Moving on, operating profit before depreciation and amortization was up 9% to just over $1 billion. OPDA margin of 28.5% was down about a point from a year ago, due in large part to the increase in both new and existing subscribers upgrading to HD and DVR services, and in particular upgrading to the HD DVR combination receiver.

Also included in our retention and upgrade expenses were higher costs of about $30 million for MPEG-4 swaps compared to only $10 million a year ago.

I’ll remind you that for customers upgrading to an HD DVR, we continue to charge an up-front fee of $299 and require a two-year commitment. These investments remain a high priority for us because even compared to a standalone HD or DVR customer, we continue to earn higher returns from households with an HD DVR due to their materially lower churn and higher ARPU. These subscriber returns will get even better when later this year we get the cost reductions Chase referred to earlier.

In addition to upgrade and retention costs, programming costs were also higher in the quarter, mostly due to a few contracts that we mentioned earlier in the year relating to Fox News, the NFL Network, and Showtime.

One other quick note before moving on to cash -- you may have seen in the press release that we collected and booked a $25 million gain for the settlement of several hurricane related insurance claims. The gain was booked in G&A and explains why G&A costs for DIRECTV U.S. were lower this year compared to the prior year.

Looking quickly at our cash and balance sheet, the DIRECTV Group generated a bit over $300 million in cash flow before interest and taxes in the quarter, and about $200 million in free cash flow. On a consolidated basis, the main use of cash in the quarter was for the repurchase of almost 26 million shares for $596 million.

Also in the second quarter, we had capital expenditures of about $660 million. This includes DIRECTV U.S. CapEx for set-top boxes of $335 million compared to $253 million a year ago. We ended the quarter with net debt at the corporate level of $1.4 billion.

With that, I will turn the call back to Chase for some closing remarks.

Chase Carey

Thanks, Mike. Looking toward the second half of 2007, clearly our headline event will be our launch of really what will be the best and largest selection of HD channels that customers ever imagined, which will really enable us to leapfrog our competition. Everything is going well with our new satellite, which launched about a month or so ago.

Today we have agreements in place with about 90 channels, and continuing to work on more so we are adding to that. We will launch with an HD package with over 70 channels around the end of the third quarter. Again, the difference there is some of the channels need a couple more months to get their HD stream online, and we do expect over the coming months, between the end of the third quarter and the end of the year, we’ll get to the 100 channels that we talked about. So we will launch with really a fabulous HD package, the 70-plus channels and then over a couple of months build to the 100 channels that really we think will define us in a unique way competitively in the marketplace.

The other major content event during the second half will be the launch of our initial VOD offer in the fall. This VOD offer, which will use both the hard drive and broadband connection, and will be we think really will be a truly distinctive and exciting new feature. We believe customers will find its easy-to-use characteristics, which is something we focused a lot on, and attractively packaged offering will really be uniquely attractive and differentiated from others out there.

Financially, the only real change in our outlook for 2007 is due to the higher-than-expected demand for HD and DVRs. It now looks like we’ll finish 2007 with over 40% of our customer base with some type of an advanced product.

Financially, this will have a couple of implications. Revenue and ARPU will be higher than we planned. SAC will still be in our $650 to $700 band that we’ve talked about but probably in the upper half of that band. Second half retention spending will probably be close to first half retention spending, although the second half will include some increased spending on MPEG-2 conversions, and DIRECTV U.S. cash flow before interest and taxes will probably be closer to 2006 than up to the extent expected as we invest in up front in that advanced product and hardware for new and existing customers.

Overall, we feel really good about where we sit today. We have some exciting new features like the HD coming. We’ve got some of our building block initiatives behind us, like the new set-top boxes we launched in 2006, so I think we’ve really got the foundation in place that we’ve looked to build over the last year plus. And we are really beginning to make, to execute in some of the key areas like churn and, probably as important as anything, delivering a higher quality service at a lower cost to our customers.

There is no question it’s an increasingly competitive marketplace but we really feel good about where we are positioned and think we’ve got a lot of wind at our back as we go forward competing in the marketplace.

Before I close and turn it back to John for questions, I do want to note that we finished the $1 billion share buy-back we began in March. We finished that in the last few weeks. We announced today a new $1 billion buy-back, which will enable us to continue to take advantage of our low DIRECTV stock price that we clearly do not feel comes close to reflecting the value of our business.

We recognize this buy-back does not answer the larger issues around our balance sheet and growing cash flow but as we said before, we believe it is important to make those decisions with our long-term shareholders in place. However, as we wait on the News Liberty transaction approval, we do want to make sure we take advantage of our under-valued stock.

With that, I’ll turn it back to John for your questions.

Jonathan Rubin

Thanks, Chase. Before moving on to Q&A, investors should note that we have members of the media on this call in a listen-only mode. I would like to remind the media that they are not authorized to quote any participants on this call, either directly or in substance, other than the representatives of the DIRECTV Group. In addition, we are webcasting this call live on the Internet and an archived copy will be kept on our website.

Operator, we are ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is coming from Vijay Jayant with Lehman Brothers.

Vijay Jayant - Lehman Brothers

Good afternoon. If I could, two questions; first, there’s been some comments made by Liberty that there’s been increased cooperation between Dish and DIRECTV and you are working on a lot of different initiatives. If you could drill down on what they are, what the scope of the savings or value creation of that could be.

Second, Chase, in the last conference call you mentioned that there was the prospects of developing an integrated box that would work in BellSouth and/or Verizon territory. I haven’t heard anything on that front, the home box for Dish. Could you give us an update on that please? Thanks.

Chase Carey

In terms of Dish and DIRECTV, I’m not sure there’s a whole lot of insight to give. We have been talking to Dish, certainly not just the last few quarters but the last couple of years. We’ve done a few, we’ve done some things that we haven’t -- we back all -- a fair number of standard def signals to get today. We’ve talked about some areas like ad sales and I think we continue to work through those issues. I don’t think there’s really a -- I think Liberty sees the opportunities. We see the opportunities. Clearly there are issues as you -- in any one of the arenas that we could work together, you have to figure out what does it means to each of our businesses.

I don’t think this is a dramatic change and I think it’s really just part of an ongoing process. I think we’ll be opportunistic in looking at an array of places that, whether it is -- and there obviously is a lot of -- are a lot of areas in theory we could, but in some of them there are issues you have to deal with in one or the other businesses to make it happen.

I think both us and Dish have tried to approach those intelligently and make sure that on one level we recognize fully we are very aggressive competitors with each other in the marketplace but to the degree there are places we can take advantage of economies that provide both of us savings, we’ll do so.

It is tough to quantify. I think it is really -- I think we have a pretty good handle of the areas and I think we will continue to try and work through them.

In terms of set-top box, we are certainly working through -- we are actually working with, continue to work with some of our partners in terms of that set-top box. We actually -- it is a box that we are talking about deploying in the marketplace, certainly in the short-term. It is very much a part of our roadmap of both moving towards a box, a single box that could integrate broadband and satellite delivery to the home, as well as the generation pack, which is a box that really provides the whole home experience for all the devices in the home.

I mean, the set-top box exists today so it is really working through some of the software and working through some of the distribution issues with some of our partners. But I think from a technological perspective, the box is really a box we could deploy in the next quarter. So it is really more probably the logistics around the distribution of the box with the appropriate partners to make it happen.

But our boxes are going to have, like VOD, which we are launching in the next couple of months, will in essence have broadband connectivity to it. We have set-top boxes that can integrate a PC and a TV today.

In many ways, the technological and software issues around it are largely there. It is really probably more working through the business issues around distribution with an array of partners.

Vijay Jayant - Lehman Brothers

Thank you.

Operator

Thank you. Your next question is coming from Jonathan Chaplan with JP Morgan.

Jonathan Chaplan - JP Morgan

Thanks. A couple of quick questions, if I may. Firstly, it seems like I’m not exactly sure when the share repurchase program kicked off but it seems like to be done, you’d have to have done $300 million in share repurchases in July. I just want to confirm that that’s the case.

And then I’m wondering, of the ARPU increase, how much of it came from the sell-through that you guys have been seeing in HD and in DVRs? I’m wondering if you can break out that impact versus the rate increases.

Finally, just in follow-up to the last question with the hold-ups that you are having in getting a home zone type product out there, when you say it is more to do with issues around distribution partners, do you mean your ILEC distribution partners? Is there something that is being held up based on your discussions with AT&T while they figure out what they are going to do in the BellSouth footprint and the AT&T footprint in terms of who they partner with? Thanks.

Chase Carey

In terms of the -- what was the first question? The share buy-back, we are through and I’m not going to break out July versus August day by day but yes, whatever was left that we reported, we got in the statements that was reported as left at the end of June, we finished before today. So we are through that buy-back, so that’s correct.

In terms of breaking out ARPU, I think -- I don’t think we really -- that level of detail is probably not ones that we would love to publicly share them. It gets to be competitive information about it. I mean, there’s no question it’s a factor in the ARPU growth but I don’t think we are going to provide factor by factor breakout of what is comprising ARPU and what are they but there is no question advanced products were a meaningful part of it.

In terms of set-top box, I think it is wrong to look at it as being held up. There are -- we are going forward with it. It’s not an AT&T issue. We have partners. We have Quest, we have Verizon and continue to talk. A lot of it is sort of logistics and it’s a different way of doing business. I think we’ve got a lot of customers in a lot of places and big organizations and you work through those intelligently.

I don’t think it’s a -- it’s not an AT&T issue and realistically, it’s not a hold-up issue. It’s really working out the logistics and terms and practices you need to deploy to make it happen.

Jonathan Chaplan - JP Morgan

Thanks, Chase.

Operator

Thank you. Your next question is coming from Anthony Noto with Goldman Sachs.

Anthony Noto - Goldman Sachs

Thank you very much. Chase and Mike, it was mentioned in the call that 40% of your gross adds came from the direct channel. I was wondering if you could let us know what percent of your gross adds have come from the RBOX relationship channel and potentially how the other 60% of the gross adds, what channels they came from. Thanks.

Chase Carey

I guess in a general sense, the RBOX have been probably generally within the 20% to 25% range, I would say for the quarter. They were more in the 25% range but that’s sort of where they are, and then probably the next sizable, or rather the only other really sizable block are third party dealers, and then you get an array of smaller factors like national consumer electronic chains and the like. But your three primary ones would sort of be the direct, the RBOX with that 20% to 25%, and the dealer channel, or third party dealers.

Anthony Noto - Goldman Sachs

One follow-up question; have you seen any impact on your gross adds from a slowdown in home starts?

Chase Carey

I think it is a factor. I’d call it a factor at the margin. It is certainly not one you could track to or really end up saying it cost X subs. I think it is the dynamic in the market but I would really say it is for us a dynamic in the margin when we look where customers are -- I guess we do look, we track to do research on where our customers are coming from and certainly if you looked at that array and through what channels, you wouldn’t end up seeing anything that was sort of a meaningful shift versus what we’ve seen in terms of where we are -- you know, competitively where we are getting our subs from.

I do think probably more just from a gut instinct perspective than something that I could track through to the numbers, I think it is one of an array of factors but I do think it is one at the margin.

Anthony Noto - Goldman Sachs

Thank you.

Operator

Thank you. Your next question is coming from Spencer Wang with Bear Stearns. Please go ahead.

Spencer Wang - Bear Stearns

Thanks. Good afternoon. So my first question is Chase, as you roll out HD more broadly in the second half, should we expect an acceleration in your programming cost growth as that happens?

The second question I guess is for Mike; I believe your ’07 CapEx guidance is $2 billion. I think you are running about 15% higher than that on an annualized basis through the first half. Could you just update us on what you think that -- if that’s still an okay number for the year?

And then at DIRECTV Latin America, there seems to have been a little bit of a spike in CapEx in the quarter. Was it just a one-time thing or if you could just give us some clarity there. Thanks.

Chase Carey

In terms of HD rollout, it will not have an impact. We are looking to get the HD channels as part of what we would expect as part of a relationship on the standard def channels, so we do not -- we will not have a programming cost increase related to HD.

On CapEx --

Michael W. Palkovic

Yes, the increases we talked about with respect to HD and HD DVR will probably move that number up slightly. Instead of the $2 billion range, it might go up 5% or 10% above that. That’s kind of the range. It’s not significant.

In Latin America, you’ve got -- we had two things going on there but I probably ought to defer to Bruce on this but I think there’s a timing issue with how they buy their boxes and there is also the increased demand that you are seeing in the subscriber numbers that is probably driving the number up a little bit. But if Bruce wants to elaborate more, then he should do that.

Bruce B. Churchill

You’re correct, Mike. It’s really just CapEx related to SAC.

Spencer Wang - Bear Stearns

Okay. Thank you.

Operator

Thank you. Your next question is coming from Qaisar Hasan with Buckingham Research.

Qaisar Hasan - Buckingham Research

Thank you. I was wondering if you could elaborate a little bit on your expectations from the Clearwire partnership that you announced a few weeks ago. Since then, obviously they have announced a roaming partnership with Sprint as well. I was wondering if the agreement automatically carries over into Sprint markets or whether that is a separate agreement that you need to reach with Sprint itself. And secondly, just how this partnership potentially impacts your appetite for participating in the upcoming 700-megahertz auction. Thanks.

Chase Carey

Well, I guess the latter, I don’t think it affects it a whole lot. I think we will judge that on its own merits.

The Clearwire relationship is very early stages. We think WiMAX has the potential to be a growing force in the marketplace. To the degree there are opportunities with Clearwire, we look to take advantage of them and they haven’t really gotten that far. They’ve announced the arrangement with Sprint which will enhance their ability to create a wide WiMAX offering. We are obviously always going to be a compatible partner as in fairness is Echostar. To that, we’ll take advantage through the opportunities there.

I think it will take time to tell how fast and what happens with the Clearwire business. I mean, WiMAX does -- if you look at broadband, I think there continues to be attraction to wireless broadband. We would like to see it grow. I think it has the opportunity to compete effectively because it obviously offers something the existing players don’t, which is mobility.

I think as everything else gets commoditized to broadband and players struggle there, I think they are going to look for differentiation. Probably at the top of the list is mobility and to the degree that can get some traction but I think it will take some time.

But we will -- we’d look to be opportunistic and take advantage of it and drive it in whatever ways make sense for us. But I think it is awfully early days to make any statements. We are really just at the starting gates in terms of trying to even working through some of the logistics on our own end to bundle an offer to Clearwire. And the Clearwire service will enhance itself.

Qaisar Hasan - Buckingham Research

I realize it is early days but do you think in its current shape, you principally are using Sprint simply as a resale for their broadband Internet access and voice services, or do you eventually think that it could include enabling some of your video set-top boxes for two-way on-demand capability as well through the network?

Chase Carey

I think you want to look at everything. Again, I think it is pretty -- I would not want to get into at this, you know, at this early a stage trying to create roadmaps that end up having, implying there’s some grand roadmap here other than one that as this entire technology works out, that will work to -- we could do all of that. I think we have to see what the, how the market evolves, how the appetites evolve, what other types of content, products evolve and how we go forward. We certainly have the capabilities but I think it is probably premature to be trying to hypothesize what an end game or what it looks like in a more mature market.

Qaisar Hasan - Buckingham Research

Thank you.

Operator

Thank you. Your next question is coming from Ben Swinburne with Morgan Stanley.

Ben Swinburne - Morgan Stanley

Thanks. Good morning, guys. My understanding is that you spend roughly a similar amount of marketing, discretionary marketing every quarter. I just wanted to confirm. It sounded like from the opening comments that the SAC increase in 2Q was an advanced set-top driven phenomenon rather than an up-tick, a material up-tick in your discretionary marketing spend.

And then, along those lines, Chase, we’ve seen most of the cable operators who have reported this quarter lost basic customers. You’ve heard some concerns on the housing market side but yet the satellite gross adds at least continue to grow. Any thoughts there in terms of positioning of the product? You don’t really even have your HD product out there yet but it seems like there might be some share shifting going on. Any thoughts there would be helpful.

Michael W. Palkovic

The first question, the majority of the increase in SAC was tied to driving advanced products. That was hardware, there’s an install component and there’s a marketing component but that was probably something in the two-thirds or greater of the increase and the rest of it was in like three or four other places. So that was the lion’s share, was AP, advanced products.

Chase Carey

In terms of HD, look, I think the campaign we have launched -- I mean, it’s been to really communicate to the marketplace what we had coming in HD has been successful. I mean, and I think to some degree, I guess a best estimate would be to the degree you look at how our competitors have spent an awful lot of energy in the last three or four months trying to refute or muddy the waters about the advantages we are going to have. So I think it has been successful. I think it is tough to track.

At this point, I would not end up saying it’s been in the results to date a sort of uniquely driving factor. I think it has probably been a help but I think probably the opportunities are more in front of us than ones we are capturing today. I think today you would look at it because it is this much -- you know, it is DVRs as much as HD, so I think it is probably a more widely spread desire as customers seem to really have an appetite for this enriched television experience, enriched both through DVR and enriched through HD.

I think the marketing has probably helped to put a little light on that but I think the opportunities that will be driven by that are really more ones in front of us as we make it a reality as opposed to anything that’s happened to date.

Operator

Thank you. (Operator Instructions) Your next question is coming from Jason Bazinet with CitiGroup.

Jason Bazinet - CitiGroup

Thanks so much. I have a question for Chase. I get this question so often from clients that I’m starting to wonder whether I understand it or not but it relates to the telco JVs. I guess my understanding was when the RBOX report a net add under that agreement that you have, only about 25% of those are in fact true net adds. The balance would be existing DTV customers that opt into some sort of bundle. I was wondering if you could just confirm that and give us any update on any sort of change in those ratios, just roughly.

Chase Carey

Well, I might give you -- I mean, we do give -- well, it does include both new customers wanting to take the bundle of services from us as well as existing customers opting into one half or the other of something they may not have, so their opt-ins, the opt-ins go both ways. There can be customers that are incremental to us but not to them, or they could be incremental to them and not to us. So all those things exist.

I don’t know, Mike, if you can give a general sense of --

Michael W. Palkovic

Actually, I don’t think that’s the case. In fact, I think the better way to look at is we are probably driving more new gross adds in through the acquisition channel than we are opt-ins, and that’s telco as a total, so that’s all of our partners.

I think the ratio is actually higher on the gross add side than it is on the opt-in side, so maybe it’s different within a telco but --

Chase Carey

Yes, I don’t -- I can’t speak to how they -- I mean, I should also say -- I mean, I really can’t speak to how they report. I can speak to how we report where we -- you know, we’re looking at the customers we’re getting through that channel.

Michael W. Palkovic

Just to be clear, the 20% to 25% that you mentioned of gross adds is all new.

Chase Carey

Yes, when we talk about they are new customers to us. How they report, probably I’ll leave more to them to explain. I don’t spend time on how they report.

Jason Bazinet - CitiGroup

So you are saying that roughly 20% to 25% of your gross adds are coming through the telco JV?

Michael W. Palkovic

Yes.

Jason Bazinet - CitiGroup

Okay, got it. Thank you.

Operator

Thank you. Your next question is coming from Doug Mitchelson with Deutsche Bank Securities.

Doug Mitchelson - Deutsche Bank

Thanks. Good afternoon, gentlemen. I guess I’m not sure I understand the strategy yet for homes that take multiple advanced set-top boxes. What I mean by that is right now cable will lease you as many as you want for free, and right now you charge $99 for the first one and I think a bunch more for number two, three, and four. And with the HD coming out this September, I would think you would have a huge increase in demand from your customers and new customers to have more than one HD set-top at least, much less HD DVR.

Are the returns -- what do the returns look like for you as you go to more than one advanced set-top box per home? Thanks.

Chase Carey

Again, I think what we are trying to -- I mean, some of this as we get some actual results under our belt as opposed to just projections, I think we will continue to sort of determine what makes sense. I think the way I guess I would look at it today is in the second half of the year, the incremental cost for an HD box versus a DVR box versus the basic box is about $100. We are going to be -- we’ll have an HD box that will be under $150 in the second half of the year, the basic box is $50, a touch under $50.

Essentially that amount we get and we charge a customer $99 to get that box, so we are whole against what would be the economics of a basic box, and we are charging then $5 for that box to go into a home. I think we will wrestle with how many homes are taking more, what is the trend there and how do you address that.

But I think in a simplistic sense, the way I guess I’d look at it is we are getting an HD increment against the home and essentially keeping ourselves economically whole for an advanced set-top box.

In reality with a DVR, with the HD DVR dropping -- right now we charge $299 if you go to a second one of those. The HD DVR is going to be not much above $300 by the end of the year and it is going to be in the mid $200s by the middle of next year, so in some ways that is actually going to end up being above what is cost.

But again, I think going into it philosophically, what we’ve looked to do is recapture up front so there is not an incremental investment, you know, the cost for that advanced equipment. I think we will continue to try and evaluate what’s the right -- what’s the demand for what mix of product and how do we optimize the opportunity.

Doug Mitchelson - Deutsche Bank

If I could just use my follow-up, I guess what I would ask is are you doing anything organizationally to prepare the company for potentially faster growth in the back half of the year once the HD channels are up? Thanks.

Chase Carey

Yes, I mean, not within -- within a range. We are not going to -- probably the areas you’d have box inventory, call centers and installation. Probably call centers are probably more flexible than, you know, and within some range box tops, probably installation would be the one.

So I think we try to think through it. We are not going to get our costs in front of our -- we’re not going to get our costs our in front of ourselves. I think we want to think through how we deal with increased demand. We are not going to invest -- I don’t want to be investing too far in front, sort of something before you get some clarity and visibility to it, and I think we will try, we’ll manage through that and try to be prepared for how we deal with things to the degree there is more demand than we anticipated.

But I think we feel okay around all of it but again, clearly if there’s a demand issue is one that we will have to see.

Doug Mitchelson - Deutsche Bank

Thank you very much.

Operator

Thank you. Your next question is coming from Steve Mather with SMH Capital.

Steve Mather - Sanders Morris Harris

Good afternoon, Chase. Chase, a hot topic on a lot of minds is how your brand extension and partnership strategies or really the aggressiveness with which you address these will kind of change given Liberty’s influence. Could you talk about that?

Chase Carey

Brand -- I mean, can you give me an example? I mean, I’m not sure when you say brand extensions or partnerships.

Steve Mather - Sanders Morris Harris

Well, let’s see -- it looks like in 2008, you’ll have more partnership opportunities with telcos and how that shifts, possibly with wireless broadband as that evolves, maybe with the 700-megahertz spectrum auction may give you some opportunity for brand extension, and all this in itself plus the shift with Liberty, I’m just wondering how you --

Chase Carey

I got it now. I didn’t understand when you said brand whether it was brand in a different context as opposed to -- I don’t think it is going to be a -- probably the one thing I would say that probably shifts a little bit is I think with Newscorp you had a large shareholder that respected DIRECTV should pursue what made sense for DIRECTV. That being said, Newscorp had a lot of businesses that related to DIRECTV and therefore had a view with how our relationships fit with theirs.

I think with Liberty, you got a partner that is probably much more -- that does not have the same degree of sister businesses and therefore probably provides us a greater degree of flexibility to simply determine to pursue things that really are looked at from a DIRECTV perspective as part of a larger, as opposed to part of a larger whole. But I don’t think it radically shifts it.

I think by and large we’ve been pursuing things that were on an opportunistic basis but it probably gives us a degree of more of an open slate to look at things.

Steve Mather - Sanders Morris Harris

Great, thanks.

Operator

Thank you. Your next question is coming from Tom Eagan with Oppenheimer & Company.

Tom Eagan - Oppenheimer

Thank you very much. Just a couple of questions on HD. First, could you remind us of the timing after the satellite launch in ’08, the timing and how many distinct HD channels you are going to have in ’08? And what research you guys have or that you’ve done among your or cable subscribers or I guess all yours of how many channels they need to switch say from cable to satellite? Thanks.

Chase Carey

How many -- I’m not sure I understood the last question on how many --

Michael W. Palkovic

The first part we said the satellite that is up will get us something like 70 at launch, 100 by the end of the year. The second satellite, which will go up in the second half of the year, will give us the full capacity we talked about of 150 channels, plus a ton of local markets, virtually all of them if we chose to. So that hasn’t changed and that will be where we will be kind of the middle of next year on a capacity standpoint.

As far as doing research on what customers need to switch, that’s --

Chase Carey

Yes, I guess in HD, I think you have to look at what’s our capacity and how are we filling that capacity. We’ll have the capacity around the end of the third quarter if the satellite comes online to do 100 channels. We look to have 100, probably have 70 plus of them, but we are probably going to have 20 or 30 channels that need a couple more months to get an HD feed online, which is why we will sort of grow from that 70 to 100 over those few months.

The second satellite, which I think actually launches somewhere around the end of ’07, beginning of ’08, will give it the expanded capacity. Today I think we’ll determine what is the programming and content and how should we use it that would be most attractive to customers.

I think in terms of research, your question of research is --

Tom Eagan - Oppenheimer

How many channels will it take customers to switch and I think that’s --

Chase Carey

Look, I think it’s clearly -- it’s probably stating the obvious -- more is better. It is probably not a straight line progression but I think there is a magic to having a unique volume, which is why I think the 100 has been important to us, that it really resonates that you’ve got an incredibly rich HD experience.

I think that being said, as customers digest that, there are obviously channels beyond that that won’t be in the hundred that will appeal to some niche. It is not probably that different in some ways than the decision to add or not add a channel. We are adding the Tennis Channel at the end of this month. It is not going to -- for a tennis fan, it’s a nice thing. There will be some number of customers to whom that is important enough and probably there will be a different number that when you add an HD version of the Tennis Channel, it matters too.

I think it is difficult in -- I think there is a critical mass that is important and I think it’s why it is so important that second half of this year is to really end up getting past this confusion of a customer who sort of thinks they get HD and then they find they got 15 channels or 20 channels and it’s a selected group of programming, as opposed to getting a place where it won’t be obviously -- 100 is not everything but it is a wide range of the channels that most of the, not just an individual but a household would look at. For the kids, it’s got kids channels, it’s got news channels, it’s got sports channels, entertainment channels, niche channels -- it’s got a wide-reaching range and the implication to somebody that resonates that I’ve got a really rich HD experience.

And then I think adding HD past that is sort of a subset of the dynamics you go through when adding a channel, and you know it’s probably got the -- obviously it doesn’t have quite the same impact of having it not at all versus having it in standard def versus having it in HD. Each has a different factor but for some people, HD is all it is about.

Mr. Rubin sitting next to me says he won’t watch anything but HD now, so it’s -- and I think obviously we’ve done research. I’m not going to share it because it’s competitive. There is an incredibly growing, significant portion of this marketplace that is putting that at the top of the list of what they value in a television experience.

Tom Eagan - Oppenheimer

Thank you.

Operator

Thank you. We have time for one more question. Your next question is coming from Tuna Amobi with Standard & Poor’s Equity Group.

Tuna Amobi - Standard & Poor’s

Thank you very much, guys. First, Chase, I would like to congratulate you on your renewal which was announced today.

Chase Carey

Thank you.

Tuna Amobi - Standard & Poor’s

I guess my question is on the integrated broadband VOD product. It is not clear to me if that product is an extension of your broadband video product, which I believe you launched approximately around Q406 with about 2,000 titles, or is this an independent, standalone product?

Chase Carey

What it really is going to be, from a broadband perspective, is a product that is much more integrated into the television. I mean, you can get products -- it is going to integrate the broadband and our product, we’re going to push down to the disc, integrate it into the guide and integrate it into the customer experience in a different way, in a much more user-friendly and easy-to-access way. That really is what it does, is it takes it, and as opposed to being able to get it and then figure out how you get it, it is going to really take those offerings and put them on the screen, make them available to our customers in a way that they can get at it just like they get at channels today, and promote it and package it in a way that is truly attractive to them and educate consumers on it. So it will really become a much more, for the customers that get it a much more central, sort of core part of the DIRECTV experience for the customers who value that.

Tuna Amobi - Standard & Poor’s

Was this product contemplated at the time of that launch or are you going back to the studios to renegotiate the rights to this product? I mean, I’m not sure.

Chase Carey

This is all an evolving -- these are -- we’re not going back. This is all an evolving product. I think we’ve actually been talking about this for over a year, so this is a process just as we’ll have a richer, version of this we’re continuing to enhance. It is not like we are finished developing. We had initial products earlier in the year. This is a meaningful step forward to take the VOD to another level. We’ll take it to another level in ’08 and as we add disc capacity and other new features, we will continue to enrich this experience but it is all part of an ongoing continuum.

Obviously a part of that ongoing continuum is working with content providers, but we’ve been doing that as an ongoing process, so this is not -- this is not going -- none of these are going backwards or sideways in any way. This is an ongoing process as we’ve evolved our technology and our capabilities and the experience to continue to build, just as we’ll keep doing going forward.

Tuna Amobi - Standard & Poor’s

Lastly, still on that same topic, can you speak perhaps to the number of titles you expect at launch, and maybe a sampling of which studios you have deals in place, interactive advertising component, if any?

Chase Carey

I think we’ve actually demo’d some and I think we’ve actually shown a fair bit. I don’t have it here but we actually even had it earlier in the year because again, we’ve been planning this -- at CES, we actually had a fairly comprehensive -- it’s got a lot of mainstream products and it is -- I probably would just, John or somebody can get it, but we have made -- this is not an announcement today. This is something we’ve announced and we’ve been, as I said, we actually demo’d part of it as CES earlier in the year. And again, it’s probably enriched from today but it is an ongoing process. And ultimately through the -- you’ve got a lot of -- you have lots, you have hundreds of titles. I don’t know, maybe -- but it is a wide, wide range of selection.

Again, what we are trying to do, and I think it is the right way, is I think right now VOD is not a very -- I don’t think the way VOD has been done, it has been done with a prioritization of sort of ease of use and consumer friendliness. It’s sort of been there, go find it. What we are going to try and do is package, present, and organize this in a way that is much more user-friendly and therefore it is one that consumers find, as they try to learn how to use it, a much more rewarding experience but with a rich, with a truly rich set of choices but one that you can whip through and figure out what do you really want to watch.

Tuna Amobi - Standard & Poor’s

Thank you.

Operator

Thank you. This concludes today’s DIRECTV Group second quarter 2007 earnings conference call. You may now disconnect your lines and have a pleasant day.

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