Brady: Before we begin, you must be thrilled with yet another Emmy sweep this year. Kessler: The Emmy sweep was huge for us, but it was also a strong year with affiliates. There are two drivers to our continued success. First, the ongoing strength of our lineup: both the movie lineup, which is the strongest theatrical movie lineup in the business, and of course our original programming. This year we successfully launched some new shows, Deadwood and Entourage, and Carnivale got off to a good start and had some excellent reviews. And we will continue that momentum as we go into the second season of those shows next year. And we’ve got some other new pieces of programming coming that we’re very excited about. Brady: Such as? Kessler: There’s a show called Big Love, which Tom Hanks is producing for us, and a huge series called Rome. We support that lineup by aggressively promoting it out in the marketplace. We feel really good about our lineup going forward. Obviously there’s an ongoing challenge for any network. You’ve got to keep filling the pipeline hopefully with really strong programming that the audience responds to. Which is what we always try to do. We feel really good about where we’re going, and we do a lot of local partnerships with our affiliates. The second area that has really driven our success in the cable world this year, and will continue to drive the business, has been the success of HBO on Demand. That is really having a significant impact on our business and on the affiliates’ business. What we know from operators is when you look at all of the On Demand requests including video on demand and free on demand product, in HBO homes, HBO On Demand will account for roughly 50% of the On Demand requests, which is an extraordinary number. What we’re seeing is that it increases the usage of On Demand and the satisfaction with the service, it increases the value perception and as a result we are seeing a significant reduction in the disconnect rate for both pay television and for digital. So our affiliates are saying, wow, this is having a tremendous impact on my business and they’re out there aggressively supporting it. And HBO On Demand is also a significant point of difference for our cable customers versus the satellite guys. Brady: How widely available is HBO On Demand now? Kessler: There are now 5 million-plus HBO On Demand homes, all of which of course have HBO as a linear service. So we measure in those homes the reduction in the disconnect rate, so you will see those home that have HOD [HBO On Demand] that fewer people disconnect, that they disconnect at a reduced rate. Also, those people who have HOD disconnecting digital overall—so they don’t just have HBO, they have a digital package—at a significantly reduced rate. So the longer our affiliates can hold onto these subscribers, it clearly has a significant revenue impact for us and for the cable operator. We and the cable operators have always looked at ways to reduce the disconnect rate of pay television and digital. Clearly HOD is a product that is doing that. Brady: Is HBO On Demand also serving as a subscriber acquisition driver, or acting as an incentive for existing subscribers to upgrade to digital? Kessler: HOD is definitely a selling point to our operators as an acquisition tool. Not only does HOD affect the disconnect rate, but we are finding as HOD becomes more widespread, people talk about the service. And people who do not have HOD yet, or who do not have On Demand services, when they hear about it, they hear great things about it, so word of mouth is spreading about the product and it’s starting to have an impact on the acquisition side of the business. That’s why all of our communication efforts with our affiliates to consumers are really focused on the On Demand component now. We’re very aggressively in all of our acquisition materials—whether it’s direct mail, telemarketing, the spots we produce for barker channels and also running off-channel for HBO—it’s not simply a "Get HBO and get this discount" offer-driven [message], it’s more about HBO on Demand and how this product literally revolutionizes your use of HBO. We’re also starting now to use HOD in new ways. For instance, we’re creating new windows with HOD to help drive some of our programming. So for example, when we were launching the show Entourage we put 18 minutes of the first episode on HOD before it even appeared on the linear network. So we’re using On Demand as a promotional platform for the linear service. And we will continue to do that over time and educate the consumer by using On Demand as a sampling device for our programming. Brady: Do you use HOD to keep interest going in a series that may not currently be available on the linear service? So between seasons of Six Feet Under, for instance, you might program the video on demand platform in ways that don’t mimic the linear channel but also whet viewers’ appetites for the return of a series? Kessler: In a word, yes. In terms of ongoing series, after one of our appointment viewing shows runs on Sunday night, it appears on HBO On Demand on Monday. We do a lot of focus groups, and what we hear from our viewers is that while they want to be part of the audience that tunes in at 9:00 Sunday night because they know everyone’s watching and they want to be able to talk about it Monday morning, but they’re comforted by the fact that they know that if they miss it on Sunday night for some reason, they know and appreciate that come Monday, they can catch it on HOD. So our first priority is to keep HOD up to date with our series that are running on the linear service so our subscribers can catch their shows on demand in case they miss them. Secondly, what we’re finding is that HOD is serving as a great sampling device not only to promote new shows like that Entourage pre-premiere, but it also gives people an opportunity to catch up with programming they’ve heard about but never watched. For instance, Curb Your Enthusiasm gets great reviews and people may have heard about it but never watched it. We found that in the third season, a lot of our HOD homes sampled the show On Demand and that really helped its ratings. So we’re now looking at what we can do around Carnivale [returning in January with a second batch of 13 episodes] which in terms of its plot was very complex, to promote it very aggressively on HOD prior to its coming out on the linear service. So episode 1 would come on HOD on Monday, then episode 2 would come on Tuesday and episode 1 will stay on, and then 3 and so on, so we’ll build through the whole first season. We’ve got 150 hours of programming on the server and every week we refresh 25% of that, so over the course of a month subscribers have an incremental 300 hours of On Demand product. In addition to touting premieres & driving sampling that takes place, HOD also has a lot of older seasons of our hit shows. Some of our subscribers can’t get enough of our programming, so this satisfies that appetite when there’s nothing else on TV they want to see, or just because they want to revisit their favorite episodes. So our linear programming also is becoming evergreen hits on our On Demand service. Brady: Any other ways you’re trying to make HBO On Demand a unique service? Kessler: Absolutely. The beauty of On Demand technology is it’s very flexible and we’re pitching product every week. So we’re also creating stunts so there’s different ways other than "Let’s just put up the first six episodes" of any one series and that’s that. We would rather do "The four best episodes featuring Christopher" for The Sopranos, or "Fans’ Favorites" or "The Best Marital Scenes between Tony and Carmela." So we’re trying new ways of packaging our programming [on VOD], and that helps us keep some excitement about the product. We do this with our movies as well. Brady: So it’s really evolving as the platform evolves… Kessler: Yes, and we will increase the amount of what we put on as our affiliates increase their server capacity. How high do we go? We don’t necessarily want to put 400 hours on there. Right now the 150-hour model for HOD is generating enormous levels of usage and satisfaction. And we anticipate getting the Cinemax model up to that level too. We agree with Comcast that On Demand, and more specifically HOD, is a very valuable property, and it’s in all our interests to aggressively promote it to subscribers. Brady: DVD sales are also very important to HBO. How do you make VOD and DVD work together? Kessler: DVDs in general are important to us and continues to be a growing part of our business, and reflect the success of the linear shows on the service. Content sales—DVDs, foreign, syndication, etc—represent 20% of HBO’s revenue. What we are doing, going back to our linear and on-demand services, is taking a lot of the material we created for the linear service and we are packaging much of that and putting it on the HOD service. We know people enjoy watching that material, we have a lot of exclusive material, and we’re packaging it and putting it on OD, so if we might put on six episodes of SFU and a seventh item that’s behind the scenes, DVD-like extra material. We’re trying to offer our VOD customer a lot of different entertainment options. Brady: How soon will we see HBO On Demand in high definition? Kessler: It’s really going to be an important part of the future of pay television. We offer both HBO and Cinemax in HD and though [HD] is only in a limited number of homes now it’s going to grow and be substantial in the next few years. It’s another technological enhancement that enhances the overall perception of the service. This is premium television, so we need to deliver to our subscribers with HD sets the best picture possible. The majority of our original series are being shot in HD—The Wire isn’t, but Rome, Big Love, Six Feet Under, The Sopranos and all our championship boxing is now shot in HD. Brady: Just as HBO On Demand really spurred the VOD business for cable operators, do you think it will help drive HD VOD? Kessler: At some point that’s the next evolution. In the words of Bob Zitter [EVP, technology operations and chief technology officer for HBO], our resident tech guru, at some point it won’t be called "high definition television"—it will just be television. Brady: Are you also looking at launching any "virtual channels" for VOD with a more focused lineup of programming targeting a niche part of your audience? Kessler: I can’t discuss anything specific but what I can say is that in general we’re always looking at new product ideas and new On Demand ideas, whether it’s around HBO, Cinemax or a completely different service programmed under a different brand using different programming and targeting a unique demographic group. Brady: Bernadette, let’s talk about how affiliate marketing has been evolving as all these new platforms, such as On Demand, evolve. Aulestia: We adopted a new approach in the past year. With distributors on both sides focusing on their multi-product strategy—HD, DVRs, SVOD—their attention is on how to package all these multiple products. So in looking at the landscape over the past two years, we tried to be really proactive about looking at the effectiveness of our affiliate marketing campaigns and initiatives and really figure out whether we were meeting the needs of that changing environment. And what we heard was that people are more and more feeling that the one size fits all model—the one big promotion, the one big idea—is not what they need. Instead, they’d say, "What we really need this quarter is to focus on these three elements." Brady: So how did you respond? Aulestia: We readjusted the way we did things and set up our direct marketing group a little differently in order to make sure we’re coming to the table with highly customized and flexible plans for each of our distributors. It goes without saying that each of our distributors is into differentiating [themselves], whether it’s cross-platform or their product mix or their brand like Time Warner [Cable] or Cox [Communications] or Comcast, and how do they make sure consumers understand they’ve got great products and that they’re the ones bringing them to market. This means we’re now more account-focused [rather than regionally-focused] so each account has their own individual needs met by a specific sales and marketing team that understands their business and can work directly with them. So now our approach is one of having individual conversations with each of our distributors about their priorities are for a quarter or for the year, and really plan ahead as best we can to come up with marketing plans and strategies that really are unique and meet their needs. Brady: How are your affiliates responding? Aulestia: Where we see our role, and where operators have been welcoming our new approach, is they now have a partner who can help them think about solutions for what they’re trying to accomplish. They can now see us as a brand that humanizes all their products. People like to relate to brands, and that’s the special bond that we have with consumers at HBO as they equate us with bringing them the best entertainment experience. So affiliates can now see us as the sexy brand that humanizes their products. Whereas we used to call these one-offs, one-offs are basically our life. Everyone’s in different stages of their rollouts [so] it’s about meeting their needs at that moment with something unique to what they’re trying to accomplish. And hopefully they’re able to wrap that in packaging that’s consistent with their sales philosophy and their brand guidelines. Brady: So this evolution is in response to a consolidating distribution environment? Aulestia: Yes, this is a response to industry consolidation, we also still have many independent distributors and they need support and creative outlets so by putting more of the creative control more in their hands, we’re trying to meet their needs. It gets back to how more and more, the quarterly campaign is gone. Our affiliates may have new things happening month to month. It’s turned into a world of high customization where to remain relevant we really needed a new model. Brady: Can you give me some examples of this new model of affiliate marketing? Aulestia: For instance, Comcast is really bullish on the HBO On Demand product and what it’s done for the rest of the On Demand category. For fourth quarter this year, our campaign with Comcast is to do an HBO preview in the month of October but unlike the previews of old, this preview is on— yes—showcasing HBO, but also showcasing HOD and getting people exposed to HOD and the functionality of it and taking a new look at HBO, as well as talking about our HD product. So that’s a campaign with multiple tactics but highly focused on consumers experiencing HOD. That’s new for us, blending the two different pieces—HOD and HD—and the first time that we’ve really focused on a preview in this way. So Comcast is the first one out of the gate with our first big initiative in this sense and clearly we’ll be doing more of these kinds of things with more of our distributors. Brady: Such as? Aulestia: Again, when you look at all our accounts they all have their own highly customized needs. Cox is in the middle of launching HOD for fourth quarter, and we’ve found that having them be a part of our creative brief process enables them to really have a say in the messaging and how HBO and Cox are positioned together. That’s been key, because they’re highly focused on the reinvention of the category, and that through HOD, Cox is going to bring you a new experience. So this [Cox] campaign is happening in fourth quarter and into first quarter as they launch HOD in those markets. Another example: Sometimes it’s not even just one MSO, but about customizing needs. You’ve got something like the New York Co-Op [a marketing co-op that owns 1-800-OK-Cable] where you’ve got three MSOs that any given time have their own priorities and strategy, but on a quarterly basis they get together to figure out how to get cable business in the New York market. So the Co-Op came to us to discuss possibilities of things we might do to make a campaign really compelling, and so in September we launched a campaign that focused on our new show Family Bonds, our documentary Nine Innings From Ground Zero, two great New York stories that we lent themselves to coming up with a New York angle. So we secured for them the first 12 minutes of the first episode of Family Bonds and distributed it on their high-speed platforms, and via grassroots [street marketing] teams in the Metro New York area where consumers received that same 12 minutes on DVD. That’s another example of some interesting ways that we’re now customizing our tactics and our message. On a broader scale from our direct marketing team, one of the other areas that we found was sometimes you’ve got systems that want to do really, really local initiatives – to drop a piece of mail or a bill-stuffer card or ad slick. So one of the things we introduced this year is a web-based tool for affiliates called Quick Response Creative that allows them to go online and download materials that they can customize and get out to market quickly. The creative is already done, so they can customize the messaging on the postcards, inserts, bill stuffers and so on. Brady: How about using HBO to help your cable affiliates sell other kinds of products beyond high-speed Internet, VOD or HD? Aulestia: We’ve got a few things happening that will roll out in 2005, big campaigns that focus on our affiliates’ products. A lot of our distributors are also thinking about some of the tests that they’re going to start conducting in telephony markets, the rollouts of DVRs, some markets are even talking about ITV. All the conversations we’re having focus on marketing campaigns and promotions and messaging strategies around these products. What’s really heating up for next year are the discussions around telephony and DVR roll-up and HSD continues to be a priority. So in addition to more customized marketing we’re also from the content side we’re more and more using our content in creative ways that enhances products. We’re looking at ways we can imbed our content into all their new product lines. Brady: So with cable telephony, for example, you might offer content such as ring tones with The Sopranos or Curb Your Enthusiasm theme songs to new customers? Aulestia: Hey, not a bad idea.

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