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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549-1004

FORM 10-Q

For the quarterly period ended June 30, 2004

OR

For the transition period from                to

Commission file number 0-26035

THE DIRECTV GROUP, INC.

(Exact name of registrant as specified in its charter)

2250 East Imperial Highway

El Segundo, California 90245

(310) 964-0808

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive office)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes ¨  No x

As of August 6, 2004, the registrant had 1,385,115,565 shares of common stock outstanding.

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THE DIRECTV GROUP, INC.

INDEX

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THE DIRECTV GROUP, INC.

PART I – FINANCIAL INFORMATION (UNAUDITED)

ITEM 1.    FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

Reference should be made to the Notes to the Consolidated Financial Statements.

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THE DIRECTV GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

Reference should be made to the Notes to the Consolidated Financial Statements.

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THE DIRECTV GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

Reference should be made to the Notes to the Consolidated Financial Statements.

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The DIRECTV Group, Inc. (the “Company”) is a world-leading provider of digital television entertainment and broadband satellite networks and services. On March 16, 2004, the Company changed its corporate name from Hughes Electronics Corporation to The DIRECTV Group, Inc. Effective on March 17, 2004, the Company’s ticker symbol on the New York Stock Exchange was changed from “HS” to “DTV.” The name of the Company was changed to better reflect the Company’s commitment to building its business around the DIRECTV businesses and had no impact on the Company’s common stock or the rights of stockholders.

On December 22, 2003, General Motors Corporation (“GM”), the Company and The News Corporation Limited (“News Corporation”) completed a series of transactions that resulted in the split-off of the Company from GM and the simultaneous sale of GM’s 19.8% interest in the Company to News Corporation. GM split-off the Company by distributing the Company’s common stock to the holders of the GM Class H common stock in exchange for their GM Class H common shares on a one-for-one basis. The Company paid to GM a special cash dividend of $275.0 million in connection with the transactions. Immediately after the split-off, News Corporation acquired an additional 14.2% of the outstanding common stock of the Company from the former GM Class H common stockholders, which provided News Corporation with a total of 34% of the outstanding common stock of the Company. Upon completing these transactions, News Corporation transferred its 34% interest in the Company to its 82% owned subsidiary, Fox Entertainment Group, Inc.

On April 20, 2004, the Company and PanAmSat Corporation (“PanAmSat”) announced the signing of a definitive agreement that, subject to the satisfaction of the conditions described in that agreement, provides for the sale of the Company’s approximately 80.4% interest in PanAmSat to an affiliate of Kohlberg Kravis Roberts & Co. L.P. (“KKR”) for about $2.84 billion in cash. The Company recorded the expected loss on this transaction of $478.6 million, net of a tax benefit of $291.0 million, in the quarter ended March 31, 2004, as a charge to “Income (loss) from discontinued operations, net of taxes” in the Consolidated Statements of Income. During the second quarter of 2004, the Company’s investment in PanAmSat increased as a result of net income recorded by PanAmSat during the second quarter. Because the sale price is fixed at about $2.84 billion, and the Company’s investment in PanAmSat increased during the second quarter of 2004, the expected loss on the transaction also increased by $41.4 million, net of a tax benefit of $6.9 million. The total expected loss of $520.0 million includes an estimate of direct costs associated with the transaction and retention of certain tax liabilities for which the Company has agreed to indemnify PanAmSat. As more fully discussed below in Note 8, on August 3, 2004, the primary propulsion system on Galaxy 10R, a PanAmSat satellite, experienced an unexpected shutdown that the manufacturer has determined is a permanent failure. This satellite can, however, operate normally on its available bi-propellant fuel for over three years. Under the terms of the agreement for the sale of the Company’s interest in PanAmSat, the permanent failure on Galaxy 10R allows KKR to not consummate the transactions described above. KKR is evaluating the impact of the failure on the transactions and is working with PanAmSat and the Company to address the effect of this event.

On June 8, 2004, the Company, Hughes Network Systems, Inc. (“HNS”) and Flextronics Sales & Marketing (L-A) Ltd. (“Flextronics”) entered into an agreement whereby Flextronics will acquire HNS’ 55% ownership interest in Hughes Software Systems Limited (“HSS”), an Indian telecommunications software products and services provider, for $226.5 million in cash. The Company received the $226.5 million of cash proceeds on June 11, 2004 and deferred the approximate $177.5 million pre-tax gain, included in “Accrued liabilities and other” on the Consolidated Balance Sheets, which will be recognized in the third quarter of 2004 upon close of the transaction following compliance by Flextronics with Indian regulatory requirements.

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

Revenues, operating costs and expenses, and other non-operating results for the discontinued operations of PanAmSat, which formerly comprised the Satellite Services segment, and HSS, which was a component of the Network Systems segment, have been excluded from the Company’s results from continuing operations for all periods presented herein. Consequently, the financial results of PanAmSat and HSS are presented in the Company’s Consolidated Statements of Income in a single line item entitled “Income (loss) from discontinued operations, net of taxes” and the related assets and liabilities are presented in the Consolidated Balance Sheets in line items entitled “Assets of businesses held for sale” and “Liabilities of businesses held for sale.” See Note 12 for further discussion of discontinued operations.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting. In the opinion of management, all adjustments (consisting only of normal recurring items) which are necessary for a fair presentation have been included. The results for interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year. For further information, refer to the revised consolidated financial statements and footnotes thereto included in the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on June 3, 2004, the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 filed with the SEC on May 6, 2004 and all other filings by the Company, including other Current Reports on Form 8-K, filed with the SEC after such date and through the date of this report.

Beginning on January 1, 2004, the Company allocates pension and other postretirement benefit expenses to its subsidiaries. Prior period segment information has been reclassified to conform to the current period presentation.

Note 2. Accounting Changes

Subscriber Acquisition, Retention and Upgrade Costs

Effective January 1, 2004, the Company changed its method of accounting for subscriber acquisition, retention and upgrade costs. Previously, a portion of these costs were deferred, equal to the amount of profit to be earned from the subscriber, typically over the 12 month subscriber contract, and amortized to expense over the contract period. The Company now expenses all subscriber acquisition, retention and upgrade costs as incurred as subscribers activate the DIRECTV^® service. The Company determined that expensing such costs was preferable to the prior accounting method after considering the accounting practices of competitors and companies within similar industries and the added clarity and ease of understanding of the Company’s reported results for investors. As a result of the change, the deferred subscriber acquisition cost balance of $503.9 million that was included in “Prepaid expenses and other” in the Consolidated Balance Sheets as of December 31, 2003 was expensed as a cumulative effect of accounting change on January 1, 2004. The amount of the cumulative effect was $310.5 million, net of taxes. Had the new method of accounting been applied in 2003, operating costs would have decreased by $7.8 million and increased by $4.7 million for the three month and six month periods ended June 30, 2003, respectively.

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

The following table sets forth the Company’s income (loss) from continuing operations before cumulative effect of accounting change and net income (loss) on a pro forma basis as if the change in accounting for subscriber acquisition, retention and upgrade costs had been applied retroactively:

Revenue Recognition

In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 requires the allocation of revenues into separate units of accounting for transactions that involve more than one deliverable and contain more than one unit of accounting. The Company elected to apply the accounting required by EITF Issue No. 00-21 prospectively to transactions entered into after June 30, 2003. The adoption of this standard did not have a significant impact on the Company’s consolidated results of operations or financial position.

Variable Interest Entities

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities—an interpretation of ARB No. 51” (“FIN 46”). FIN 46 requires the consolidation of a variable interest entity (“VIE”) where an equity investor achieves a controlling financial interest through arrangements other than voting interests, and it is determined that the investor will absorb a majority of the expected losses and/or receive the majority of residual returns of the VIE. The Company applied this interpretation beginning on July 1, 2003 for entities created prior to February 1, 2003. The Company determined that the partially-owned local operating companies (“LOCs”) providing DIRECTV^® programming services in Venezuela and Puerto Rico, of which the Company owned 19.5% and 40.0%, respectively, were VIEs. As a result, on July 1, 2003, the Company began consolidating the Venezuelan and Puerto Rican LOCs resulting in an increase in total assets of $55.1 million, which included $29.1 million of cash. The adoption of FIN 46 resulted in the Company recording an after-tax charge of $64.6 million to cumulative effect of accounting change in the Consolidated Statements of Income on July 1, 2003.

Prior to July 1, 2003, the Company accounted for its investments in the Venezuelan and Puerto Rican LOCs under the equity method of accounting and, through June 30, 2003, reflected approximately 75.0% of their net income or loss in “Other, net” in the Consolidated Statements of Income due to the accumulation of net losses in excess of other investors’ investments.

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

Stock-Based Compensation

On January 1, 2003, the Company adopted the fair value based method of accounting for stock-based employee compensation of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendment of SFAS No. 123.” Under this method, compensation expense equal to the fair value of the stock-based award at grant is recognized over the course of its vesting period. The Company elected to follow the prospective method of adoption, which resulted in the recognition of fair value based compensation cost in the Consolidated Statements of Income for stock options and other stock-based awards granted to employees or modified on or after January 1, 2003.

All outstanding options to purchase GM Class H common stock were converted to options to acquire the Company’s common stock as a result of the completion of the News Corporation transactions on December 22, 2003. Under SFAS No. 123, the conversion was considered a modification of all outstanding options, and accordingly, all options are accounted for under the fair value based method subsequent to the completion of the News Corporation transactions.

The following table presents the effect on earnings of recognizing compensation cost as if the fair value based method had been applied to all outstanding and unvested stock options and other stock-based awards for the periods presented:

On June 2, 2004, the Company obtained shareholder approval for The DIRECTV Group, Inc. 2004 Stock Plan. During June 2004, the Company granted restricted stock units and stock options, as contemplated by the approved plan. The stock options were granted to the Company’s CEO to replace stock options that were cancelled by News Corporation, his former employer. During the quarter ended June 30, 2004, the Company recognized $35.1 million of stock-based compensation expense, which includes the cost related to restricted stock units, the cost of replacement options granted to the Company’s CEO and the cost associated with News Corporation options retained by former News Corporation employees recently hired by the Company. The Company expects stock compensation expense to be about $10 million in each of the third and fourth quarters of 2004.

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

Note 3. Inventories

The following table sets forth the amounts recorded for inventories, net, as of the periods presented:

Note 4. Goodwill and Intangible Assets

As of June 30, 2004 and December 31, 2003, the carrying amounts for goodwill by reporting unit were $3,031.7 million for Direct-To-Home Broadcast and $2.4 million for Network Systems.

The following table sets forth the amounts recorded for intangible assets as of the periods presented:

Amortization expense for intangible assets was $11.8 million and $30.3 million for the three month and six month periods ended June 30, 2004, respectively, and $18.5 million and $37.0 million for the three month and six month periods ended June 30, 2003, respectively.

Estimated amortization expense for intangible assets in each of the next five years and thereafter is as follows: $40.2 million in the remainder of 2004; $80.3 million in 2005; $80.3 million in 2006; $80.3 million in 2007; $80.3 million in 2008; and $212.0 million thereafter.

Note 5. Investments

On January 28, 2004, the Company sold 10,000,000 shares of XM Satellite Radio Holdings, Inc. (“XM Satellite Radio”) common stock for $254.4 million. On March 25, 2004, the Company sold its remaining 9,014,843 shares of XM Satellite Radio common stock for $223.1 million. As a result of these transactions, the Company recorded a pre-tax gain of $387.1 million in the first quarter of 2004 in “Other, net” in the Consolidated Statements of Income. In addition, the Company sold other equity investments for $33.0 million

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

and $17.9 million in cash during the six months ended June 30, 2004 and 2003, respectively, and recorded a pre-tax gain of $9.4 million and $6.0 million in the six months ended June 30, 2004 and 2003, respectively.

Note 6. Short-Term Borrowings and Long-Term Debt

Short-Term Borrowings and Current Portion of Long-Term Debt

Long-Term Debt

Overview.    During the first quarter of 2003, DIRECTV Holdings LLC and its subsidiaries (“DIRECTV U.S.”) raised approximately $2,625.0 million of cash through the issuance of $1,400.0 million of senior notes and $1,225.0 million of borrowings under the Term Loan portion of the senior secured credit facilities described more fully below. The Company used a portion of these proceeds to repay the $506.3 million outstanding principal balance plus accrued interest under a prior credit facility agreement, which was then terminated.

Notes Payable.    DIRECTV U.S.’ $1,400.0 million in registered senior notes are due in 2013 and bear interest at 8.375%. Principal on the senior notes is payable upon maturity, while interest is payable semi-annually. The senior notes are unsecured and have been fully and unconditionally guaranteed, jointly and severally, by each of DIRECTV U.S.’ domestic subsidiaries (other than DIRECTV Financing Co., Inc.).

The fair value of DIRECTV U.S.’ senior notes was approximately $1,553.7 million at June 30, 2004 based on quoted market prices.

Credit Facilities.    DIRECTV U.S.’ senior secured credit facilities consist of a Term Loan and a $250.0 million revolving credit facility, which was undrawn at June 30, 2004. DIRECTV U.S. is required to pay a commitment fee of 0.50% per year on the unused commitment under the revolving credit facility. Borrowings under the Term Loan bore interest at a rate equal to the London Interbank Offered Rate (“LIBOR”) plus 2.75%, until it was replaced in March 2004 with a new Term Loan with substantially identical terms except that the interest rate was reduced to LIBOR plus 2.25%, which may be increased or decreased under certain conditions. The Term Loan matures in 2010 and the revolving credit facility matures in 2008.

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

Principal payments under the Term Loan are due primarily in 2008 to 2010. However, at each year end DIRECTV U.S. may be required to make a computation of excess cash flows for the year, as defined by the senior secured credit facilities agreement, which could result in DIRECTV U.S. making a prepayment under the Term Loan. Based upon the calculated excess cash flows for the year ended December 31, 2003, DIRECTV U.S. made a prepayment of $201.0 million under the Term Loan on April 15, 2004.

The revolving portion of the senior secured credit facilities is available to fund DIRECTV U.S.’ working capital and other requirements. The senior secured credit facilities are secured by substantially all of DIRECTV U.S.’ assets and are fully and unconditionally guaranteed, jointly and severally, by all of DIRECTV U.S.’ domestic subsidiaries.

The Company’s short-term borrowings, notes payable, credit facilities and other borrowings mature as follows: $15.8 million in the remainder of 2004; $11.5 million in 2005; $13.9 million in 2006; $12.0 million in 2007; $252.9 million in 2008; and $2,128.3 million thereafter. However, these amounts do not reflect potential prepayments that may be required under DIRECTV U.S.’ senior secured credit facilities.

Covenants and Restrictions.    The senior secured credit facilities require DIRECTV U.S. to maintain certain financial covenants. The senior notes and the senior secured credit facilities also include covenants that restrict DIRECTV U.S.’ ability to, among other things, (i) incur additional indebtedness, (ii) place liens upon assets, (iii) make distributions, (iv) pay dividends to the Company or make certain other restricted payments and investments, (v) consummate asset sales, (vi) enter into certain transactions with affiliates, (vii) conduct businesses other than DIRECTV U.S.’ current or related businesses, (viii) merge or consolidate with any other person, (ix) sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of DIRECTV U.S.’ assets, (x) make voluntary prepayments of certain debt (including any repayment of the senior notes) and (xi) make capital expenditures. Should DIRECTV U.S. fail to comply with its covenants, all or a portion of the borrowings under the senior notes and senior secured credit facilities could become immediately payable. At June 30, 2004, DIRECTV U.S. was in compliance with all such covenants.

As of June 30, 2004, restricted cash of $46.7 million was included as part of “Prepaid expenses and other” in the Consolidated Balance Sheets. The $46.7 million was deposited to secure certain letters of credit and obligations of the Company and the Company’s majority-owned foreign subsidiaries. Restrictions on the cash will be removed as the letters of credit expire and the foreign subsidiaries’ obligations are satisfied or terminated.

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

Note 7. Pension and Other Postretirement Benefits

The components of net periodic benefit costs were as follows for the periods indicated:

Components of Net Periodic Benefit Costs

The settlement costs and contractual termination benefit costs recognized during the six months ended June 30, 2004 are attributable to benefits provided to participants of the contributory plan who were terminated as part of headcount reductions following the completion of the News Corporation transactions. See Note 10 for additional information.

Employer Contributions

The Company previously disclosed in its consolidated financial statements for the year ended December 31, 2003 that it expected to contribute approximately $17.5 million and $31.2 million to its qualified and nonqualified pension plans, respectively, in 2004. During the six months ended June 30, 2004, the Company contributed $21.2 million to its nonqualified pension plan. In July 2004, the Company contributed the $17.5 million to its qualified pension plan. Currently, the Company expects to contribute approximately $10.0 million to its nonqualified pension plan in the second half of 2004.

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

Note 8. Commitments and Contingencies

Litigation

Litigation is subject to uncertainties and the outcome of individual litigated matters is not predictable with assurance. Various legal actions, claims and proceedings are pending against the Company arising in the ordinary course of business. The Company has established loss provisions for matters in which losses are probable and can be reasonably estimated. Some of the matters may involve compensatory, punitive, or treble damage claims, or demands that, if granted, could require the Company to pay damages or make other expenditures in amounts that could not be estimated at June 30, 2004. After discussion with counsel representing the Company in those actions, it is the opinion of management that such litigation is not expected to have a material adverse effect on the Company’s consolidated results of operations or financial position.

DIRECTV U.S. filed suit in California State Court, Los Angeles County, on June 22, 2001 against Pegasus Satellite Television, Inc. (“Pegasus”) and Golden Sky Systems, Inc. (“Golden Sky”) which are referred to collectively in this paragraph as the Defendants. The action was subsequently removed to the U.S. District Court for the Central District of California. The lawsuit sought to recover approximately $52 million, excluding interest, that the Defendants owe DIRECTV U.S. under the parties’ Seamless Marketing Agreement, which provided for reimbursement to DIRECTV U.S. of certain costs that resulted from new subscriber activations in the Defendants’ territory. On April 14, 2004, the jury returned a verdict awarding DIRECTV U.S. $51.5 million in damages against the Defendants as a result of the Defendants’ breach of the agreement. The court granted DIRECTV U.S.’ request for prejudgment interest and on May 24, 2004, entered judgment against the Defendants and in favor of DIRECTV U.S. in the amount of approximately $63 million. Defendants filed a voluntary petition for Chapter 11 bankruptcy in the U.S. Bankruptcy Court, District of Maine, on June 2, 2004, staying DIRECTV U.S.’ ability to collect on the judgment. On June 21, 2004, the Defendants filed a Notice of Appeal.

Pegasus and Golden Sky, which are referred to collectively in this paragraph as the Plaintiffs, filed an action on January 11, 2000 against DIRECTV U.S. in the U.S. District Court for the Central District of California. The Plaintiffs alleged, among other things, that DIRECTV U.S. interfered with their contractual relationship with the National Rural Telecommunications Cooperative (“NRTC”). The Plaintiffs alleged that their rights and damages are derivative of the rights and damages asserted by the NRTC in its lawsuits against DIRECTV U.S., which have been settled. On May 13, 2004, the court entered an order eliminating all of the Plaintiffs’ remaining claims and dismissed DIRECTV U.S.’ claim on the term of the member agreements based on lack of standing. The Court entered final judgment on June 2, 2004. On June 10, 2004, the Plaintiffs filed a Notice of Appeal.

As discussed above, Pegasus and Golden Sky, among others, which are referred to collectively in this paragraph as Debtors, filed a voluntary petition for Chapter 11 bankruptcy in the U.S. Bankruptcy Court, District of Maine, on June 2, 2004. Debtors also filed an Adversary Complaint in the bankruptcy court against DIRECTV, Inc., the NRTC, and various officers and directors of the NRTC. The complaint seeks declaratory and injunctive relief, rescission of certain agreements between DIRECTV U.S. and NRTC, specific performance against NRTC, restitution, compensatory and punitive damages. On July 30, 2004, DIRECTV U.S. entered into certain arrangements with Pegasus, Golden Sky and certain other related entities, which are referred to collectively in this paragraph as Pegasus, whereby DIRECTV U.S. will purchase certain direct broadcast satellite assets of Pegasus, including rights to all DIRECTV subscribers activated through Pegasus. As part of these arrangements, Pegasus Satellite Communications, Inc., Pegasus Communications Corporation, DIRECTV U.S., The DIRECTV Group, Inc., NRTC, the creditors’ committee in Pegasus’ Chapter 11 proceedings and certain other parties also entered into a Global Settlement Agreement pursuant to which such parties have agreed, effective upon the closing of the asset sale, to release each other from substantially all claims outlined above between the parties, including the judgment entered in May 2004 in favor of DIRECTV U.S. against Pegasus.

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

These transactions are described in more detail in Note 12. Should the contemplated transactions be approved and successfully close, then the Global Settlement Agreement would result in the termination of substantially all of the litigation with Pegasus and related entities outlined above. Until such time, the parties have agreed to a stay of the litigation outlined above.

Satellites

The in-orbit satellites of the Company and its subsidiaries are subject to the risk of failing prematurely due to, among other things, mechanical failure, collision with objects in space or an inability to maintain proper orbit. Satellites are subject to the risk of launch delay and failure, destruction and damage while on the ground or during launch and failure to become fully operational once launched. Delays in the production or launch of a satellite or the complete or partial loss of a satellite, in-orbit or during launch, could have a material adverse impact on the operation of the Company’s businesses. The Company has, in the past, experienced technical anomalies on some of its satellites. Service interruptions caused by anomalies, depending on their severity, could result in claims by affected customers for termination of their transponder agreements, cancellation of other service contracts or the loss of customers.

The Company uses in-orbit and launch insurance to mitigate the potential financial impact of satellite fleet in-orbit and launch failures unless the premium costs are considered uneconomic relative to the risk of satellite failure. The insurance generally covers the unamortized book value of covered satellites. The insurance generally does not compensate for business interruption or loss of future revenues or customers. The Company generally relies on in-orbit spare satellites and excess transponder capacity at key orbital slots to mitigate the impact a satellite failure could have on the Company’s ability to provide service. Where insurance costs related to satellite components or systems that have suffered anomalies in the past are prohibitive, the Company’s insurance policies contain coverage exclusions and the Company is not insured for certain other satellites. At June 30, 2004, the net book value of satellites that were insured with coverage exclusions amounted to $275.3 million, all of which relates to satellites owned by PanAmSat, and the net book value of the satellites that were not insured was $1,403.2 million, $1,020.4 million of which relates to satellites owned by PanAmSat. Amounts for satellites owned by PanAmSat are included in “Assets of businesses held for sale” in the Consolidated Balance Sheets.

The agreement to sell the Company’s interest in PanAmSat may be terminated by the purchaser, KKR, if, among other things, there is a total loss of any one of certain specifically identified satellites in PanAmSat’s fleet, including satellites under construction and not yet launched, prior to the close of the transaction. Recent satellite anomalies at PanAmSat are described below.

On August 3, 2004, the secondary Xenon Ion Propulsion System (“XIPS”) on Galaxy 10R experienced an unexpected shutdown. XIPS is an electronic propulsion system that maintains the satellite’s in-orbit position, as its primary propulsion system. The primary XIPS on this satellite had previously failed and the manufacturer has determined that the secondary XIPS system has now permanently failed. In the absence of the secondary XIPS, this satellite can operate normally on its available bi-propellant fuel for over three years.

The Company does not expect this event to affect service to PanAmSat’s customers or to affect revenues from the customers on this satellite over the remaining life of the satellite. As a result, there should be no material impact on services, revenues or operations. In addition, the remaining fuel for the backup propulsion system should provide ample time to transition customers to a new or replacement satellite and substantially all of PanAmSat’s customer contracts would continue in effect on their terms on such new or replacement satellite.

As a result of the Galaxy 10R shutdown, the Company expects to accelerate its planned capital expenditures during the 2004 through 2007 timeframe to replace this satellite. Galaxy 10R is insured and a claim will be made under its insurance policy. Any insurance proceeds will be used to partially offset the replacement cost.

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THE DIRECTV GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

PanAmSat had already begun construction of Galaxy 17 as an on-ground spare for Galaxy 16. Upon the successful launch of Galaxy 16, Galaxy 17 will be available as a replacement for Galaxy 10R. PanAmSat also has contractual arrangements in place that would allow it to procure the construction and launch of an additional satellite.

Under the terms of the agreement for the sale of the Company’s interest in PanAmSat, the permanent XIPS failure on Galaxy 10R allows KKR to not consummate the transactions contemplated thereby. KKR is evaluating the impact of the XIPS failure on the transactions and is working with PanAmSat and the Company to address the effect of this event.

On April 2, 2004, PanAmSat announced that it would de-orbit its PAS-6 satellite, one of its in-orbit international spares, due to a failure in the satellite’s power system. As a result of this event, PanAmSat recorded a $63.3 million after-tax charge in the first quarter of 2004, which is included in “Income (loss) from discontinued operations, net of taxes” in the Consolidated Statements of Income.

On July 31, 2003, PanAmSat filed a proof of loss under the insurance policy for one of its Boeing Satellite Systems, Inc. (“BSS”) model 601 HP spacecraft after the secondary XIPS ceased working. During 2003, PanAmSat reached an agreement with all but one of the insurers and received $102.6 million in proceeds. In March 2004, PanAmSat reached an agreement with the last insurer of the satellite and received $26.9 million in proceeds.

On February 19, 2003, PanAmSat filed proofs of loss under the insurance policies for two of its BSS model 702 spacecraft for constructive total losses based on degradation of the solar panels. On December 29, 2003, PanAmSat reached a settlement with its insurers for payment to PanAmSat of $260.0 million. PanAmSat received the $260.0 million settlement amount during the first quarter of 2004 and plans on using these proceeds to replace existing satellites over the next several years.

The availability and use of the $26.9 million and $260.0 million of proceeds from the PanAmSat insurance claims, which are included in “Assets of businesses held for sale” on the Consolidated Balance Sheets, were restricted by PanAmSat’s credit facilities until the restrictions were lifted in June 2004.

As part of an arrangement with Telesat Canada (“Telesat”), a Canadian telecommunications and broadcast services company, DIRECTV U.S. agreed to provide Telesat the use of the DIRECTV 3 satellite, which is currently used as an in-orbit spare, through the end of its useful life and in return, Telesat agreed to allow DIRECTV U.S. the use of its 72.5 degrees west longitude (“WL”) Canadian orbital location. DIRECTV U.S. plans to relocate DIRECTV 5, or a similar satellite, to 72.5 WL to provide additional local channels and other programming in the U.S. through 2008. Both DIRECTV 3 and DIRECTV 5 are currently not in use for primary DIRECTV services. In the second quarter of 2004, the Federal Communications Commission (“FCC”) granted approval for DIRECTV 3 to be moved to a Canadian orbital location and used by Telesat. DIRECTV U.S. is currently awaiting approval for the use of 72.5 WL. If DIRECTV U.S. is successful in obtaining FCC approval to use 72.5 WL, the net book value of DIRECTV 3, which was $72.2 million at June 30, 2004, will be reclassified as an intangible asset and amortized over the life of DIRECTV U.S.’ right to use 72.5 WL. However, if DIRECTV U.S. is unsuccessful in obtaining FCC approval to use 72.5 WL, DIRECTV U.S. will be required to immediately expense the net book value of DIRECTV 3.

Other Contingencies

As of June 30, 2004, the Company was contingently liable under standby letters of credit and bonds in the aggregate amount of $44.3 million, which were undrawn at June 30, 2004.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (continued)

Commitments

At June 30, 2004, minimum future commitments under noncancelable operating leases having lease terms in excess of one year were primarily for real property and aggregated $363.3 million, payable as follows: $89.6 million in the remainder of 2004, $123.4 million in 2005, $64.7 million in 2006, $37.7 million in 2007, $30.9 million in 2008 and $17.0 million thereafter. Certain of these leases contain escalation clauses and renewal or purchase options. Rental expense under operating leases, net of sublease income, was $33.1 million and $29.8 million for the six months ended June 30, 2004 and 2003, respectively.

The Company has minimum commitments under noncancelable satellite construction and launch contracts, programming agreements, telemetry, tracking and control services agreements, billing system agreements, customer call center maintenance agreements and other vendor obligations. As of June 30, 2004, minimum payments over the terms of applicable contracts are anticipated to be approximately $2,917.9 million, payable as follows: $363.2 million in the remainder of 2004, $544.5 million in 2005, $651.1 million in 2006, $804.3 million in 2007, $531.2 million in 2008 and $23.6 million thereafter. Excluded from the minimum payments above is a commitment to purchase in excess of $1 billion of set-top receivers from Thomson Inc. (“Thomson”) during the first three years of the contract term based on current set-top receiver prices, as more fully discussed below in Note 12.

Note 9. Related-Party Transactions

In the ordinary course of its operations, the Company enters into transactions with related parties to purchase and/or sell broadcast programming, telecommunication services, advertising, equipment and inventory. Transactions entered into with GM and its affiliates prior to December 23, 2003 were considered related-party transactions. Other related parties include DIRECTV Latin America, LLC’s (“DLA LLC”) Puerto Rican and Venezuelan LOCs prior to their consolidation with the Company on July 1, 2003. As a result of the completion of the News Corporation transactions, beginning on December 23, 2003, News Corporation and its affiliates are considered related parties.

The following table summarizes sales and purchase transactions with News Corporation and its affiliates:

The following table sets forth the amount of assets and liabilities resulting from transactions with related parties:

Effective March 1, 2004, NDS Limited (“NDS”), a subsidiary of News Corporation, became the exclusive provider of conditional access products and services, including system access cards, a key component of the access security system in set-top receivers, to DIRECTV U.S. NDS will be responsible for developing and periodically replacing system access cards during the term of the agreement.

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Note 10. Severance and Retention Costs

As a result of the sale of HNS’ set-top receiver manufacturing business to Thomson in June 2004, HNS restructured its support functions to coincide with the resulting reduction in business operations. As a result, during June 2004, 228 personnel received termination notices and HNS accrued $12.1 million for severance and related costs to be paid to employees during the third quarter of 2004. See Note 12 for additional information regarding this transaction.

During the first quarter of 2004, the Company announced the reduction of corporate office headcount by over half as a result of a plan to consolidate corporate and DIRECTV U.S. support functions. There were also additional headcount reductions at DIRECTV U.S. and at DLA LLC. As a result, the Company recorded charges of $41.9 million and $3.5 million in the three months ended March 31, 2004 and June 30, 2004, respectively, in “Selling, general and administrative expenses” in the Consolidated Statements of Income. Total charges of $45.4 million for the six months ended June 30, 2004 are comprised of $21.2 million in severance costs and $24.2 million of related costs under the Company’s pension benefit plans. DLA LLC expects to record an additional $3.8 million during the remainder of 2004 related to severance benefits to be paid to employees who have been asked to continue providing services for periods ranging from three to twelve months. Substantially all of the severance benefits will be paid during 2004.

As a result of the completion of the News Corporation transactions on December 22, 2003, certain employees of the Company are expected to earn about $36.0 million in retention benefits during the 12 month period subsequent to the completion of the transactions. During the three month and six month periods ended June 30, 2004, the Company recorded an expense of $9.1 million and $20.7 million, respectively, related to these benefits in “Selling, general and administrative expenses” in the Consolidated Statements of Income.

Note 11. DLA LLC Reorganization

On March 18, 2003, DLA LLC filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware (“Bankruptcy Court”). On February 13, 2004, the Bankruptcy Court confirmed DLA LLC’s Plan of Reorganization (the “Reorganization Plan”), which became effective on February 24, 2004.

Also, effective February 24, 2004, the Company made a contribution of certain claims, loans, equity and other interests in LOCs selling the DIRECTV service in Latin America, and converted certain debt into equity, which increased the Company’s equity interest in the restructured DLA LLC from 74.7% to approximately 85.9%. Darlene Investments, LLC (“Darlene”), which also contributed its equity and other interests in various LOCs, holds the remaining approximately 14.1% equity interest in the restructured DLA LLC. The restructuring in bankruptcy and the contributions by the Company and Darlene provided DLA LLC with direct control of DIRECTV Latin America’s most significant LOCs and assets. As the LOCs were being consolidated prior to the contributions, the net result of these transactions was an increase in minority interests of $47.3 million.

Reorganization (expense) income reported in the Company’s Consolidated Statements of Income was ($1.8) million and ($4.1) million for the quarters ended June 30, 2004 and 2003, respectively, and $43.4 million and ($11.0) million for the six months ended June 30, 2004 and 2003, respectively. Reorganization income for the six months ended June 30, 2004 includes a $62.6 million gain as a result of the settlement of certain obligations in connection with the confirmation of the Reorganization Plan, partially offset by costs incurred to file the bankruptcy petition, legal and consulting costs and other charges related to the reorganization. Cash payments of $1.1 million and $200.8 million were made during the three month and six month periods ended June 30, 2004, respectively, to settle claims made during the bankruptcy proceedings.

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The DLA LLC Second Amended and Restated Limited Liability Company Agreement (the “DLA LLC Agreement”), as amended in February 2004, provides Darlene the right to require the Company to purchase all of Darlene’s equity interests in DLA LLC for $200.0 million (plus the amount of any outstanding debt of DLA LLC owed to Darlene). The DLA LLC Agreement also provides that the Company has the right to require Darlene to sell all of its equity interests in DLA LLC to the Company for $400.0 million (plus the amount of any outstanding debt of DLA LLC owed to Darlene). Such events are triggered if there is a combination of the business or operations of DLA LLC with substantially all of the direct-to-home satellite business or operations of Sky Latin America, an affiliate of News Corporation, or other events as described in the DLA LLC Agreement. For further information, see the Company’s Current Report on Form 8-K filed with the SEC on March 2, 2004.

Note 12. Acquisitions and Divestitures

Acquisitions

NRTC Contract Rights

On June 2, 2004, DIRECTV U.S. and the NRTC announced an agreement, effective June 1, 2004, to end the NRTC’s exclusive DIRECTV service distribution agreement to certain rural territories in the United States and all related agreements. As consideration, DIRECTV U.S. agreed to pay the NRTC $4.4 million per month through June 2011, or $322.1 million on a present value basis, calculated using an estimated incremental annual borrowing rate of 4.3%. As a result of this agreement, DIRECTV U.S. now has the right to sell its services in all territories across the United States. At June 30, 2004, the present value of the cash payments to be made to the NRTC was recorded in “Accrued liabilities and other” and “Other Liabilities and Deferred Credits,” with a corresponding amount recorded as distribution rights in “Intangible Assets, net” in the Consolidated Balance Sheets. The distribution rights intangible asset is being amortized to expense over seven years, which represents the remaining life of the original DIRECTV service distribution agreement.

NRTC Member Subscribers

In connection with the NRTC transaction described above, DIRECTV U.S. provided the NRTC’s 95 members, excluding Pegasus, the option to retain their subscribers with substantially the same terms and conditions as they had prior to the NRTC transaction, or sell their subscribers to DIRECTV U.S. for $875 or $1,050, per subscriber, depending on the member’s contract period, payable in a lump-sum or over five or seven years plus interest. Members may make their elections through August 31, 2004. As of June 30, 2004, 47 members, representing approximately 157,000 subscribers out of the NRTC’s total subscribers of approximately 357,000, excluding Pegasus, elected to sell their subscribers to DIRECTV U.S. As a result, at June 30, 2004 DIRECTV U.S. recorded liabilities in the Consolidated Balance Sheets in “Accrued liabilities and other” amounting to $83.2 million for members electing a lump-sum payout, which was paid in July 2004, and in “Accrued liabilities and other” and “Other Liabilities and Deferred Credits” amounting to $81.1 million for those members electing the long-term payment option. DIRECTV U.S. also recorded a subscriber related intangible asset in “Intangible assets, net” in the Consolidated Balance Sheets amounting to $164.3 million, which will be amortized over the estimated subscriber lives of approximately six years.

In July 2004, DIRECTV U.S. received elections from an additional 47 NRTC members, representing approximately 200,000 additional subscribers, who elected to sell their subscribers to DIRECTV U.S. As a result, DIRECTV U.S. paid an additional $90.1 million in July 2004 to those members electing a lump-sum payout and accrued an additional $119.1 million for those members electing the long-term payment option. As a result, in July 2004, DIRECTV U.S. increased the amount of the subscriber related intangible asset equal to the amounts paid and accrued.

In total, DIRECTV U.S. paid out $173.3 million in July 2004 for those members electing lump-sum payments.

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Pegasus Subscribers

In July 2004, DIRECTV U.S. entered into an agreement with Pegasus and related entities for DIRECTV U.S. to purchase certain direct broadcast satellite assets of Pegasus, including rights to all DIRECTV subscribers activated through Pegasus. DIRECTV U.S. will pay $875 million in cash, which is net of the approximately $63 million judgment returned in May 2004 by the U.S. District Court for the Central District of California in favor of DIRECTV U.S. The aggregate purchase price is $938 million prior to taking into account the reduction for the judgment. The purchase price will also be reduced for amounts owed by Pegasus to DIRECTV U.S. for programming and other services and is subject to certain other adjustments at the close of the transaction. The agreement, which has been approved by the creditors’ committee in Pegasus’ Chapter 11 proceedings, will also result in a release of substantially all claims among the parties. The transaction is expected to close late in the third quarter of 2004, subject to the approval of the U.S. Bankruptcy Court, District of Maine. The $875 million cash payment to Pegasus will be made from available cash balances.

During August 2004, the Company deposited $875 million to secure a letter of credit issued to facilitate the close of this transaction.

Divestitures

PanAmSat

On April 20, 2004, the Company and PanAmSat announced the signing of a definitive agreement that provides for the sale of the Company’s approximately 80.4% interest in PanAmSat to an affiliate of KKR for about $2.84 billion in cash. The Company recorded the expected loss on this transaction of $478.6 million, net of a tax benefit of $291.0 million, in the quarter ended March 31, 2004, as a charge to “Income (loss) from discontinued operations, net of taxes” in the Consolidated Statements of Income. During the second quarter of 2004, the Company’s investment in PanAmSat increased as a result of net income recorded by PanAmSat during the second quarter. Because the sale price is fixed at about $2.84 billion, and the Company’s investment in PanAmSat increased, the expected loss on the transaction also increased by $41.4 million, net of a tax benefit of $6.9 million during the second quarter of 2004. The total expected loss of $520.0 million includes an estimate of direct costs associated with the transaction and retention of certain tax liabilities for which the Company has agreed to indemnify PanAmSat. The transaction, which has been approved by the boards of directors of the Company and PanAmSat, is subject to satisfaction of the conditions described in that agreement, including, among others, applicable U.S. and foreign regulatory approvals and approval by the stockholders of PanAmSat. The agreement may be terminated at the option of KKR if, among other things, there is a total loss of any one of certain specifically identified satellites in PanAmSat’s fleet, including satellites under construction and not yet launched, prior to the close of the transaction. Total loss per the agreement is defined as a satellite that is lost or destroyed or its actual operational capability is less than 50% of its stated operational capability.

As more fully discussed above in Note 8, on August 3, 2004, the primary propulsion system on Galaxy 10R experienced an unexpected shutdown that the manufacturer has determined is a permanent failure. This satellite can, however, operate normally on its available bi-propellant fuel for over three years. Under the terms of the agreement for the sale of the Company’s interest PanAmSat, the permanent failure on Galaxy 10R allows KKR to not consummate the transactions described above. KKR is evaluating the impact of the failure on the transactions and is working with PanAmSat and the Company to address the effect of this event. Subject to the outcome of this evaluation, this transaction is otherwise expected to be completed in the third quarter of 2004, at which time the Company will receive the approximately $2.84 billion in cash.

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As part of the transaction for the sale of the Company’s interest in PanAmSat, the Company has agreed to enter into or cause its subsidiaries or affiliates to enter into certain commercial arrangements with PanAmSat. These arrangements include, among other things, entering into new lease agreements and the extension or amendment of certain existing transponder lease agreements.

Operating results of the discontinued operations of PanAmSat are as follows: