BT Group, Q1 2006 Earnings Conference Call Transcript (BT)

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BT Group (NYSE:BT)

Q1 2006 Earnings Conference Call

July 27, 2006 5.00 am EST


Ben Verwaayen, Chief Executive Officer

Hanif Lalani, Finance Director

Ian Livingston, Chief Executive Officer, BT Retail

Paul Reynolds, Chief Executive Officer, BT Wholesale

Andy Green, Chief Executive Officer, BT Global Services

Steve Robertson, Chief Executive Officer, BT Openreach


Mike Williams, Citigroup

(Steve Malcolm, Harris Hale?)

Sam Morton, Dresdner Kleinwort

Chris Fremantle, Morgan Stanley

Morten Singleton, WestLB

Matthew Glocson(?), Deutsche

(Breda Taaffe?), Dow Jones


Ladies and gentlemen, welcome to the BT Center Auditorium. Can you please make sure that you have all your mobile phones and pagers switched off. There are no fire alarms planned for today, and, in the event of an alarm sounding, will you please leave the auditorium by the two fire exits at the front of the room.

Ben Verwaayen - CEO

Good morning and thank you for coming. I know it's an extremely busy day. Many, many people reporting, but I think you've chosen the right one to come to, because we have some good news to tell you. First, I want to draw your attention to this wonderful slide. Our lawyers have worked very hard on it, as always, and I am sure you will read it maybe during the coming weeks when you're at a place of leisure. So let's talk about our business. I think this is a chart that I wouldn’t mind putting up every single time. All the arrows are up and they are green and I think they tell the story of a strong momentum in the business. This is a story about not just growing the business, but growing the business in a profitable way. This is about confidence in continuation. It's about the ability to perform in a changing market and making the change happen in the company while we speak. I would like to draw your attention to the last one, the free cash flow. It is £100 million better than a year ago. So I think we have done pretty well here. Now, if you want to look to the balanced picture, this is an important one. We have been talking about EBITDA for a while, and you see it's growing. It was positive in Q4, 0.9%. It's now almost double that. I think it's a good line.

It tells you the story that in the mix, where we know that if you replace existing traditional business, with new business, for a while you have to suffer on the EBITDA line. But we have now mastered that art. Look to our revenue growth, it's now ten consecutive quarters of growth. It becomes almost a boring slide, it become predictable and it's a good thing. It's a good thing. More important, if you look to the composition of the growth. You've seen the New Wave business outperforming the fall in traditional now for a while. If you look to those numbers, there are two remarks I would like to make. First of all, the increase in absolute terms of the New Wave has been consistent over the last nine quarters, of approximately £250 million every single quarter. The other observation that I'd like to make is the decline in traditional was £123 million in quarter, so that is half of the increase in New Wave. I'll say it differently. Our New Wave business is growing at twice the rate of the decline in our traditional.

Change happens in the market and change happens in our mix. This slide has two change messages. The first message you've heard over and over and over again. That is, that we are winning in the enterprise market, we are winning in the B2B market and we are pretty consistent in where we are in the consumer market. That's 26% now and profitable. More important is the other message here, look to New Wave and the growth of New Wave. And look to New Wave in consumer business, it made a jump from 8% to 14%. And it's also now really, really important in our SME business. So the change is not just to whom we sell, but what we sell.

Let's talk about our customer segments - let's talk about corporate. I think it's a very strong message for us to give to you in a market where you've seen many, many messages. Our message is that we are in the right spot at the right time with the right product set. We're growing 6% to corporate, which means that New Wave is double digits. And we have - we eat our decline away, so as to say, in our traditional business. It's important to see that we are adding customers outside the UK. More than 200 - 230 branded companies not being a BT customer before added to the list this particular quarter. It is important to note that our order intake of £1 billion is a good performance. Yes, we have those big contracts, headline contracts, very hard to focus them on any particular quarter. They happen when they happen. If you take that out, that £1 billion is a very strong number in the market. And there is consistency that we grow not just here in Europe, but in America, Asia Pacific, we grow around the globe. 96 countries are reached by our MPLS. We have added 17 cities over the last three months. I think we have a capability here that is pretty unique. Instead of me trying to convince you, it's probably better to listen to what our customers have to say.

[Video Presentation]

So from Azerbaijan to Zambia, I really like that. And it's not just individual customers who say that. If you look to the watchers of the industry, they all recognize that we participate in a market that is changing the face of our industry. It is convergence working in real time. If you look to where we get our accolades, it's not just on the strategy, it's on very mundane things, such as where do I get my service. Is there a local helpdesk? Can I get services that really help me to transform my business? And a transformation of the business is not just happening in the corporate world. It's also happening in the small and mid-sized markets. I think this is a great chart, because in living memory, we have not been able to tell you that we would increase our revenue in the SME market. Well here we are, it's happening. And I don't think that for the last couple of years, we could talk about stabilization of our market calls market in the SME. Well here we are - it's happening. Over 500,000 sites in the UK now having the BT business plan. That's a great basis for doing much more with that customer base. That's our story. Our story is the expansion into new areas that help businesses, small, mid-size and large, to do much better in what they want to do.

If you're a small company, you don't want the hassle. You want to get on with your life. You're on the move, you're an agile organization, and what you want is to get a partner. Most of those guys, they have Bob. Bob lives around the corner and comes in with a big screwdriver and helps you at a time that's convenient to Bob. Well we're going to compete with Bob, because we have something in the box that helps you to do the job much easier, seamlessly and brings you all the great stuff, downloaded. If you're Bob, watch this.

[Video Presentation]

In addition to what we do for corporates and the SME market, we have a whole bunch of specialized companies that deal with niche markets in the B2B market. We don't talk about it too much, but if you add it all up, you're talking about a business of £700 million plus in revenue, over £100 million in profits and growing, growing very nicely. Why don't we take four out of those companies and talk about it a little bit. BT Conferencing - Frost & Sullivan and comes out just recently and tells the world that BT Conferencing is the fastest growing conferencing business worldwide. We grew in quarter 32%, 40% growth in the U.S, over 300,000 customers in BT conferencing. Well let's look to BT Expedite. Retail markets, we talk a lot about the financial markets if we talk about Andy's business. Let's talk about the retail business. What is the issue there? It is IT solutions on the work floor. Real in shops. Where can we make a difference? How can we make a difference? Well guess what - Electronic Point of Sale terminals and systems is what BT Expedite does. And we're winning. We're winning great names and it gives a capability much further than just the point of sales.

It gives us new technologies like RFID, those tags that you can put on stuff. A better, much more efficient and much more forward-looking inventory management capability. And we have household names all over. European brands and we think that this is a market that has a great promise. It's not the first thing you think about if you talk about BT, but you should give it a thought. As you should give a thought next time you see the Emirates stadium, and you no doubt will see that often. You'll see great football from Arsenal, what should you remember? You should remember that BT RedCARE has the contract for the CCTV environment there. Many, many different markets, many, many different offers and a great growth potential. The latest additions,, has been terrific. Since they're on board, they give us the ability to sell the combination of the BT service and hardware through the channel to market. And I think you will see that that is a great way to reach part of the markets that in the past we had difficulty getting at. It seems to me that everybody always wants to talk about the consumer business, and I understand that. It's a great business. It's a great business for us. It's 26% of what we do, as you have seen. But it occupies the mind, so let's talk about consumer markets.

We have great stories to tell here as well. Let me start by the contracted business. This is no longer an impulse business. 68%, which is 3% higher than a year ago, 1% higher than last quarter, is under contract. The second thing you see here is the ARPU is up. If you would do the calculation quickly, you would see it 35% up over a year ago. That's important, because the consumer market is not one blanket market. It's not one market, there are segmentations in the market. This telco market that we knew from the past is no longer there. People make choices based on very, very different appreciations of the various elements in the market. Yes, there is a price market that's there. It's very crowded nowadays. There is a value for money market, and we are, I think, occupying that part of the market. As you have seen, when we talked about the SME market, we had a great performance in that market on broadband and people buy the higher packages.

The same is going on here in this particular part of the market. People look to BT for much more than a dumb pipe. They want to have the services. And that's how we have positioned. I think we've positioned it very well. First of all, know your facts. It's not official - the BT retail broadband network is the best in the country. It's now official. Independent research has brought that to bear. Now, the packages that we have introduced, I would say are also very clear. This is all about added value. This is not just a pipe, this is the 'so what' of the pipe - what can you do with it. And we have communicated against price, the word 'complete'. You can have your solution and don't worry about the rest. Every new service that will come along will be a software download. No more hassle, it's all about services. It's all about services. And the service capability of BT total broadband is second to none. Interesting to note, when we engage with the customers, there is a tendency - a clear tendency - to go to the higher packages which is good for us and I think it's great for customers.

Now if you look to this picture, you've seen it before, we're adding new services as we speak every single time. Now what we do is we take, every single time we have this wonderful quarterly review, we take a subject and talk about it a bit. Voice over IP has been, for a long time, an issue that you've put if you were on that side of the room on the negative issue, on that side of the room it was a positive. Now let me look to where the reality is. We're talking about getting a million customers. A million customers in the next 12 months on VoIP. Because we think it's a great thing. It's a tool to combine services and to do something that is what customers really want. Let's get the hassle out, making sure that I can really use what I want to use when I want to use it and how I want to use it. And the other part of the explanation of what is the difference is in the introduction of the video element. Voice, data and video, combined, is what broadband is all about. It's not high speed internet access. It's about the choices you have to bring whatever you want on whatever terminal in whatever way or form you want. That is what broadband really is all about. Now, BT Vision, we've talked about it and you've seen these wonderful additions. It's all about variety and choice. And it will be an experience. That is the next generation in personalized TV.

But yesterday we made an announcement, and I would like you to look at the announcement in 55 seconds.

[Video Presentation]

So what is the significance of this? I think there are three extremely significant points. The first one is what you heard the guy from Universal tell us. We, from the media industry, he said, reckon that broadband is a transformational tool on how we go to market. The second 'so what' of this is that it gives BT Vision access, not just to your PC, as it will as of Monday, where you can download great movies just out of the cinema at the same time as otherwise you had to go to a high street shop to get it, for a very attractive price, very, very attractive prices, but it will also be able to take that download and bring it, when we have BT Vision, to your TV. If you have to wait for pay per view, as some of the other guys, you have to wait three months longer. The window is three months earlier through this mechanism. What is important here is that it gives choice a different meaning. Where we start here with Universal, and we're very happy to have a brand like that choosing BT because of our capabilities on streaming and the rest of the capabilities you need to bring that to the homes, I guess that we will have thousands of titles in the months coming forward.

So what you see here is an expansion. It's not just another site. It's an expansion of what the media and the communications industry are willing to do together. So if we look to the market, how about wholesale? An important part of our market, and interestingly enough there are fascinating trends there. First of all, Openreach is open for business and I know that there was some suspicion in the market about whether we could deliver. I think Steve Robertson and the team have done a tremendous job and they're recognized all over the industry. We have delivered what we said we would and the business is a business. It's a very deeply, intensely regulated business. Everybody knows what to do and what to expect. I think this business is delivering. We have real customers, 15 LLU customers, we now have LLU in, if I'm not mistaken, 932 exchanges with an average of seven in the exchange. We have plans to go to 1240 exchanges and it's all working. Mass migration will be working until September, so we are delivering from a BT Openreach point of view what we said we would. It's done on an equivalence basis. I think that's terrific, because it takes a lot of stuff out of the market, I mean blaming, finger pointing and the rest.

It is a normal market, it gives us all the certainty and security that you want and the other side is we get of course on the retail level our deregulation and also delivered. In wholesale, there is a fantastic, interesting move. It says here 'managed services'. Basically, what it does, it gives people now the state of mind that they say, let's see what we really want. How do I want to go to the market? Should I do it myself? Should I make all the investments, take the operational risk, or should I go as managed services? And BT wholesale is now in a much better position to be a normal partner to have those discussions. You will see going forward, with 21CN, when we're going to talk about it in a minute, that we will get an expanded capability in services to offer to the market. So if you are a new mobile player, or you're a new broadband player, or you are just a CPS player, you can now choose and say I'm going to do it myself, or you know what, I'm not going for it, I'm going to Managed Services. This business will grow and it will be substantial business, where you'll see competition on one side in the market when it comes to the consumer business, and very much cooperation on the network part.

And the capabilities and the next generational services will make this market more attractive. Of course, the market to look at is the broadband market and you'll see where we are today is, this Summer, 9 million. I just want to remind everybody that three years ago, there was a big party here. You were part of it. You may not have noticed, but there was a big party here because we celebrated 1 million and we had a big bet out whether we would reach 5 million or not and there were people that were saying, read your own notes back, please, saying 5 million? Forget it, won't happen. 9 million this summer. I think what you see is two things here. 40% of households in the UK now have broadband. Two ways to look at it - 40% means 60% don't. It's a great market opportunity for us. Or you can say 40%, so there must be a slowdown somewhere going in the market in the S-curve. I think what you see it that this is a market, as you said before, driven by campaigns - very much driven by campaigns - where the variety of offers will increase and broadband will be no longer a single product in and by itself. People will get broadband on the back of services they buy. Unless you really want to go for a pipe. So there will be an interesting next phase in the market and I think this will be a growth market for some time to see.

Let's talk about the next subject, 21CN. Is it real? Many people have asked. We thought it was good to give you some facts. The first fact is over 3,000 people in BT are full time now, engaged in 21CN. It is really working. Over 23 million calls over the last couple of months have been done over the network configuration that we call 21CN, the equipment that we put in 21CN. You haven't noticed a beep - that's very good news, it's working. Full IP, end to end, it's working. 23 million calls. We have a full consultation with the market and we expect in the coming weeks to have those streams resulting in work plans with the other suppliers in the market. We go to the next big thing, we go to Cardiff, we go to our 350 in November and I think we are making steps that will help us to deliver something much more important than just the core network. Although that's very important to do, the converged core network is very important to do. It gives us the savings that we've talked about and the capability to have a streamlined portfolio. We have now adjusted the 158 products in voice and data and we have been able to eliminate 30 products because we have better products, better new products than the old products.

But it is much more than that. I want you to look at this, because what's the relevance of 21CN? We've talked about this part. Building a new converged core network where voice, data and video can go all over the way, as you see fit. But the more important thing than the core infrastructure, is the capability to bring new products to the market very, very fast. Where we had months, you talk about weeks, and where we had weeks you talk about days. Because common purpose capabilities are in the process of being developed and we can add the know-how and the creativity of others to this. Therefore, it is important to have a core infrastructure. It's important to have the corporate willpower to create common capabilities that we use all across. But the most important thing is to talk. That is the customer integration. That is what we can do for customers by having a softer layer around it, and everybody who can program around the globe in an open architecture can put their creativity on top of it and bring services to our marketplace that can use 21CN just by clicking on an icon and bringing that capability into that programming.

That is working, I can demonstrate to you today, by announcing that we have our first licensing agreement in the market around 21C. This is not hardware put together in a smart way. This is about our own capabilities, creativity, software developments that will really define how the world will look through this capability. 21C in itself is a guarantee for innovation. Now, great to talk about the market, great to talk about all that stuff. It will work better if you have a very good cost management and we do have a very good cost management. We promise you over £400 million this year and we delivered it last year. We are very good at it, and we also have delivered a Q1 that is in line with that. The good news is every single one of our businesses has contributed to that. I can dwell on it and give you all the examples: let me take two just to give you a feel for where we are. First of all, when we talk about faults in the network, down 9% this quarter, that's a fantastic saving that is just more than a saving from a cost perspective, it's also a saving that you can make from a customer services perspective.

The second example is what we do on global sourcing. We sell the world the capability to go wherever they want to go. And we use that capability ourselves more and more and more. And it will give us best in class performance and it gives us the flexibility that we need going forward. So we're on track on the cost. Now, you know this chart, because last time we used it as well. There are a few alterations here. First of all, we have adjusted the numbers because 17 is better than 16 and 10 is better than nine. Six is better than five. And I think you will agree with that. The second thing we said is yes, we have a strategy and we haven't shown you the strategy chart this time. I apologize for that. We haven't said 'trends are your friends' so I apologize for that. I've said it now. And yes, we are consistent in winning business but you know, how confident are we? We are confident. I think what you see is a business that is much more than one single product. If you go through the numbers, and I think they're terrific numbers, and you dig and you dig and you dig, you can always have a debate about a certain number against a certain prospect and you can find yourself the evidence for feeling how you want to feel.

It's certainly out there, so I want you to feel sunny. You can always find that. But if you then take two steps back and say, where's this company going? You can see that we do not depend on one single product. We do not depend on one single development. This company has now built itself the space by great cost management, by growing our business, by having the capabilities to look to our margins. We have given ourselves the capability to deliver what we said we would and are not dependent on every single part of our business always to deliver. That's great, because it gives us the confidence to end this presentation. My part of the presentation, the Q1 results underpin what we said for the year and we are very confident to deliver that. Hanif?

Hanif Lalani - Finance Director

Thanks, Ben. Good morning everyone. Our Q1 performance builds on the momentum from last year. These are strong results and underpin the confidence we have in the outlook that we provided you on May 18. Overall, group revenue rose by 3%, with declines in Retail and Openreach, more than offset by growth in Wholesale and Global. Group EBITDA pre leavers grew by nearly 2%, with each line of business EBITDA performance in line with what we shared with you last quarter. Depreciation and Amortization was £6 million lower, resulting in an operating profit of £683 million pre leavers. Operating profit margins increased by 0.2 percentage points on last year, to 14%. This reflects higher revenues, but importantly improving cost management across all lines of business. Leaver costs were £18 million higher than last year's very low levels. Net finance costs were £96 million lower than last year. This was due to a number of factors, firstly stronger cash flow generation in the business, resulting in lower net debt. Secondly, refinancing high coupon debt reduces our average interest rates. Thirdly, pension interest credit that I shared with you last quarter, and fourthly mark to market movements on derivatives.

So profit before tax and specific items were £615 million, an increase of 20%. Our effective tax rate reduced by 0.7 percentage points to 24.5%, resulting in an EPS before specific items increasing 24% to £0.056. Let's move onto cash. Free cash flow was more than £100 million better than Q1 2005, reflecting our focus on working capital, interest and tax management. These benefits were partially offset by higher capital payments. The rise this quarter in those payments does not change our guidance on annual capital expenditure, which remains at around £3.1 billion. Net debt at £7.7 billion is 5% lower than last year. Let's now move to each line of business performance. Firstly, global services. Revenue increased by 4% to £2.2 billion, driven by growth in New Wave services, which now account for 55% of the total revenue. Increased revenue and ongoing cost reduction programs result in EBITDA improving by 3% YoverY to £228 million. Leaver costs were £15 million higher as support headcount reduced, reducing in an operating profit of £63 million, £4 million lower than the prior year.

BT Retail, traditional revenue declined by 8% whilst New Wave revenue grew by 31%, predominantly driven by broadband. New Wave now accounts for 19% compared to 14% at the same time last year. And although revenue fell by 4%, gross margin grew by 4% to £560 million, an increase of 1.8 percentage points compared to last year. This was driven by effective margin management and a focus on reducing our cost of sales. After holding SG&A costs flat by continued efficiency improvement, EBITDA before leaver costs was 15% higher. The fourth consecutive quarter of EBITDA growth. And despite the £6 million increase in depreciation, operating profit of £140 million was 16% better than last year. Let's move onto BT Wholesale. Revenue of £1.8 billion increased by 2%, driven by growth in external revenue of 3%. External revenue was boosted by a 21% increase in New Wave services.

Internal revenue also increased to £850 million due to growth in broadband, more than offsetting the impact of lower prices and lower call volumes. Gross variable profit at £927 million increased by 5%, as a result of a change in sales mix and increased revenues. Network and SG&A costs rose by 8%, as cost savings in the network efficiency areas were more than offset by opex investment in the 21CN and a growth in broadband volumes. Overall, EBITDA before leaver costs increased by £10 million to £478 million. Higher depreciation due to shortening of the economic life of legacy transmission equipment has resulted in a £5 million decline in operating profit at £192 million. This is the first time that we're reporting on Openreach separately. Revenue was £1.3 billion, a decrease of 3% on the prior year. This was driven by regulatory price changes to both of its key products, LLU and WLR. The impact of WLR price reductions will reduce throughout the year, with an impact in Q1 of £63 million. The volume shift from internal channels to external channels means that external revenue increases by 145% and the internal revenues decreased by 9%.

Operating costs in Openreach at £787 million were held flat, despite the increased infrastructure cost of supporting Openreach, volume increases in activities and inflationary rises. And this is due to the fact that Openreach itself has a variety of cost reduction programs throughout its business. Overall, there was a £35 million decrease in EBITDA before leaver costs. Depreciation was £11 million lower due to the lengthening of the useful life of copper, consistent with the Ofcom methodology. Q1 operating profit of £295 million was £26 million lower than last year. Capex rose 5% to £271 million, driven by the increased expenditure in systems to deliver equivalence. Finally, EPS remains one of the ultimate measures of our performance and in Q1, we delivered our 17th consecutive quarter of YoverY growth. We have established a track record of delivering across a number of key financial parameters. These improvements have been underpinned by positive operational trends across the group, both in the UK and abroad. We remain committed to extracting efficiencies through process improvements, through cost transformation programs and our success in executing our strategy stems from our ability to be innovative and competitive and responding to customer needs. All of these combined with financial discipline, gives us the confidence to say revenues, EBITDA and EPS and dividends will growth through this year. Ben?

Ben Verwaayen

Right, so we're going to some of your comments and questions.

Questions and Answers

Q - Mike Williams, Citigroup

Good morning, it's Mike Williams from Citigroup. I just have a question on Global Services. There's little evidence so far of margin expansion, despite order intake slowing down for two consecutive quarters. I just wanted to check that your medium-term margin guidance in excess of 15% at the EBITDA level is still intact. Perhaps more importantly, when should we expect to see that margin improvement coming through in the numbers? Thanks.

A - Andy Green, Chief Executive Officer, BT Global Services

We're sticking to the medium term guidance and we've said that we expect that the EBITDA will accelerate over the year and Ben said we were sticking to those numbers. So we're seeing continuing decline in the traditional business in the UK, offset by revenue growth around the world and the services business growing. I think you can see from the results that are being published around the world and we're continuing to win in the marketplace, in sharp contrast I think in our non-traditional business with what's going on in many of the services companies between 10% growth in the non-traditional area which compares very well with everybody in the I.T. services sector. And the overall growth of 4%, you know, contrasts pretty starkly with the 7% decline in France Telecom's enterprise unit, put out this morning.

A - Hanif Lalani

Mike, I'm sure you've realized, with the creation of Openreach we've also pushed out a lot more cost out of the center, into the lines of business. And you'd expect every finance director to make the life of their CEOs in the lines of business harder, so I have taken a percentage point of margin away from Andy, so if you look at the pre and post restated numbers, you'll have seen that it's gone from 11% to 10%. And therefore getting to 15% is an even harder task. Thank you, Andy.

Ben Verwaayen

Right. Some internal interesting debates there! Over here.

Q - Participant

Can I just come back to that, firstly the Global Services question. Presumably that means the 15% is still intact and not 14%? Is it? Just to check?

A - Hanif Lalani

Yes, it's intact.

Q - Participant

In terms of the ISPs, there's a lot of focus there on services from the ISP side on retail for Ian. But, are you counting out in the urban areas that are moving to a cut price brand, for example, or a separate branding from current, or should we assume that you're going to stick with the higher pricing point plus video, for example? Plus Vision for BT? Particularly after the Sky launch, for example.

Ben Verwaayen

Ian can't wait to stand up.

A - Ian Livingston, Chief Executive Officer, BT Retail

I was surprised it wasn't the first question, actually. Look, it's not so much a higher price point I think, certainly the value message is proving very popular with our customers. BT total broadband has gone down well and it's very interesting to look, you know, really important because all of you people being London-based won't understand what's happening out in the rest of the country. We actually offer a national proposition and that's really important as well. Because it's all very well to say to people in London or Manchester or even Glasgow, you can get this price, but the rest of you have to pay £18 or something a month to get it. So I think a couple of important things. National proposition and go for value. The market may change, but that seems to be something that's pretty popular with our customers. And also, we do also want to make a profit as well and it's something that we think would be very profitable for our shareholders and really good for our customers. Because we're sending out the BT hub, we can add more and more services all the time to it. Making an investment today to allow us to deliver more and more services over the course of the months and years to come. I think that’s the right model rather than treating it as a dumb pipe today.

Q - Steve Malcom, Harris Hale

I want to labor the point on broadband, to your frustration I'm sure. In the 923 exchanges that are being unbundled, can you just give us an idea of what you think broadband penetration in those exchanges already is? Secondly, from Openreach's perspective, can you sort of give us an idea of what LLU churn is? Because looking through the numbers, it looks quite high amongst customers. You know, how many gross connections do you need to get for those net numbers? And thirdly on IP Stream pricing, can you just update us on what the rules are regarding when you go to 1.5 million lines, how you think the average web prices might go, because I know Ofcom made some quite hard to pin down rules. Thanks.

A - Paul Reynolds, Chief Executive Officer, BT Wholesale

I think two things for me. Firstly, the broadband penetration. I mean, the national figure is about 40% of homes. There's huge headroom yet for marketing growth. In the central areas, it's a bit higher. It depends where you go - 50-60%. 50-55% can be achieved and 40% nationally. On the IP Stream thing, and pricing, the commitment we gave was a voluntary hold on price changes until 1.5 million lines of LLU. LLU is growing well, so that looks like it's going to happen at the end of this financial year and we're already in advanced planning as to what the changes will be. Clearly, as I said last quarter, the prices are going to come down.

Q - Steve Malcom, Harris Hale

How far can you bring them then, because I think you said you made a commitment to Ofcom about the level of the averaging and it's quite hard to find where that commitment is.

A - Paul Reynolds

There's no specific limit, but you know, clearly there's considerable scope for it to come down. It's a scale business and IP Stream is a platform built at quality and built at scale and there's a volume growth that gives us the capacity to reduce. So we will be able to compete. I can't give you the figure.

A - Ben Verwaayen

It's important, because it's not just for BT retail, but there are many, many other suppliers in the market of IP services that rely on the fact that they can keep competing in the future, and we have made no secret about it. We'll develop new services, new capabilities, managed services, to help them also to thrive in a changing environment. So you can expect that.

A - Ian Livingston

In addition, churn is quite an interesting one. The market now is very volatile. I mean, obviously there's a lot of offers out there. We're seeing very strong demand for LLU. Over the next year, I suppose our plan is roundabout 30% churn rate but let's understand, there is a lot of stuff happening in the marketplace to make customers more sticky. And the contractual arrangements really are right across the piece. I think it's a very immature market just now, but round about 30% we expect in the year. But I think it's going to be an interesting one to keep our eye on.

Q - Participant

Good morning. I've got three really boring numbers questions, actually. The first one is looking at the new cost disclosure you've given in the KPIs, we can see that your own work capitalized was up about £60 million YoverY yet capex was quite flat. Can you just give us some color on why that might be? Secondly, on depreciation, it looked quite low in the quarter. Should we expect that trend to continue for the rest of the year? Thirdly, can you just comment on whether the sort of start up unbundling fees that you're getting from some of the unbundlers at the moment are significant in the numbers?

A - Hanif Lalani

Starting with own work capitalized, if you flip to the press release and look at the capex pages, you'll find the software line. In the software line you'll see a substantial increase in expenditure, and that really relates to expenditure to develop equivalent systems. That expenditure effectively has been contracted with our One IT organization, some of it being our people but a vast majority of it being programmers outside the UK. It's that line that's feeding through as own work capitalized. So it's not anything to do with putting more people into capital work or anything of that nature. It's purely to deliver software, the majority of the work being done by third parties, it's within the capex line and the capex is being prioritized to deliver the strategy of the Group. And as I mentioned earlier, we're sticking with the £3.1 billion capex line. On depreciation, as I took you through, there are lots of different factors this quarter that affect it. Shortening of lives and lengthening of lives, assets we can fully depreciate, so net/net I would expect throughout this year that the rate of depreciation will increase year on year at the same levels that we saw last year, which were around 1.4-1.5%. The last question was unbundling - I think on unbundling, I think it's about products and services. If I go back a year, we introduced WLR 18 months ago. If you go back two years, we introduced CPS, so every year or 18 months there'll be new products that come into the market, that have connection fees, they have migration fees, they have cessation fees. So I think you'll see new products now and you're going to see new products in the future. These items are not significant. We tend to kind of assume that as one product dies, another product comes along. So there's nothing exceptional in that/

A - Ben Verwaayen

You saw, maybe in the press release, when you look to the next generation of products, they already announced 24Mb broadband, next generation IP connect, backhaul for LLU - the pipeline we've given you also gives an insight on what's coming.

Q - Participant

Can I just clarify what you said on churn before. Are you saying that broadband churn next year could be 30%? Or am I missing something? That seems quite a high figure.

A - Ian Livingston

That question was specifically around LLU. On the 30% number, just to be clear, it's the sort of range that we're planning for, and as I said to you, it's a very immature market. We have to wait and see how the various contractual arrangements play out in practice. There's a big impetus in the market…

A - Ben Verwaayen

But that's something else than the broadband position.

A - Ian Livingston

But that's something totally different.

A - Ben Verwaayen

But it's the way how you present the broadband, how you bring it to homes. If you decide that you no longer will do LLU but you'll do managed services, it's churn for him but it's not necessarily churn in the retail market. So you have to be careful there.

Q - Participant

I understand that now. Just a couple of questions, firstly is it fair to say the mobile strategy is not really working at the moment and probably needs to get a bit more traction in the marketplace? What is your thinking on that? Do you think you need to make a bigger investment or change the proposition somewhat? And then secondly on the balance sheet, now that SMP have downgraded you, what sort of headroom would you have from here to consider either extra gearing or investments and staying within that current rating?

A - Ben Verwaayen

Before I give Ian the floor on the mobile, let me give you one piece of insight. The Philips contract which was a great contract that we signed this week, is not only coping with the traditional data and voice services, 40 countries a year, it also includes all the mobility parts. Convergence means that it doesn't matter how you're going about, it matters that you give people the capabilities where they need it, when they need it. So on the move, people want to get an access to the same type of information they find behind their desks. That's what we're delivering there. So I just want you to think about the traditional way of looking to the market as a fixed and in mobile is less and less real. Ian?

A - Ian Livingston

A year ago when we talked about Fusion becoming, we got pooh-poohed by so many mobile companies - it wouldn't work, it would never come, it would be the size of a brick, why would anybody be interested in convergence, 3G would rule the world - and life has changed. And now every mobile company suddenly is a convert to convergence. So I think in terms of strategy, and strategy has shown itself to be absolutely right, and of course mobility is far more important than mobile. What's happening in WiFi city is we announced a dozen WiFi cities we're going to do. We think WiFi is going to be really important. We've got between 7,000-8,000 hotspots, we've included it in our proposition, it's growing exponentially, it's really important. On Fusion, we said that's device one, and that's true. I would have liked to see the WiFi Fusion devices coming a little bit earlier, I think they're going to be Autumn. And we expected that growth into it. And we are expecting to see also a number of other people coming with similar sorts of devices and that's going to be great. One of the problems and confusion is spending your time explaining what it is, or spending your time promoting the proposition. It's quite difficult to do both. It's item one, we very much said that this would be an S-curve. You're going to see, coming in the Autumn, lots of different propositions, lots of different devices, WiFi based, for consumer, for business, and we feel that this is absolutely a market. The conversionability market to give you the same capabilities when you're at home, when you're on the move or when you're on the pause, it's exactly the right strategy and you'll see us continue to invest in it.

A - Andy Green, Chief Executive Officer, BT Global Services

On SMP and ratings, bbb+, you're right, I mean it gives us additional flexibility and additional headroom. I think if I asked three different banks here, I think they'd all come up with a different answer so I think it is quite subjective. The most important thing is it gives us a lot more choices.

A - Ben Verwaayen

That's a very sophisticated answer. I have to say I have a less sophisticated answer. I give him a hard time because I'm not smart enough to understand. Our company, for three or four years, had a massive problem with the balance sheet, a debt level that was almost killing the company and a strategy that was not clear, at least to many of the outsiders. It has a great capability now, a fantastic balance sheet, a lot of choices, it has a strategy that gets, for most of the people, at least the benefit of understanding what we're doing and clarity and performance. That's the time to downgrade. It's very difficult to understand. But my friend here has a better answer than I've just given you.

Q - Sam Morton, Dresdner Kleinwort

On 21CN, I saw some speculation that the turnout of the PSTN had been delayed in favor of an ADSL 2+ rollout? What are the cost implications on the back of that, if it's true? And secondly, in terms of BT Vision, are you able to give any sort of subsidy number on the set top box at this point?

A - Paul Reynolds

First of all, 21C, the PSTN rollout is absolutely on target. Two years ago, we said we would start H2 2006, November, we said the first customers will turn up and we'll be the first incumbent to get PSTN users end to end IP and other services starting in Cardiff, so that's on track. What has happened, and we mentioned it last time, is we've worked - this is an enormous consultation program. This is not just BT. The whole of the industry is moving in this transition. We've had to create a vehicle through what we call a Consult 21 program, to get all of the industry needs so that the program meets the industry's needs going forward. As we did that against our original plan, we did some little flexes, some puts and takes, and what the puts and takes - one is on PSTN, it's very complex with other legacy products. PBXs, alarm systems, different phones - make sure they all work perfectly, we've got a massive program of testing underway to make sure they all work perfectly in the new environment. And it's going great. But what the industry said, and we agree with them, was let's get the first phase in Cardiff done, let's review how that's gone and then go hell for leather to get the PSTN across the country. So it's like start on time, learn the lessons from the initial phase and then do the country fast. What industry also said was you know, it's a new world of unbundling, LLU, you know we need new products in 21CN for that. So what we had to do is accelerate the development of Ethernet products for LLU operators and that's in the new program. Then thirdly, the broadband market, I don't need to tell you, is super dynamic. It's changing all the time, so yes while we're doing the analysis of testing on PSTN, we will accelerate advanced broadband services during next year. All in all, these are puts and takes. The program's absolutely on track, we've got industry on board which we're delighted about and there are no adverse cost comments to make on it. We're going to hit our cost targets.

Q - Sam Morton, Dresdner Kleinwort

There's been no slip on the PSTN?

A - Paul Reynolds

No. We'll start when we said we would and we'll finish when we said we would.

A - Ian Livingston

Are you a BT broadband customer? You see, if you became a BT broadband customer, you would be one of the first to know what the pricing of Vision will be. So that would be my encouragement - become a BT broadband customer, you'll be one of the first to know.

Q - Chris Fremantle, Morgan Stanley

Sorry to go back to broadband, but you've done a good retail share of additions this quarter. To what extent do you think that's in addition to that, your total broadband adds number, including wholesale, including LLU, is quite low. To what extent do you think that's part of consumers sort of waiting for Sky to come online, waiting to get connected by Carphone? And in conjunction with that, can you just comment on the progress of retail DSL adds and total DSL adds post the quarter end?

A - Ben Verwaayen

Before I give Ian the floor, let me give you my perspective. I'm very, very pleased with what Ian and the team has done. I mean, just be honest and look to what many of you have said a couple of quarters ago, where we would be and where we are. I personally don't take the view that I have to just look to the quarter, I look to the totality. We're in here for creating a capability for our customers. We're 3 million customer today around retail, give or take. If you take it as a base, it's a fantastic base to develop. You see what I find very encouraging is that this is a market that grew from one to nine in three years time. So if you take that perspective, you know, I heard somebody this morning say yes, last quarter you had 31%, now you have 30%. Well, it's a rounding difference of 5,000 adds. With all due respect in the numbers we're talking about, you can't take any measure out of that. So my perspective is much more in the longer term, to say what is this doing for us for our business? It's totally changing what we sell to our customers and how we now can segment the market. Ian?

A - Ian Livingston

For three weeks since the quarter end, well three weeks, a couple of days and a few minutes. So I don't think there's really much point in going through it, other than to say BT total broadband launch, we're pleased with it, we've seen higher sales as a result of it, I think with so many people entering the market it will probably effect churn. Not particularly seen it to date, but I think you will see that. You can't expect to have 10 people entering the market, each saying they're going to get 20% of the market. And not to expect some sort of churn. I think some of the math doesn't add up and that will be an impact. If you look at our net adds this quarter, I think we're about 160,000. That, if you looked over the same quarter in the previous two years on average, I think they averaged about 160,000, so very similar. We're pleased with progress. We know it's going to be a tough market. I think customers are holding off waiting for Sky, given that I don't think they announced, actually, until after the quarter end, and most customers don't study this thing quite as carefully as some of you guys do. But there's a lot of competition in the marketplace and we'll fight very hard. You know, we've got 32% market share, we've got almost 3 million customers, that's the ambition of a lot of people. We're already there and we tend to grow it from there.

Q - Morten Singleton, WestLB

Two quick questions. Firstly, I might have missed the announcement, but I sense you've dropped the N from 21CN - is that because you no longer want to be perceived as a network company but more as a services company? And the second question surrounds the 12-month rolling ICT contract net adds. It's actually half the level that it was a year ago now and has been declining QoverQ. I know you've had a few significant NHS contracts to wash out, but I just wondered if you're concerned at all about it being a lead indicator of potential slowing growth in the ICT business?

A - Ben Verwaayen

Good catch about 21CN and 21C, because the slide that I showed you, where you see it's so much more than the network part of it, has created - and I apologize for that, there are slogans in companies - the slogan and the language used in BT is very much around it's more than the network itself and it's the web creation, which is more than the network. You will see more about 21C as a concept in the quarters going forward. I think it's absolutely fascinating, what we're creating here, because we're creating not just another network, which is global by the way, we're creating a capability that we have not seen before. But we'll talk about it later. Andy?

A - Andy Green

Well we're hoping to hold an investor day in September and I hope I can show you some of this stuff more clearly, but what has happened to our business is we haven't had any of those very big multi-billion pound contracts. So you're right, if you take the quarterly run rate and you drop out DFPS and Reuters, it's slightly growing. So our underlying confidence in our standard sales force's delivery and the pipelines is good. Because we operate in this networked IT space, where you're seeing the globalization, you're seeing the continued requirements of people for really high resilient capability on a global basis because of what we're doing, we're not seeing the sort of demand problems that others have been reporting, but we aren't seeing the very big contracts I think you'll see right across the world, everybody's saying they're aware of the multi-billion pound contracts. We've had a dearth of them. Now I've said before, they're like London buses. There's not much you can do about them. You know, you can't plan your business on them. We've always said they're very good to accelerate things when they come along, but you can't magic them out of the air. Underneath that, it's rock solid, the pipeline's looking good, I have no great concerns about that.

Q - Matthew Glocson(?), Deutsche

A couple of questions on wholesale broadband. One was, I mean we heard Carphone this morning saying that they have problems at the moment on IP Stream and connectivity with wholesale line rental, so there's a multi platform of things they have to do to connect customers to their e-proposition before they go to unbundling. I was just wondering what the plans are for you to start offering your kind of MSAN proposition to your wholesale broadband customers, so they can have one provisioning process to do both voice and broadband. Because it that what the IP Connect is? And the second question about wholesale broadband was, we haven't heard anything specific from Vodafone, Deutsche or Hutch on broadband and how they plan to do that. Just wondering how confident you are that you'll get one of those mobile operators, a big customer, on your wholesale platform rather than on unbundling?

A - Ben Verwaayen

Right, the first question is for Steve, about the connection of their systems to our systems. I think we've done exactly what we - and I thought that Carphone Warehouse this morning also acknowledged that. We have done exactly what we said we would do, to the letter and to the minute. It's true, there are complexities in there. Are we planning to do more?

A - Steve Robertson, Chief Executive Officer, BT Openreach

The issue around the evolution of wholesale line rental is in the 21CN environment. It's something that we would love to work together on. There isn't an answer to that. So that decision hasn't been made. What we can say is that, as it stands, and the continuity service and that is there and the adds are going fine. There are no problems whatsoever in the provisioning environment for wholesale line rental full stop. It's absolutely fine. I don't know if you want to say anything about the MSAN stuff, Paul? That's more you than me. In that sense, he's my supplier.

A - Paul Reynolds

I think there's two sets of issues. There are lots and lots of new, branded players coming into the broadband space. You can see that. I think Ben was kind of edging on it in the piece. There are lots of people saying do I build it myself or do I buy wholesale? I think the sense in the market is an inclination to buy wholesale. And we're talking with all the players. Obviously I can't tell you the details, we're talking with all the players. What we're finding is people want to specify what they need for their customers. So it's a marriage service, or a spokes service offering that meets the service requirements of the individual brands and whatever. However they want to pitch it in the marketplace. Point two is about MSANs. You know, 21C, MSANs at the edge and a single network for multiple services at the core. What that does is enable all our offerings, whether they be retail or wholesale, and it enables us to converge services on an IP network. So for sure, down the road we will be offering bundled voice and broadband services on the platform.

Q - (Breda Taaffe?), Dow Jones

I was wondering if you would consider expanding the use of your broadband platform to other countries, and also if you would consider fiber to the home from retail customers?

A - Andy Green

The broadband platform operates on a global basis for the corporate marketplace. We have some SME presence in the Irish market, in the Spanish and the Italian market. But we've got no current plans to directly supply the home markets across the world. Increasingly, people are interested in collaborating on those sorts of things and we may well end up being a business to business provider behind somebody who is marketing out into the home market. But we wouldn’t be inter-marketing to consumers directly ourselves anywhere in the world.

A - Ian Livingston

We should add, in the Republic of Ireland, which is one place where we do consumer, we launched yesterday 'three for €45', which is line, calls and broadband and it's going very well. Customers really like it. It's half the price of eircom and will also contain many of the great services you get in the UK as well, so the Irish consumer is going to get the great benefits the UK consumers do, and hopefully we'll see broadband penetration in the Republic of Ireland starting to climb towards UK rates as a result.

A - Ben Verwaayen

That must be a great thought and comfort to all of you. Have a great vacation, great holiday, good summer, thank you very much.

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