BT Group Management Discusses Q2 2014 Results - Earnings Call Transcript

Oct.31.13 | About: BT Group (BT)

BT Group (NYSE:BT)

Q2 2014 Earnings Call

October 31, 2013 5:00 am ET

Executives

Gavin E. Patterson - Chief Executive Officer, Executive Director and Member of Operating Committee

Anthony Everard Ashiantha Chanmugam - Group Finance Director, Executive Director and Member of Operating Committee

John Petter - Chief Executive Office of BT Consumer

Luis Alvarez - Chief Executive Officer of BT Global Services and Member of Operating Committee

Analysts

Carl Murdock-Smith - JP Morgan Chase & Co, Research Division

Wilton Fry - BofA Merrill Lynch, Research Division

John Karidis - Oriel Securities Ltd., Research Division

Nick Lyall - UBS Investment Bank, Research Division

Maurice Patrick - Barclays Capital, Research Division

Paul Sidney - Crédit Suisse AG, Research Division

Stephen Howard - HSBC, Research Division

Simon Weeden - Citigroup Inc, Research Division

James Britton - Nomura Securities Co. Ltd., Research Division

Andrew Lee - Goldman Sachs Group Inc., Research Division

Stephen Paul Malcolm - Arete Research Services LLP

Jeremy A. Dellis - Jefferies LLC, Research Division

Unknown Executive

Ladies and gentlemen, we will start. If you don't mind, we have -- can you put on the film?

[Presentation]

Unknown Executive

Ladies and gentlemen, welcome to the BT Centre Auditorium and to BT's Results Presentation. Can you please make sure that you have all mobile devices switched off. There are no fire alarms planned for today. And in the event of an alarm sounding, would you please leave the auditorium by the 2 fire exits at the front of the room.

Before we start, we need to draw your attention to the usual disclaimer on forward-looking statements. Please see this slide and our latest annual report and Form 20-F for examples of the factors that can cause actual results to differ from any forward-looking statements we may make.

Gavin E. Patterson

Good morning. And welcome to our Q2 results. Now, given this is my first set of results as CEO, I wanted to start by looking backwards and just give you a sense of the context that we are announcing these results today and then before we talk about what's going to happen in the future.

So if you look back in history, there have been many, many chapters in the development of BT. If you go back to 2001 in the turn of the century, it was about rehabilitation. It was about restructuring the balance sheet, reducing debt and really getting the business back to its core. Between 2002 -- 2003 and 2008, it was about the move into data. Yes, it was about defending the core, defending our traditional business, but it was also about growing new wave products, and particularly, broadband.

In 2008, Ian took over, and Tony was promoted to CFO. The real focus then had to be around cost transformation, and in particular, becoming a better business with a better future. It wasn't just about cost, of course. Ian and Tony began to lay down investments, lay down those foundations for our future, which takes us to 2013 and today.

Today is about realizing that vision, realizing the future. Yes, we've got more to do on cost transformation. And undoubtedly, we've got more to do on customer service. But we've also got to deliver on those investments in order to deliver our long-term financial objectives.

I want to spend a little bit of time talking about those growth engines, those investments now. And there are 5 of them we've talked to you about in the past. So this is a slide you might recognize from our Q1 results. These are the foundations we've put in place for the exciting future that we see ahead of us.

First of all, fiber. It is our ambition to create the best, super fast broadband network across Europe. And we're well on our way to delivering that. Today, I announced that we've passed our 17th million premise in the U.K., and we're well on track to delivering 2/3 of the U.K. by spring 2014.

After that, it's about delivering rural broadband, and we've already started, and I'll talk about that later. And ultimately, we think we'll get well into the 90% coverage of premises across the U.K. I think that's a very exciting vision, and I'm very proud to be part of it. It's very early days still. You forget we've only been in the fiber business 3 or 4 years, and this as you know, is a double-digit payback, and even longer for those rural broadband contracts.

Secondly, TV and Sport. It's a very exciting period for us in the TV business, and particularly, Sport. Sport has made a confident start, and I'll give you some detail on that later. But it's also about ensuring we have a competitive triple-play product for customers who don't necessarily like Sport, of course. And we've had some exciting progress on that in the last quarter.

In the business market, we have a great opportunity to grow the network IT services, both in our business-to-business arm, BT business and Global Services. We've got a relatively modest share. This is the way the market is moving. We've got a great opportunity to grow going forward.

In mobility, again, this is a very much a greenfield opportunity for us. You won't have forgotten, I hope, that we bought some 4G spectrum in February. We've just recently announced, in principle, we've agreed a new MVNO with EE. And of course, we've got an extensive network at WiFi network -- WiFi hotspots across the U.K. You put those all together, and you can create some really interesting propositions, both for consumers and businesses. We're not going to be talking much about that today. You'll hear more about it from us next year.

And then last, but certainly not least, realizing the full potential of the investments that we laid down a couple of years ago in LatAm and AsiaPac, in the high-growth regions of the world. And that's particularly pertinent for Global Services. All in all, I think you can say we've got some really interesting growth opportunities ahead of us, the real focus now is about delivering on them, and that's where my focus lies. And if we do that, we'll be able to deliver on our financial objectives.

Our focus, of course, is about driving profitable revenue growth. And if we combine that with continued cost transformation, and we'll be -- remain disciplined about that, we'll be able to grow our EBITDA and free cash flow over the long term. This is how we run our business in good times and in bad, it's a focus on free cash flow. In terms of the use of that cash, cash will continue to invest in the business. We'll also reduce our net debt, we'll make sure the pension fund is appropriately funded, and we'll continue to pay a progressive dividend.

Having the strategy is one thing, you've got to have the team to deliver it, and I want introduce a couple of new members to the Operating Committee today. When I took over, one of my first decisions was to split BT Retail in 2: into a consumer arm and a business arm, a B2B arm. And the B2B arm will pick up BT Enterprises and BT Ireland. So 2 separate units, 2 new lines of business. We're going to continue to report on them together for the rest of the fiscal, rather than make another change, which I know won't be exactly welcome. But for next fiscal, we'll be reporting on them separately.

John Petter is leading the Consumer business, and he's in the front row today and will be available for questions later. And Graham Sutherland is running the Business unit. And he's here, too, as well. I think the other characters on this chart, you know very well. And they are also available today for questions.

Okay. That's what I want to do as an introduction. I'm now going to pass over to Tony to go to the group results, and then I'll come back and talk about the line of business performance.

Anthony Everard Ashiantha Chanmugam

Thank you, Gavin. Good morning, everyone. We've delivered a good financial performance this year -- this quarter, I should say. Our figures are ahead of market expectations, and we've grown our earnings and our cash flow, despite the large investment we've made in launching BT Sport.

Regulation remains the biggest headwind to our business, but a combination of managing our business, a strong performance in cost transformation and impact of our strategic investments, this has counteracted that. This quarter's results underpin our outlook for the year, which remains unchanged.

Let me start now with a brief overview of the main group results. Our key measure of the group's revenue trend, underlying revenue, excluding transit, was down 0.5%. This is an improvement on last quarter, which was down 1% and significantly better than Q2 last year, which was down 5.5%. EBITDA was down 4%. This decline is in line with our expectations and reflects our investment in BT Sport. We expect to grow our EBITDA and cash next year in line with our historic trends.

It's worth highlighting, this is our 16th consecutive quarter of growth in earnings per share, which is up 2%. Normalized free cash flow was almost 300

[Audio Gap]

than last year, but this reflects the timing around working capital, which I've said before, can bounce around from 1 quarter to another. We continue to aim to reduce our net debt. It was down almost GBP 1 billion compared with last year, but this is up slightly on last quarter. As I reported, free cash flow was offset by the payment of last year's final dividend and our share buyback program.

Now, looking at the performance across the lines of business, on the revenue line, a strong performance from Retail, driven by growth in consumer broadband and TV. This was more than offset by the impact of regulation, although it can reach this revenue. As we flagged to you last quarter, Global Services was impacted by the timing of contract milestones, while Wholesale's year-on-year trend was flatted by the negative impact of ladder pricing, the decision that had on revenue and its impact from revenue last year.

The decline in EBITDA reflected Retail's investment in BT Sport. This was partly offset by good growth in Global Services, driven by its cost transformation programs and an increase in Wholesale to EBITDA, largely due to the impact of ladder pricing.

On cash flow, the working capital improvement, as I mentioned earlier, were largely in Global Services and Wholesale, with these offsetting the impact of Retail paying for the first installment of the Premier League rights.

Taking a closer look at costs in Slide 11. Underlying operating costs, excluding transit, were up by 1%. However, excluding the impact of investment of BT Sport of around GBP 140 million and the increase in the pension operating charge, the underlying operating costs have reduced by around 5%. This is actually a faster pace than we achieved in Q1. We continue to focus on process reengineering, procurement efficiencies and generating savings from in-sourcing. We've made good progress in these in the quarter and continue to identify further opportunities.

Last quarter, I talked to you about our call center environment. We have 80 call centers, with less than 100 people. That's obviously inefficient. Again, if you look at that environment, we have a large cost of failure because of the way the process has worked. If we worked the right things in relation to our processes, get the right organization infrastructure, consolidate our call centers, we can take out between 10% and 20% of our cost base. And we can use that cost savings to reengineer our processes and improve our cost performance, but also and just as importantly, improve the quality of customer service we offer our customers. And that's why it's important.

If you look at Global Services, we took out 8% of our cost base there, excluding the impact of transit on an underlying basis in Q2. One of the enablers there was that we're using the same process as we work through in the U.K., in France, Germany, Italy, Brazil, Benelux. The net impact there is that we'll get over GBP 100 million of annualized savings. It makes a material difference.

Now, the benchmarking will show that we are probably in the top quartile in the sector. But what I'll say to you is every company has the opportunity to make cost savings. The good companies identify that opportunity. I think we're in the position of identifying that opportunity. And it strikes every single day.

During the course of this week, simple things like, you wouldn't believe, but we used our competitor's Ethernet services to provide service for our customers. Not a large chunk, GBP 2 million or GBP 3 million. Those GBP 2 million or GBP 3 million, that could be coming to BT. We have a field force in France, servicing our Global Services business. Our Conferencing business chooses to use the third party. Why? No reason. It can easily transfer across.

There are numerous examples. That just starts to happen over the last 2 days that we will fix. But the key here is that we've got plenty of opportunities across the business. And I genuinely believe if we execute well, we can make further material savings.

Let's turn to debt and liquidity on Slide 12. At September 30, we had cash and investment balances of GBP 1.2 billion and available facilities of GBP 1.5 billion. These provide us with a very strong liquidity in funding position with GBP 0.3 billion of term debt, and GBP 0.5 billion short-term borrowing repayable in the second half of this year.

Our debt maturities are fairly evenly spread over the next few years, and we'll continue to reduce our debt level with a target of achieving a BBB+ rating or equivalent. We continue to review our funding options with a view to maintaining our liquidity, while minimizing our cost of carry. We will only refinance debt when there is a clear financial and commercial benefit to do so.

Turning now to what's obviously your most favorite subject, the pension. The IAS 19 pension deficit was $5.4 billion net of tax, up from GBP 4 billion at quarter 1. This may have been slightly higher than some of you were expecting. But as I've said previously, this number does fluctuate. The increase in this deficit was principally due to a higher present value of the liabilities. There was an GBP 800 million impact from a reduction in the discount rate, which reflects the tightening of corporate credit spreads during the quarter. In addition, there was a GBP 200 million impact from future inflation expectations, which moves slightly against this.

I know a pension deficit is an ongoing topic of interest with a certain level of complexity around it. So we will be organizing a pension teaching towards the end of November, in which we'll go through the moving parts of the various valuation methods in a lot more detail. I'm sure you all can't wait to attend.

But before that, a quick preview, Slide 14. It's a quick reminder of the measures we often refer to. Firstly, IAS 19 is a prescribed accounting measure, which we have to report each quarter, whether we like it or not. It tends to be volatile, as it uses a market yield curve for AA corporate bonds as a discount rate. It has no bearing on the cash we pay into the scheme. Secondly, we have our median estimate, which is BT's best estimate of the funding position. This is, in essence, compares what we expect to pay in future pensions against the scheme assets that we hold. This is more stable as it uses long-term asset returns expectations as the discount rate.

And thirdly, we have the actuarial funding valuation, which forms the basis on which cash contributions to the scheme are agreed every 3 years. This is required by regulation, and is a prudent view. The next triennial funding valuation will take place in June 2014.

I just want to show you how the IAS 19 and median estimate have moved over the last 5 years. IAS 19 is a spot measure, and you can see that it has historically been quite volatile, mainly driven by movements in corporate bond yields and inflation. Our median estimate in pink has been much more stable and continues to show a surplus, which was GBP 0.7 billion at Q2.

On regulation, on Slide 16. I just want to remind you what we said previously on regulation. We expect an impact of about GBP 120 million of our EBITDA this year, from the WLR LLU and an ISDN30 charge controls.

Early next year, we expect Ofcom to publish its final statement on the next charge control. This is due to come into effect on the 1st of April, 2014. The Business Connectivity Market Review will have an impact of around GBP 50 million to GBP 100 million of EBITDA this year and next.

And finally, the wholesale narrowband market review will lower our fixed call termination revenues from the 1st of January, 2014, with this partly offset by higher call origination prices. This will provide a noticeable headwind for wholesale, particularly in the next financial year. All these numbers are factored into our guidance, which is set out in Slide 17.

Our group outlook for the year remains unchanged. We continue to expect an improved trend in underlying revenue, excluding transit compared with last year. We expect adjusted EBITDA to be between GBP 6 billion and GBP 6.1 billion, a normalized free cash flow to be around GBP 2.3 billion, with these both growing in the next 2 years.

In line with our policy of 10% to 15% growth in the dividend per share over the next 2 years, we're announcing an interim dividend of 3.4p. This is up 13%. We'll also continue with our share buyback program during the quarter. We bought a further 23 million shares for GBP 77 million.

Our shareholder returns remain well covered by our cash flow, and we remain committed to paying progressive dividends, not just this year and next, but in the years to come.

And with that, I'll hand you back to Gavin.

Gavin E. Patterson

Thanks, Tony. Okay. I want to spend some time now looking at the line of business performance. And we'll start with Global Services.

So Global Services had a really solid quarter. Revenues were down 5%, that's a little bit worse than Q3, but there are some one-off effects in there. So for example, we have contract milestone payments that would have been due in quarter 2. They're going to be in quarter 3, so we'll see the benefit there.

Encouragingly, we saw double-digit growth in our high-growth regions, that was the thing I talked about earlier. We've made good progress of cost transformation, so costs are down 8% in the quarter, and that compares with 4% in Q1. Some of that is down to the lower revenue base, yes, but we can also see the effect of cost transformation really making some real traction now in global services. And one example of this is that we've moved from 3 global packet networks to 1 in the last 18 months, saving OpEx and CapEx at the same time.

Operating cash flow is up almost GBP 200 million in the quarter. We had a net inflow of GBP 74 million within the quarter, which is significant. As Tony mentioned, there were some working capital benefits that we saw in the base. But if you look at the 12-month rolling average, you can see consistent progress quarter-after-quarter, and that's what we're focused on.

If you look at the operating side of things now, I'm really pleased to say the order book is up 19% at GBP 1.5 billion in the quarter. And if you look at what's happening in Asia Pac and Latin America, that growth rate is 25%. We've had some great deals signed in the quarter. For example, Unilever have signed a deal for mobile, voice, data and video for all their 173,000 employees across over 100 countries, which is a great deal. With Visa, Visa have chosen us for a new payment platform in Europe. We've resigned a deal with Fiat around outsourcing around the globe. And Wipro have chosen us to provide voice and WAN services as they go in and serve a U.K. major utility company. So I think this gives you a taste of the sort of deals that we're seeing. And if you look at the 7 month -- sorry, if you look at the 12-month rolling average on the order book, it's now over GBP 7 billion for the first time in 2 years.

One other thing I wanted to mention on Global Services, is that we launched BT MeetMe with Dolby Voice last week, 1 or 2 of you might have noticed this. It was something we talked about in the strategy presentation earlier this year. I think it's been a really exciting initiative. I think it's probably the biggest breakthrough in audio conferencing of the last 10 years. And it's an expensive between BT and Dolby. What it does is it removes all that background noise that you get in a conference call, so that you get a much better audio experience. And I think that's an area that we're going to see real growth in going forward.

Moving on to Retail. Retail had a strong quarter. Revenue's up 2%, driven by a really strong performance in consumer. EBITDA was down GBP 66 million, and you can see the impact of BT Sport there, but that's broadly in line with what we were expecting and we talked about last quarter. Overall, we had some good operational progress to report. So the share of net adds on broadband in the quarter at 93%, particularly good. We had almost 200,000 fiber net adds. Interestingly, the fiber net adds are increasingly moving towards new customers, so 1/3 of those are new to BT. And that is getting higher as we move forward. And we've now got a base of over 1.7 million fiber customers in Retail. Also worth mentioning, our WiFi business, which continues to grow, is a real differentiator for us. So that doubled to 6.6 billion minutes within the quarter, and continues to be one of the areas that really helps us drive down churn.

So we've always said that our goal over the long term is to grow revenues, and I think you can see that within the Retail chart here. It's beginning to turn.

If you look at Consumer in more detail. Consumer had the best revenue performance for 10 years, and it was revenue growth across -- the improvements in the revenue trend across the board. So in calls and lines, revenues declined just 1%, and that compares with 5% in Q1. Broadband and TV was up 17%, and that compares to 9% in Q1.

Sport was a successful launch, and I'll show you some of the operational metrics in a minute. But we've begun to see some of the revenues come through from Sport, particularly with standalone channel sales, commercial revenues, the wholesale deals that we've put in place. But I think the most important thing to take away is we've always said, judge the success of Sport based on whether or not it's driving our Consumer business, top and bottom line over the medium term. And while it's still very early days, I think you can see the trend is an encouraging sign in the right direction.

And you look at the operational metrics in more detail, I think you can see the impact it's having on the base business. So if you look at line losses, 65,000, that's 2/3 lower than this time last year. Active customers, the number of customers we've lost in the quarter, at 34,000 is 3/4 less than we had this time last year. We talked about the broadband share at being 93%, that's a very good number. I think it will be difficult keeping it to that level going forward, but you would expect to see a benefit from the advertising, the marketing in the first quarter. But nonetheless, I think that's acknowledged as a decent number in itself. We've also seen the halo on our TV business, where the net adds were up 3x what they were this time last year.

It's also worth mentioning that half the customers of BT Sport are existing BT Broadband customers, indeed, much more than half are. And these are customers who've chosen to take a new contract with us, which is part of the requirements for BT Sport. And so we'll see the benefits of that coming through in our churn in future quarters.

And if you look at the channel itself, I think it's made a really confident start. We've got over 2 million retail customers direct. We passed that number a couple of weeks ago now. And if you include the customers we get through cable, that's over 4 million customers.

In terms of audience, we're making good progress on building a good audience for the channel. So for example, in the Premier League, we're getting 70% higher audiences -- higher audience share than ESPN got last year. And on rugby, our rugby audience, is more than Sky was getting last year, and 3x more than ESPN were getting last year. And that's with our best games to come, I think, because if you look across the Christmas period between the 1st of December and the 1st of January, we've got 10 Premier League games, including three top 6, where the top 6 play top 6. We've also got -- and it sticks in my throat, Manchester City versus Liverpool, which of course, used to be a top 6 game, but isn't classified as one today. But certainly, Liverpool bringing the second highest audiences across the Premier League. And so I think we'll see real benefit from that. So there's a lot more to come on Sport. We're going through a particularly strong period, I think. And of course, we've still got 8 more picks to come in the rest of the year. So I know many of you in the room are BT Sport customers, but for those of you who aren't, here's a taste of what you're missing.

[Presentation]

Gavin E. Patterson

It's not just about Sport, of course, it's also about the broader TV proposition. And we've made some significant changes to our TV proposition in the last quarter, and they're having a real effect.

So we've launched 18 more pay-TV channels, plus access to the 4 HD PSB channels in a new entertainment pack. You can supplement that as well with the kids' pack, or an HD pack where you can get access to more channels. Of course, there's BT Sport in SD and HD. We've also launched Sky Movies. All 11 Sky Movie channels are now available on our platform. I think the takeaway from this is customers can now choose, pick and choose to create the right value for money, the right proposition for them, so they can get great entertainment at a good price without necessarily having to have a load of channels that don't necessarily want to watch. And in particular now, we've got a very strong offer in the market, where you can get YouView, the entertainment pack and fiber for just GBP 20, which is extremely competitive, if you're on the lookout before Christmas.

Right. I want to talk little bit more about the other parts of Retail now. And the real message here is all these parts of the business are on track in delivering. So on business, similar trend to previous quarters, flat revenue where growth in IT services is just about compensating for declines in calls and lines. That's a good number when you look at what's the number of our competitors are achieving at the moment.

In Enterprises, if you strip out acquisitions and foreign exchange, we're down 1%. That's a deliberate choice we've made in conferencing where we're focusing much more on services and away from low-margin hardware. Encouragingly, the minutes on our audio conferencing business are up 10% year-on-year, and that's key -- ahead of the launch of BT MeetMe with Dolby Voice.

Ireland continues to make a significant contribution. The underlying revenues are up 2% x transit, and that's driven by particularly strong performance in the Republic of Ireland in our business division where the pipeline is up over 30% in the last 6 months.

Moving on to Wholesale. And the message here is really steady progress again, very similar to what we were achieving in Q1. I think it's easier, as Tony mentioned earlier, to look at Wholesale backing out the impact of ladder pricing, which somewhat flatters the numbers. But if you back out ladder pricing and look at the underlying revenue x transit, it's up 1%. And that the key dynamic there that's changing, managed solutions revenues are up 18%; and IP services revenues are up 23% in the quarter. So compensating for decline on the base business. Costs are flat, where our SG&A is coming down, but we've got higher direct costs with the managed solutions contracts. And EBITDA are up 3%. I'm really pleased about the progress we're making on IP exchange. This is one of the things we highlighted in our strategy presentation in May where the minutes are up 60% year-on-year.

The order intake is very good at over 400 million, up 33% year-on-year. We need to look at this in the context of the regulatory headwinds that Tony talked about earlier. But nonetheless, that is an encouraging number. 2/3 of it is renewals, particularly with our big customers, but I'd really like to highlight the performance of Nigel and the team of broadening the customer base within BT Wholesale and really introducing new deals with clients, such as Spitfire, Timico and Nine Telecom. I think that demonstrates actually this great growth if we open up the potential of our Wholesale business. We also signed a very interesting IP exchange contract with EE, which will begin to migrate their voice traffic internationally.

Moving on to Openreach, a solid performance, clearly impacted by regulation. So revenue, down 1%. That would have been up 4% if it hadn't been for the GBP 70 million regulation effect in the quarter. Within the mix there, fiber doing very well, with revenues up over 100% year-on-year. Our volume on Ethernet increasing over 10% as well.

Operating costs are up 2%, reflects the investments we're making on service in BDUK and the high volumes that we saw across the summer. In terms of the physical line base, it declined 8,000. There's some seasonality in our Openreach business, but that 8,000 compares with 38,000 decline this time last year. And if you look at the 12-month rolling average, it's up over 140,000. So I think we're seeing progress. Net-net, EBITDA down 3%, a solid performance on Openreach.

And if you look on fiber in more detail, as I said earlier, really pleased that we've passed the milestone of 17 million premises passed. We've connected over 2 million premises now, be that consumers and businesses, making real progress. Increasingly, other service providers are getting behind fiber. It's not just BT Retail that are driving this now. So we added over 300,000 net connections in the quarter, that's up 70% year-on-year. And the share that BT is getting is now near 60%, whereas a couple of quarters ago, that was nearer 85%. So we're seeing that all service providers are investing in fiber and really buying fiber from BT from Openreach.

So what -- just giving a little bit of color of what's happening at an exchange level, there are 250 exchanges now where we've got penetration and adoption of over 20%, which is really good, some that are as high as 40%, particularly in the areas where we're most developed and where we have the widest overall coverage, places like Cornwall and Northern Ireland. So I think that gives you a sense of the potential of our investment. Indeed, there is 1 exchange that has gone from 0 to 20% penetration in just 12 months, Woburn Sands and Bedfordshire, if you're -- somewhere you might know. I've just learned about it.

We are increasingly beginning to roll out our regional contracts now. So we've signed 44 regional contracts, 42 through BDUK plus Northern Ireland and Cornwall. And we're already adding premises, so we passed another 100,000 regional premises on the rural broadband contracts within the quarter. So that will increasingly become part of our focus going forward.

And it's also about innovation. So we started a vectoring trial in Barnet and Braintree. And what vectoring does is it removes the cross talk, it's like noise-canceling headphones if you want to think about it that way, but you sometimes get in a cabinet, particularly when you get to high penetration within the cabinet. What it means for the customer is you get higher speeds across the board.

So on fiber, I think the takeaway from all of this is we're continuing to deliver, we're well underway to delivering our ambitions around the commercial rollout, and we've still got the ambition that within 3 to 4 years' time, we'll have a network that is the best superfast broadband network in Europe with 90% coverage supplying all service providers across the U.K.

So in summary, these are a good set of financials with growth in earnings and cash. It's been our best ever fiber quarter. We've made a confident start on BT Sport, and you can see that amongst other things in our record share on broadband, and we've delivered strong order books in Global Services and BT Wholesale. We're building on the strong foundations, there's clearly an awful lot of potential in this business. It is a very exciting time at BT and it's a great time to be taking over as CEO. We've got a very clear strategy. Our focus is on delivering on that strategy and the financial benefits will follow.

Thank you very much and we are open for questions.

Question-and-Answer Session

Gavin E. Patterson

So I'm going to use the usual rules. One question each, and we will start -- just start over on the right. Yes? Can you wait for the mic as usual, and...

Carl Murdock-Smith - JP Morgan Chase & Co, Research Division

Carl Murdock-Smith from JPMorgan. One question, okay. On the strong consumer performance, and broadband and TV within that being up 17% in the quarter versus 9% in Q1. I was just wondering, within that, what's the performance this quarter if you strip out the Virgin Media wholesale deal and also pubs and clubs? So kind of on a very kind of core consumer performance, what would the growth be this quarter?

Gavin E. Patterson

You know I'm not going to tell you that. We've been really, really clear on this. Judge the consumer business based on whether or not it is growing top and bottom line over the medium term. So the revenues in consumer grew 4%. I gave you some color I think on actually, the impact we're having on the calls and lines business and broadband, you can see that in the metrics. There's clearly going to be some revenues, some standalone sales at the channel, and the commercial revenues are beginning to build as well. We didn't give details of the wholesale deal with Virgin and I'm not going to change that now.

Anthony Everard Ashiantha Chanmugam

Can I just add something, Gavin? Yes, Carl, if you look at Retail, and you say there's an underlying -- you that this [indiscernible] 13% down on EBITDA, yes? We've told you the Sport investment's about GBP 140 million, we've told you that roughly the EBITDA impact is in the region broadly of GBP 100 million. You play that number back and you'll see that if you look in the traditional underlying growth in retail was running at about 5%, if you play those numbers back, what you'll see is in the quarter, the underlying, excluding Sport, is materially above the base of 5%.

Gavin E. Patterson

We'll move across. Yes, please.

Wilton Fry - BofA Merrill Lynch, Research Division

It's Wilton Fry from Merrill Lynch. The trustees have got a GBP 6 billion to GBP 7 billion prudence discount on their pension scheme on the actuarial -- sorry, on their valuation, that's about 85p a share. Given obviously the crown guarantee backstops the worst-case scenario, do you think there's a chance that they could start to reduce that prudence discount once we have the next triennial valuation in June?

Gavin E. Patterson

I'll let Tony answer that, because he is our pension expert now that Ian is gone.

Anthony Everard Ashiantha Chanmugam

I'm just trying to think how Ian would answer this. Look, I mean, the key point here, your facts are spot on. The way I would look at it is that we will represent to the trustees that this business is in a materially better shape than it was in the last triennial, and materially better than the previous triennial. Given that it's materially better positioned, both in terms of EBITDA or in cash generation, the level of prudence that should be used should be less, whether they accept that, whether we can get that agreed, is another matter. But logic dictates that it should be in a better position.

Gavin E. Patterson

John?

John Karidis - Oriel Securities Ltd., Research Division

John Karidis from Oriel. I haven't had enough time to look at as much details that I'd like to working capital movements in the past this morning, but it feels a little bit overly conservative not to be changing your free cash flow guidance, given the beat in the quarter. Is it possible to give us a little bit more color on this, please?

Gavin E. Patterson

There are many things that might change in the second half of the year, particularly the timing of the contracts around BDUK in terms of receiving the money for them. So it would be prudent not to make any changes at this point. I don't know if you want to add any specifics there?

Anthony Everard Ashiantha Chanmugam

The working capital is going to bounce around primarily because of the timing of supplier payments and how that works through. Will it work against us? I've said it's worked against us, it's worked for us here. There's no reason for us to change our outlook at the moment. Yes, Nick?

Nick Lyall - UBS Investment Bank, Research Division

It's Nick Lyall from UBS. Can I ask on BT Sport, do you think you need more content now for the BT Sport channel given the 2 million subs and do you have the scale to compete in upcoming options like for the Champions League, for example? And if possible, I know it's taking [indiscernible], but if possible, could you give us a bit more detail on underlying churn, from particularly broadband and maybe line losses around not just the group shares if possible?

Gavin E. Patterson

Well, we always set out not to be #1 in Sports, but to be #2. Sky have a very, very strong position, but we felt there was room for another player. And we felt that it had a strategic value to us. And I think, as I said, I think we're very pleased with the start we've achieved. This channel is only 13 weeks old and we've got over 4 million customers, that's not shabby in anybody's definition. In terms of the amount of live sport, which is one of the key metrics, it compares extremely well with the numbers that Sky deliver in terms of live sports on their channels. In fact, I think we've got a higher percentage of live sport on our channels than Sky are delivering. That said, as with any rights, we look at the market, and we take a view whether or not they can be something that's -- has a positive effect on the value of the company. We're going to remain very financially disciplined about this. It's not chasing rights for the sake of it, but we evaluate things all the time. And what I will say is, I don't think we need necessarily to gain any more rights to deliver what we need to achieve with the channel. You had another question about underlying impact on churn. Churn is down, as you know, we don't give any specifics on that. So it's down year-on-year, and so we are beginning to see the beginnings of the impact on BT Sport. But as I mentioned earlier, the key to BT Sport was recontracting if you're a BT Broadband customer, and well over half of the customers that are taking sport are recontracting with us. So we'll see that feed through in the churn line in future quarters, I think. Maurice?

Maurice Patrick - Barclays Capital, Research Division

It's Maurice from Barclays. So on fiber, you have talked in the past I think about 15%, 20% long-term penetration, clearly quite a few exchanges and now, at the level, some obviously be higher than that. I wonder where you -- if you had any updated thoughts as to where long-term further penetration will end up given the strong progress you've seen, not just on retail, but also some of your wholesale partners?

Gavin E. Patterson

Well, the investment is still relatively new. As you know, this is a double-digit payback, and the rural contracts are a lot longer. So I think it is too early to be making too many assertions about how big it can be. What I will say is with 12% adoption now across the country as a whole and evidence that there in many places, it's a lot higher than that, there's clearly the potential to go over 20%. And we're certainly a lot more confident that 20% is achievable, and that was key to the business case. So we will continue to evaluate whether or not there's the potential to go higher. But at this stage, I think making sure we get to that 20% number is our focus. Right. I'm going to go and sort of a zigzag, if that's all right, son? Yes?

Paul Sidney - Crédit Suisse AG, Research Division

It's Paul Sidney from Crédit Suisse. What is more important to BT Retail, is it line loss reduction or price increases? Or as your line loss reduces over time, does it become more of a balancing act between the two?

Gavin E. Patterson

The way I would characterize it is, we need to build a sustainable business. The cost transformation in retail and particularly, in consumer since we're talking about that, has been going on for a long time. And it's not that it's run out of road, but we recognize that it needs to grow the top line at some point and otherwise, it is going to run out of road, I think. So pricing is one way of doing that, adding RGUs by customer is another way of doing that, reducing customer losses another. And I think what you'll see is the mix change over time. And with respect to pricing, I mean, this is a market where people talk about pricing a lot, but actually, the product, in terms of its capabilities and product performance, changes dramatically as well. And if you look at, actually, how pricing tends to be deployed, customers tend to get more for less, if you look at it in the whole. So it's the upgrade, for example, we did last year on fiber, we doubled the speed from 40 Mbps to 80 Mbps. And if you look at our fiber pricing, certainly our -- the bundled pricing has come down over that time. So I'm going to stay in the middle so I don't lose track and we'll go into the second row.

Stephen Howard - HSBC, Research Division

It's Stephen Howard at HSBC. I just had a question about competitor response. I mean, obviously your broadband net adds figures are very strong and they display the strength of the proposition. Is there any worrying signs you see of competitors and then perhaps, with an inferior proposition or one that is now relatively less strong, having to respond with more aggressive pricing?

Gavin E. Patterson

Well, I'll say a few comments and then I'll ask John just to chip in, if he's got anything to add here. But when we launched BT Sport and indeed, the weeks and months running up to it, we saw an awful lot of competitive activity. Sky were offering Sky Sports for free for 1 year, for example. That puts some very keen prices into the market for the fiber product that they're buying from Openreach. So -- and then the they invest an awful lot of marketing, so we saw an awful lot of competitive activity during that period. They also chose many of the best picks at the beginning of the season, so we didn't have the strongest set of fixtures in those first 13 weeks. So I think we've seen a lot of competitive activity. I think we'll see more going forward as we all fight for market share. But as I say, I think the start we've made demonstrates that actually this -- this is a pretty resilient proposition here. We're not complacent, there's a long way to go on it, but it looks as though it's got some legs.

Stephen Howard - HSBC, Research Division

And Talk Talk?

Gavin E. Patterson

On Talk Talk, Talk Talk are clearly looking at it from a group perspective. They're selling a lot more fiber now. They have said that sport hasn't impacted their business. I know they haven't reported yet, and actually, I'm sure they'll have a comment about that next week. They've been putting some very aggressive price points into the market on copper, they've been marketing YouView very strongly as well. So I think there is competitive activity out there. But as I said, I think the results we're getting on sport and its impact on our, particularly on the broadband business, I think demonstrates that actually, it's got some strength. Is there anything you want to add, John?

John Petter

Just a couple of thoughts. I think -- and the key point that Gavin made is right. So if the competition are doing free broadband, as in fact Sky were for Sky Sports customers, there isn't very much further it can go in fact, actually. And during the quarter, in fact, we saw some surprising tactics from Sky and they were pushing customers towards BT's website to take BT Sport in fact as a kind of defensive maneuver of some kind. For Talk Talk, in particular, their price for broadband is GBP 2.49 at the moment, that's been the case for a while. I was going back through my files from a few years ago a couple of days ago, I saw Talk Talk's, and their best deal in 2007 was free broadband forever, and forever turned out not to be for very long. This market stays very competitive and that hasn't really changed. But the strength of our proposition gives us a really good solid customers in that context.

Gavin E. Patterson

Simon?

Simon Weeden - Citigroup Inc, Research Division

My question is on your various regulatory court efforts to get access to Sky Sports carriage rights. Could you just update us on where you are in the various actions? What your pitch is to Ofcom and how it's going court-wise with regard to the last Ofcom decision on the same sort of subject?

Gavin E. Patterson

Well, I think it's important to say, we continue to have commercial discussions with Sky. At the moment on Sport, we're not talking, but as you see, we've signed a deal on movies this quarter, which I think is good for them and it's good for our customers as well. But in terms of Sport, there are probably 2 things in particular. The original wholesale must-offer Ofcom decision. We won the right to challenge the cat's appeal in Court of Appeal, and I think that gets heard in the next -- well, I think just before Christmas in December. And until then, the WMO still stands. And so we're able to show Sky Sports on our Vision -- on our Vision box. We can't show Sky Sports on YouView, which we think we're being discriminated against, given that there was never any challenge around the dominant position that Sky had in the pay TV market in Sports. And as I say, they provide Sky Sports on YouView for other players in the marketplace. So we've asked Ofcom to make a -- to look at that, we've made a complaint, and they're considering that at the moment and we expect to hear something in the new year, on whether or not they're going to take that complaint. Right. Yes?

James Britton - Nomura Securities Co. Ltd., Research Division

James Britton from Nomura. Can you just give us a sense of how quickly you expect the halo effect from BT Sport to start wearing off? Or do you actually expect the line loss level to be sustainable or could even improve from here? And then perhaps, just a quick follow on, why are you unable to accelerate the retail fiber at this quarter? I thought Sports was highly about that upsell.

Gavin E. Patterson

On line losses, clearly, we see -- we've seen the benefit in the first quarter, and you'd expect with the marketing we've put in and that the newsworthiness of it, you'd expect the first quarter to be strong. I think that will wear off a little bit, but I expect that to be a noticeable improvement still when you look at any year-on-year comparatives going forward. Sorry, I forgot your second question. Is it fiber? Yes. Fiber adds in the quarter, we were a little disappointed with that, to be perfectly honest with you. But there's a couple of things to call out in it. I mean, I say disappointed, it was around about the same amount we did last quarter. On Sport, we always said, fundamentally, it was about driving broadband first, then fiber. So the free BT Sport is available for all broadband customers. We chose in the quarter to focus our outbound telemarketing resource, our telesales resource, on taking incoming calls on BT Sport. Normally, much of the upgrade process on fiber is done through outbound calling. And you can see that in some of the other metrics I mentioned earlier. So for example, if you look at the mix in those fiber adds new to BT, completely new to BT, it increased significantly in the quarter. Historically, it'd been about 1/5, it's about 1/3 in the quarter, and I think that's a data point and it supports that. Andrew?

Andrew Lee - Goldman Sachs Group Inc., Research Division

It's Andrew Lee from Goldman Sachs. James asked the basis of my question, which is basically the sustainability of this impact from BT Sport, given it's a big marketing quarter. Can you just give a bit more detail on some of the other KPI's that improved? For example, the TV upselling, which were troubled [ph] , how sustainable was that kind of uplift? And then given James stole my question, I'll ask a semi follow-up, which is on mobile. You said you weren't going to talk much about it, and we'd hear more about it next year, but does that mean you'll launch a consumer proposition next year, or you'll just tell us what you're going to do next year?

Gavin E. Patterson

Well, let me answer the question on mobile and then I'll turn it over to John to talk about the impact on KPIs on TV. On mobile and mobility, in general, we see that as a really exciting opportunity for us. Certainly, with 4G and fiber, we're increasingly seeing the markets come together. And potentially, they'll completely merge, I think, when 4G and fiber really take off. And I think we're really well placed to benefit from it. Everybody wants to talk about what we're going to do in the consumer and business market. But it is worth noting that actually helping the MNOs rollout 4G is a great business opportunity in the wholesale business as well and Nigel's getting busy signing contracts in that area. And it also offers small sale opportunities for us in the wholesale market as well. But in the consumer and business space, I think we've got a lot of the components now, indeed, all the components we need to do some quite interesting things in mobile. If you combine Wi-Fi, if you combine 4G, if you combine the MVNO deal that we've done with EE. So we're not going to tell you what we're going to do. One of the things we've benefited from, I think, in the last 12 months, is keeping our powder dry and taking the market by surprise, and we will try to do the same on this. But you should expect some news from us in the new year. Well, let me say 2014, let me put it that way. Yes? Sorry, on TV, John. Apologies.

John Petter

In terms of the TV adds of 70,000, and they're roughly 3x the size of the same quarter in the previous year, so it was quite encouraging. There was this -- the spike incurred in by BT Sport, and plus also the fact the launch of pay channels on YouView, so there's a new proposition out there, that quarter's spike of interest. It's worth qualifying results by saying that in terms of our focus in the quarter, in speaking to Sky customers, our call center agents were actually briefed not to sell against Sky TV. Because crucially, the way the switching processes work, and Sky get a save opportunity if you switch to TV, and they don't get a save opportunity if you switch to broadband. So -- and that says, therefore, that there is a kind of a big base of customers that have switched to broadband but not switched their TV, and there's a future opportunity for us to sell into. Having said that, which I'm not complacent, and it's clearly more to do to improve the TV proposition, that's what you're seeing today.

Gavin E. Patterson

Yes?

Unknown Analyst

It's Robert Grendolf [ph] at Espirito Santo. On the BT Global Services order book, is there any particular industry segment or product category which is leading to the uptick in demand?

Gavin E. Patterson

Well, I'll just give a little bit of commentary, and then I'll -- for a bit of color, then I'll ask Luis to talk. But the order book is I think very strong, up 19%, and the rolling order book up to GBP 7 billion in the quarter for the first time for 2 years. So -- and I think this is -- what I'm pleased about is the steady progress quarter-on-quarter. There's a real visibility and stability through our GS now, and I think you can see that. In terms of the orders, we're seeing our investments in Asia Pac and Latin America begin or continue to build very well. So the order book is up 25% there. FNBM [ph], so financial services is -- started the year very strong, in particular, retail isn't bad as well. But Luis, do you want to add anymore to that?

Luis Alvarez

Yes. I think in terms of areas abroad, I will say that clearly, the network part on global fiber services and ethernet remains the strongest part of the proposition. But now we are extending services around security, which are major driver from our customers, and we have signed very good deals on that. On contact centers, we have signed a couple of deals, one in the U.S. and another one in Australia. They're also showing the strength of the complementary to the network of additional services around, and we are very pleased on the development of new opportunities on collaboration. And clearly, the BT MeetMe with Dolby Voice shows the opportunity to help companies to have an integrated approach in the world. So I think that is quite a good balanced set of portfolio.

Gavin E. Patterson

Thanks, Luis. I'm going to come back to this, I'm going to go that way, and then come back. Anymore in the center? Okay. Let's go over to the left-hand side. Stephen?

Unknown Analyst

[indiscernible] from New Street. Two questions, please. You disclosed GBP 140 million of Sport cost in the quarter. I'm assuming that was influence extent by launch costs, but probably not the whole quartile Premiere League accrued in it. So just trying to get some guidance on how that cost will develop in the next couple of quarters, please? And the second question, which is regarding Global Services EBITDA, clearly a kind of very strong quarter. Tony, you singled out more cost initiative in the division. I mean, what's your confidence in EBITDA in that division continue to accelerate from here?

Gavin E. Patterson

Tony?

Anthony Everard Ashiantha Chanmugam

I mean, in terms of the EBITDA position of Global Services, cost transformation will drive further growth in EBITDA, I remain confident in that.

Unknown Analyst

And in the GBP 140 million on Sport?

Anthony Everard Ashiantha Chanmugam

Yes, sure. Look, it's got some high marketing costs in there, but primarily, this will be -- the bulk of it will be inherent in our cost base. What we'll find is though that the EBITDA impact will become much more muted as we have better churn, and we get more revenues in terms of the revenue fee-bearing elements in the subscription, as well as from the commercial side.

Gavin E. Patterson

Okay. Steve?

Stephen Paul Malcolm - Arete Research Services LLP

It's Steve Malcolm at Arete. I was going to ask one but that answers the question before last. I'm afraid it's prompted another one. The first one is back to pricing, just your answer to Paul's question. I'll take the point in added value, but I guess when you look at line rental, it's a price that everyone seems to put up in roughly the same amount every year, despite the input costs going down. And when you think about what's going with energy companies at the moment, their rising wholesale costs and the political sort of intervention on that is happening at the moment, is that something that worries you at all? How much further do you think you've got to go on line rental, which is a product that customers probably don't get much extra value from compared to Sports and the broadband? And then secondly, just on the point John made on the Sky save opportunity, it seems like triple play switching is quite a big issue for Ofcom at the moment, and as they sort of go into the DCMS, new legislation to put for the whole sector. Is the save opportunity in Sky something that's particularly interesting and unwinding that, and how do you think Ofcom and potentially DCMS may try and change the rules around triple play switching to make it easier for all operators to move customers around?

Gavin E. Patterson

Well, first of all, on pricing and the value for money in telecoms, what I note, looking at ONS data, Office of National Statistics, is that the prices in telecoms have come down by 5% in -- since 2007, and that contrasts obviously with increases in any of the energy companies, any of the water sectors, et cetera. So I don't think you can compare them. It is a very, very competitive market, and I think the data, the independent data, will demonstrate very much that it is the case. They always get the headlines when prices go up, we put our line rental up from January 2014 by 3.5%. Others have put it up a lot more. But it's also worth noting, many of our prices came down in the last 12 months. So when we launched BT Sport, we announced our leading fiber price coming down to GBP 15, and our leading copper price down to GBP 10. So it's -- there are puts and takes here, and I'm confident that actually because the market is so competitive and so dynamic, and you can see independently that the prices have come down over time. I'm confident that government and others will see that. In terms of switching, John, do you want to add some comments on the fairness of switching in this market place?

John Petter

Sure. Just a word on pricing, too. On the line rental price, if I may, first, actually. And the pricing change that takes effect from the 1st of January that we've announced is 3.5% on line rental, and that compares versus Sky's figure from the 1st of December, 6%, and Virgin Media increased their price for line rental by about 8% at the start of the year. So in that context, our price increases look quite conservative. In terms of switching, and the outcome of the Ofcom consultation is to change the switching processes and to maybe in getting provider-led. The positive in that is it's going to create a better customer experience, the more traction we make in the taking back of broadband market share, that's clearly a good thing for us, qualified by the fact that -- and the cable still outside the regime, and that goes like a missed opportunity for customers actually, and for the market and for fair competition, and so is Pay TV. And so on the DCMS strategy paper that came out in July, I think, is going to be good for the market actually, because it talks very heavily in terms of triple play switching and combined triple play process. And that will be a good thing, I think, for us and for the market as a whole.

Stephen Paul Malcolm - Arete Research Services LLP

So do you see it happening in the next 12 months?

John Petter

One [indiscernible] a time scare against regulatory changes of this sort. Because to get this far, on, the switching process, with the latest announcement, has taken several years, in fact, actually. So I'm not going to put a time scale against it. I think the results show that in the context of the current regime, which is doing very well, the key thing that we're trying to do and that's taken back broadband market share gains of 93% in the quarter.

Gavin E. Patterson

So we have time for 2 more. Thank you, John. Yes?

Jeremy A. Dellis - Jefferies LLC, Research Division

Jerry Dellis from Jefferies. I have a question on cost transformation, cost reduction, please. In the last 3 years, you've talked about GBP 2.2 billion after the cost base, x transit. If I look at consensus forecast and consensus EBITDA or is the midpoint of your guidance range, essentially assumes GBP 800 million coming out over the next 3 years. Now given Tony's comments in particular about all the stuff that lies ahead, would you think that consensus' view on cost reduction is perhaps a bit conservative at this point?

Gavin E. Patterson

DO you want to talk about it?

Anthony Everard Ashiantha Chanmugam

Yes. I won't comment on the consensus view. What I would say is, just to reiterate, we have plenty of opportunities to continue to reduce cost base. How we choose to use those cost savings is another matter. We already mentioned earlier that we have to reinvest in terms of our customer service to improve the quality of what we do. We have other opportunities, other options of investments but the key is, we have plenty of oxygen that allows us to invest.

Gavin E. Patterson

Okay. I think we're done. Thank you very much.

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