Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Virgin Media, Inc. (NASDAQ:VMED)

Q2 2011 Earnings Call

July 27, 2011 8:00 am ET

Executives

Richard Williams - Director Investor Relations

Neil Barkett - Chief Executive Officer

Eamonn O’Hare - Chief Financial Officer

Analysts

Robert Grindle - Deutsche Bank

David Gober - Morgan Stanley

Steve Martin – Areton Research

Nick Lyall – UBS

Matthew Harrington – Wunderlich Securities

Stuart Gordon – Berenberg Bank

Bryan Kraft - Evercore Partners

Richard Williams

We’ve started with our Safe Harbor Statements on slide seven and then we’ll make a start. Today we set our quarterly disclosure which should be read with any forward-looking statement we make today, but also point out that presenters will be mentioning certain non-GAAP measures today, the required disclosures with respect to these are found in the appendix to the slide.

And with that I’ll hand you over to Neil.

Neil A. Berkett

Thanks very much everybody. I think EVO will do to our video business what DOCSIS 3.0 did to our broadband business. I think it’ll significantly change our brand opposition and our ongoing delivery. But more about that later.

I’m very satisfied actually with the quarterly performance and I’m very pleased with our strategic progress. And I choose those words carefully. And I think it’s important that we see that even in a quarter, which evenly is normally negative for us, it was negative this time last year, I’m sorry it wasn’t negative this time last year, it was just the first time I think in five years. But clearly it has been a tough quarter for consumers. We still produced the good. And it’s important I think to understand why as we unwrap why we continue to produce the good. And I’ll spend the next 20 minutes or so taking you through why that is the case.

With what we saw in the quarter was obviously significant free cash flow growth off the back of modest revenue growth, off the back of multiple leaders, some of which worked and some of which didn’t. And if you haven’t heard me say that in reverse order about our investment strategy, then I apologize we’ve never met before because I think what the quarter does is completely reinforce that investment strategy. It grew rapid by 3.2%.

Business division is a little bit unusual. As we’ve explained to some it is, at this stage of its development, quite calm around each quarter; if you take the half year you’ve got a pretty good view of where the business is currently tracking and accelerating from and we’ll talk about that. But strategically we advance on several planks. I think we continue to exploit our long-term advantage in terms of having the best further access network in the country. But we continue to grow our differentiation around an activity application and convergence and we have started to accelerate into this mass market figment of digitally savvy or digitally aware customers. And probably the headline metric for that is we acquired 170,000 customers in the quarter. Half of the broadband eds, gross eds in the quarter were super fast broadband. They were 30 MEG and above. And I remind everybody that it was only two years ago that over 50% of our base was 2 MEG. This is a massively changing market place, something that we’ve never seen before. And we continue, obviously, to build shareholder value very, very strong free cash flow. And while I remain one of those not optimistic about the economy, I am optimistic about our ability to continue to deliver our investment basis, to continue to develop and deliver great service to our customers and superior free cash flow to our shareholders. And obviously the ultimate statement is that confident, is the capital returns program that we’ve announced today. Some £850 million of capital return. £625 million in buyback, adding to that that we’ve already done a billion pounds worth of share buyback in two to two and a half years.

So if we think about our business model; modest revenue growth because of our operating leverage delivering free cash flow growth, a superior free cash flow growth in return to yourselves and accelerated by way of share buyback. You come back to the key element of that story and it’s a combination of tight cost control but equally, if not more, important is modest revenue growth. And again I think we’ve seen in the quarter in the half that modest revenue growth continue through some of the leaders that we represent here.

And we are being asked constantly over the last few weeks that how do you maintain price in such a tight and low confident economy. It’s actually quite simple; we are not a commodity. Some people that play in our market are, we are not a commodity. Estimate 75,000 TiVo sales, 50,000 in store, the gap has only been selling for two weeks. Estimate, 50% of our broadband ad, that’s 30 MEG and above. Estimate, two price increases in the last six months and you can see (inaudible). This is about a business that is targeted to consumers and business customers that need data. They need data and they want data but the most important thing is they need data.

Though our drivers are broadly going well, we continue to move with price and there will be periods when that is not available to us. We just launched TiVo at a £3 delta in terms of its price over (inaudible). We had a record mobile cross sale quarter. 40,000 and in fact 50,000 net ed of contract mobile into the home, 83,000 mobiles all across the board.

The percentage of home phone which is held as a fixed element continued decline in the quarter. No we didn’t see customer growth in the quarter and obviously we saw customer decline. We say broadband up sale in the quarter and we had the circa £5 delta between 10 and 30 and 30 and 100 and clearly we won’t leave up-speeds there.

We saw business wholesale principally be the drag on business retail. So we saw business retail continue to climb in excess of 10% but drag back by business wholesale which I’m reasonably comfortable giving my knowledge of our pipeline that will return in Q3 and Q4.

It’s been a compliment talking about the change in UK consumer behavior. But it’s a very, very important compliment. The world is changing, the world has moved five years ago where 2 MEG was plenty because all you did was use email and in fact you were only just becoming a Facebook member, some of you anyway. But since then we’ve seen a 43% growth in data consumption. Our customers are now consuming 25 gigabits a month on average. What’s that mean? It’s the equivalent of six HD movies. Not too many people download that but it jut gives you a flavor from where it is. Some of our competitors have commodity broadband with a cap of 2 Gig which is less than 10% of our average broadband user. Our video on demand continues to climb at over 50% Q on Q; it’s in the mid-60’s now in terms of customers that use video on demand and they’re using it more and more and more.

And our broadband mix is fundamentally changed. When I stand here in two years time it would have fundamentally changed again because the very modest investment in our network, as required, we can upgrade our broadband fee. But why is this important? It’s because there is an emerging mass market of data hungry, digitally savvy and aware homes that are driving the data consumption. The customers come from every walk of life. They may well be (inaudible) but let me assure you a lot of our customers are not and they choose to have Virgin media because having a great connection in the home and having a great application like video on demand to be TiVo is very important to them. And they would rather do that because it costs them less money then going to the movie or getting in the car and driving to the supermarket. There is a fundamental shift in the UK digital behavior, one that’s being encouraged by every government in Europe and across the globe. Not only are we participating in this shift, we’re making money out of it. And it will mean that more and more we will target digitally savvy, digitally aware, easy enough for me to say, our consumer. And the same thing is actually happened in B-to-B where more and more in businesses and businesses that are no longer big corporate but medium size businesses demand data consumption. This shift in phenomena, shifting in which companies and individuals spend money is playing right into our network led strategy that we put in place in 2007. An economy strong or economy weak because of this transformation in behavior, the investment thesis remains. While in the quarter, and I go back to what I think is the headline metric, we sell 50% of our broadband at 30 MEG and above at £18.50 when you can go and get a two plus product for the same cost.

It’s all about driving customer value. And sometimes you drive customer value with volume and sometimes you drive it with price and sometimes you drive it with quality and sometimes you drive it with (inaudible) and the customers stay with you longer. The more products customers have with you, the longer they stay. The more products they had with you, the greater their level of advocacy, the more they tell somebody else. The more products they had with you, the higher propensity to buy more product and actually upgrade your speed. So the metrics completely support that. How else do you grow up to 3.6? You only grow it by increasing the percentage of your customers that are on 20, to be 30, MEG and above by getting more and more of your customers to take the top end of your TV product which is where all of your margin is. To convince your customers to move from a variable based headwind for us, so they offer headwind which is not insignificant is that of the decline both in business but more pronounced in consumer. You do it through triple play penetration, you do it through quad play penetration and ultimately you find you’re accretive in terms of APU.

And just doing a double click on the quarter, our average APU for the quarter was £47.35. If we look at the 36,000 net it’s approximately for the 90% of those customers were duals or single and their average APU was £39.84. So again a data point which reinforces what has happening below the surface of (inaudible) customers. It’s not 5 million static customers, 5 million customers of which a couple of hundred thousand come in and sometimes 150 go out and sometimes 200 and something go out. But they are changing and the customers we’re acquiring today are fundamentally different from the customers that I was acquiring when I started here over five years ago. Fundamentally different. They are digitally aware, they are data hungry, they are digitally steady. And we manage our customer base to be able to create value in the annuity string. If I can take a photograph of our weekly performance then I can see that the net present value of the annuity stream has gone ahead, I will double click on why but that’s the most important metric. Not whether I gained or lost subscribers or whether I gained or lost and individual movement. There is momentum but the most important thing is we drive that number to the right. And I’m obsessed by building it into the metrics in terms of what we pay our bonuses. Customer advocacy along with OCG generation becomes the way and the main trust of the business. I’m far more interested in loving and keeping customer who pays us £50, £60, £70, £100 then I am for one who will only ever pay us £20 or £30 and in 12 months time are going to be (inaudible).

So we need to understand what is happening in terms of how we go about it. And we continue to see the metric come forward in respect to our connectivity advantage. So if we go back over time to 2009, 2010, and 2011, and we see a fundamental shift in our overall broadband mix and a fundamental shift in our APU as a result of that, and I remind everybody the journey that we’ve been on. We tested elasticity, we operated to DOCSIS 3.0, we force migrated out to meet customers. They didn’t leave us, they loved us. We did that in the middle of a recession. And the reason it worked is because of this, you’re going to get bored with it, digitally savvy data hungry growth in customers. That’s why it can happen again. You cannot use price if all you’ve got is the same product as you had yesterday. But why wouldn’t you pay more? Go find another and I will call it a commodity, it’s called a gigabyte. It has come down in price with Virgin Meter at the right time. Think about it, what you pay for a 2 MEG speed three years ago when you were consuming six or seven gigabits a month compared to what you pay for ten today or 30 today where you’re consuming 25 or 30 or 50 gigabytes. It is significantly less. That’s why the model works.

And onto application. So you saw our journey, it’s reasonably predictable around connectivity. You upgrade speed, you run tiers within your huge pipe, you yield manage across that and periodically you upgrade everybody. Tried, proven, you’ll see us do it again and again. And the top tier speed at the moment, 100 MEG, starts out very quietly as did 50, but then accelerates. You test for the market on price, it accelerates again. Application is different. Application starts to create the glue beyond the raw horsepower of connectivity. Application is nothing without connectivity and connectivity is nothing without application. And TiVo is the best connected TV certainly in the UK and I would argue in the world. It is produced by connected TV experts. That’s all they do. That’s why we partnered with them. It’s why it’s actually launched on time. A lot of our peers have stated that they will build their own. It has a net promoter score, measure of advocacy over detraction of plus 30%. If I had a customer base that had a level of advocacy of plus 30%, I wouldn’t be standing here today talking to you, I would have retired. It is a massive, massive driver of advocacy. Our customers absolutely love it. Every single review of TiVo puts it as the best way to watch TV bar none. And I’m obviously deliberately using our phrase and they may not use that, but that’s what they’re saying and that’s what you’re seeing on the billboards at the moment. It is an amazing product and it allows us to create the glue between the social string; TV, the personal string; your PC or laptop, and the remote screen or SmartPhone and the Tablet somewhere in between. Because you will be able to access, just think about October, the second drop, your access, your hard drive from another device. Your connected TV would by then know you. It will be recording things that it thinks you forgot to record. It will allow you to go backwards and see that someone’s deleted something that you didn’t want deleted and you can undelete it just like you can on a PC. It’ll have applications like the Harry Potter app where we created an application around the launch, where we have little clips and customers can go into Harry Potter and they can go in and view and purchase Harry Potter, they can look at it in the on demand library. It’s got the intelligence to look at our linear open garden, our linear wall garden, our wall garden in video on demand and our selected over the top. It will do for us in the TV space what DOCSIS 3.0 has done for us in connectivity.

And mobile, so we saw for the Q1 the impact of mobile bonus. We drove a record 83,000 net contract ads in the quarter and some 47,000 - I think it was actually 50,000 contract ads into the home. That’s a 48% increase over Q2 in 2010. You’re starting to see now the acceleration of mobile into the home. And that’ll continue as TiVo as an application is more powerful either by price or by feature on a Virgin Mobile as opposed to BT or Orange or anything else so that our customers will see the glue between their remote device and their ex devices and that will allow us to accelerate that core play and it will allow us to accelerate the very strong economic. And Eamonn will take you through those economics but you will see that it is in fact the fourth RGU. But we don’t think about our business as being limited in terms of only being able to get three though we are in fact 2.6 products out of a maximum of four. And you saw what the machine is capable of in terms of our internal sales engine and taking it from dual to triple and the fact we only had three products done.

And then finally before I hand over to Eamonn, Virgin is your business. We have a very strong and in fact growing position in local government. You can see the Westminster, Cambridge County Council where we have classic data hungry businesses that are virtually 100% on the net. So in the same way as the consumer business is becoming increasing targeted, to albeit a mass market from all walks of life, Virgin Media business is also targeted. It’s targeted to those businesses that are on net where 80% of their traffic is on the net, so we don’t have to buy circuits from anybody else so we produce the same if not better economics from Virgin Media business as we do from consumer. We have a network that is effectively idol during the day yet we only have a 4% market share. And you saw all the power of what we can do in Q1 as it came through the economics. And it’s interesting even in Q2 where revenue was flat or minus 1%, absolute gross margin increase. So you’re seeing a business continue to grow and as we said earlier, I would take the six months growth of (inaudible) to accelerate from going forward.

With that I’ll hand it over to Eamonn.

Eamonn O’Hare

Thanks Neil. Good afternoon everybody and good morning to all our US colleagues that are joining us as well. Let me kick off with the summary of our revenue performance for the quarter and for the half year. As you can see from the charts, forward revenue growth is successive a quarter that was actually forward revenue growth in the business. The total for Q2 came in at just shy of £1 billion which is up 2.2%. That was underpinned by a very strong performance in our cable business, £682 million of revenue at 3.9% growth.

Our mobile business at £133 million came in at -2.7. That was predominantly driven by mobile termination myths which I’ll talk a little bit more about in a second. But excluding mobile termination myths, mobile would have grown closer to 2%. So our MTR was a swing factor of 5 points of growth in the quarter alone.

Business is just over £150 million of revenue. It continues to be flat to -1% but as I’ll talk about a little bit later, off the back of a very strong Q1 which I flied at the time as being really not representative of future performance and 14% in Q1 we think the half year performance of 6% as Neil just mentioned is much more representative of the underlying business.

So the half one performance coming in just shy of £2 billion. 3.9% growth and extreme mobile termination will impact that number would have been closer to 4.3%

Let me go into a little more detail on each of the revenue lines. Turning first to cable. As you all know, the two key pillars of a cable revenue is APU number one and customer growth and number two. Very close to APU as we had mentioned, APU in the quarter has been the main driver of our revenue growth, up 3.2% at £47.35. Less then acceleration from our Q1 APU growth of 2.6%. It is driven by price, mix and cross sale. And it shows that the focus on the quality of our customer basis is starting to bare fruit. It’s also important to note that that’s actually also in the face of a continuation of the decline in a fixed line selector usage, which is well as double digit.

Turning to the customer growth. Customer growth year-over-year was relatively flat, .3% up. I think the real story in customer growth is when you pull back the covers of that relatively flat performance and you look into the consumers actually arrived into Virgin Media through the quarter and those that left are quad and triple. Customers actually grew by 2.6% and our dual and single customers actually declined by 3.5. So what you have is dual, single, lower value customers, lower RPU (inaudible) business minus 3.5% and the quads and the triples are much more valuable customers north of the 47 point average growing 2.6%. As Neil has mentioned, really the focus overall is much more on quality not quantity of customers are much more of value, not volume.

Turning now to mobile revenue. The revenue growth as you can see in the first part of the chart on the left hand side, the headline growth as I mentioned was a -2.7%. Mobile termination rates actually kicked in to the quarter too to the tune of £6 million. And if you actually back that out of the numbers, I believe it turns out as I mentioned the 5% swing.

And the important thing about mobile termination is although it actually depresses our revenue unusually in the UK consumer residential market and telecom market, we’re not impacted on our OCF. Our OCF is mutual for mobile termination. So even though it depresses mobile revenue, we make up the OCF difference in our telecom business. (Inaudible) about 6 million per quarter revenue head winded mobile will stay with us for the balance of the year. However the second part of the graph shows the main focus for us in mobile really is about driving contract mobile and particularly driving contract mobile into our cable bed. Contract mobile grew in the quarter 23% and is now at 1,347,000 customers and that’s a record for the business. And more impressively the number of contract mobile inner cable bid is up 21% at (inaudible), which is 60% of our contract bid.

The second thing I want to talk about in mobile really is building cross selling into the business and why it adds significant value. And I think it’s worth reminding everybody that the mobile economics for Virgin Media sound low are very strong. What you can see from the chart on the left hand side is really the economics of mobile compared to the rest of the Virgin Media business. The red bars are the Virgin Media business, the gray bars are mobile.

You can see the gross margin level mobile actually has an inferior gross margin to the rest of the business. The rest of the business is stuck at 60% and the gross margin for mobile is significantly below that. That’s because we’re virtual mobile network operator and when you move to the OCF margin level actually that gap closes a little bit. But when you actually get to the cash flow or the cash flow level, and here I use the proxy of OCF minus CAPEX. Because we don’t have to spend any CAPEX in mobile because we’re supported by network operator, you can see the difference in terms of cash coming out of that mobile business versus the rest of the Virgin Media business is pretty close, though standalone economics for mobile compared to the rest of the business are pretty close when you’re at a cash flow level. Not the gross margin level, not at the sales level but at a cash level.

And the second thing about mobile economics and why cross-sell add significant value is really the cable churn that it impacts. Now we’ve seen this chart before and I think it is quite important. But as you move from a single product customer of Virgin Media with a churn rate over 30% to a dual in the high teens, the triple in the low teens to a quad, i.e. with a contract mobile, the churn dynamics are very different – it drops down into mid-single digit; 6% is our typical churn of our quad customers today. And that lower churn rate drives significant incremental value into the cable business and that’s why cross sell is so important to us and why it’s one of our big strategic imperatives.

Business revenue growth. I’m showing here the business revenue growth from the half year basis leading from £293 million to just over £300 million which is up 6%. We think the half year’s much more representative with what’s happening in the underlying business. Q1 was up 14%, Q2 was -1%, it’s that lumpy particularly because of the wholesale revenue so we think the half year is a better indication of what’s happening underlying in the business.

The second point on business revenue is (inaudible), and in the quarter or in the half was up 14%. And the reason why data is so important is because it’s margin rich. Alike in the consumer business, in the B-to-B business, it is a focus around the margin rich higher value pieces of the revenue.

Turning to the financial performance in the quarter and the half year, the headline really is another quarter of strong financial performance where modest revenue growth is combined with significant free cash flow growth. You can see the revenue that I mentioned already up 2.2% for the quarter. The OCF at £392 million came in at just over 6% growth. And the free cash flow at £123 million, almost 13% growth for the quarter.

And then on the half year basis you can see that revenue almost 4% at the OCF just shy of 7% growth and as Neil mentioned earlier, free cash flow £223 million, 44% growth at the half way stage of the year.

The data that I’m most excited about in this chart, and I’ve mentioned this several times before when I showed this chart is going to be cash conversion dynamics of the business. And you can see on the far right hand side of this chart that for every point of growth through the half year, we actually delivered 66 pence of OCF and a very impressive 91 pence of free cash flow. You can see it at the cash conversion dynamics of the business are very, very solid and quite impressive.

Alright, turning to capital structure, we made some significant announcements today about the second season of our capital structure which I’ll come onto. But before I do that I think it’s worth reminding everybody the framework as it forms the basis of a decision when we think about our capital structure and how we optimize it going forward.

The first big thought we had is about making sure that our debt fits our purpose, and we’ve focused a lot on our debt structure over the last two or three years and we’ve got that fit for purpose. We’ve actually got the average tenure down to six to seven years which is fabulous. The average cost has been leveraged from over 7% from 6.6% and we have no amount of repayment on our debt until the start of 2015. So restructured debt works.

We continue to de-leverage in journey. We have a commitment to get our leverage down to three times our OCF over the next one to two years but the commitment that we’re on track to deliver, our senior debt is non-investment grade and our leverage has actually moved through the journey of 4.8 times way back in 2008 at 3.5%, so we’re well on our way to our 3x target.

I think the third box is particularly important. It’s really important for us to make sure that we have enough cash to invest in the business. We are a growing business, we do need capital to continue to grow the business and to sustain strong competitive advantage. That’s a very, very important feature and we are maintaining our CAPEX at a rate of 15% to 17% of our revenue, which is quite a substantial amount of money.

It’s only after those three considerations do we think about returning excess cash to our stockholders in form of either buybacks or dividend. But I think that’s quite important that we just remind ourselves of the framework that we go through. As you know, we announced a 700 million capital return program this time last year. 375 million are stock buybacks and £325 million of other financial transactions. But the good news is we’ve completed that program literally in the last few weeks. We’ve purchased 24 million shares that actually is 7% of shares as of July 10th and we have the average share price that we’ve acquired the amount of $25.

In the second basis which we’ve announced today is the 850 million of additional capital return to stakeholders and that is made up of two major components. £625 million of common stock repurchases and £225 million for other transactions. The board is authorized by the end of 2012, £625 million to buy back stock at 12% of the current market capitalization. And if you add the 625 to the 325 that we have in the one program, that gives a cumulative £1 billion of stock buyback to the two and a half years. And the balancing £225 million from other transactions, we’ve got a lot of flexibility around that, we’ve got options backing some of our debt structures in terms of increased productivity and also perhaps doing other things.

So in wrapping up hopefully our numbers in the quarter and half year demonstrate that Virgin Media is a business that has multiple sources of value. And what this chart attempts to sum up is really the resilience and the robustness of our investment opposition. You can see that we’ve got strong cash conversion of free cash flow growth underpinned by revenue drivers from multiple sources that Neil talked about. Network advantage, data hungry households, innovative products and services and our ability to monetize those. That’s a fundamental underpinning of the investment proposition. That coupled with a network that’s already built, strong cost control, excessive CAPEX, you don’t need CAPEX to build out the network, (inaudible) CAPEX, and continually lower interest rates were de-leveraging. That gives strong cash conversation and under 44% in cash flow that you seen the first half of the year. I think that combination and the powerful capital program is one that actually combined to get significant returns to our shareholders and hopefully you’ve seen up to date.

So really in summary some ways echoing Neil’s point hopefully today’s presentation gives you confidence of managements commitment to keep Virgin Media in the journey of delivering strong free cash flow and actually free cash flow for shareholders now and into the future. So with that we’ll hand back to Richard and we’ll take any questions you might have.

Question-and-Answer Session

Richard Williams

Okay. Thanks Eamonn. We’ll take some questions from the floor and from the phones. Can I please ask you to name yourself and your institution and one question please, each, so we can get more questions.

We’ll start with Rob.

Robert Grindle - Deutsche Bank

Any update please on your thoughts about network expansion using poll access, BT etcetera?

Neil A. Berkett

There are pilots in trial and we are in quite advanced conversations with some boroughs and council in respect to being able to complete a metro roll out in parts of the London area. It will obviously be the (inaudible 00:40:26) negotiations but I’m optimistic we will have the first of those in the not too distant future. The proposition would be that we would provide free WiFi access for all at (inaudible 00:40:48) with full access to Virgin Media customers up to ten megabits per second. We may consider speaking to one of the (inaudible 00:41:03) about whole selling (inaudible 00:41:05) activity.

I’m quite excited about it. I think very few things (inaudible 00:41:12) as a businessperson, that’s probably one of them. But even (inaudible 00:41:19) get it wrong. But I think it is a real opportunity if you think about the gap that is increasingly occurring between consumers needs the data outside the home and what they can get on 3G and the gap between 3G time wise to 4G RTLE. And in fact the power of a reasonable consistent five, six, seven megabits per second across a wifi network versus the spottiness that you’ll get through the (inaudible 00:41:54).

So we’ll keep you updated. I think we’ll be a huge cash flow contributor in 2012. But it is something that I think is part of our resource in investing in advancing digital lifestyles, if you like, and pushing the envelope the roll that we play in UK (inaudible 00:42:17) the other infrastructure in keeping them honest.

David Gober - Morgan Stanley

Can I just ask you how fast do you think the mass market data hungry homes are going to grow? Because obviously within this quarter, I know it’s slightly seasonal, your triple play shrank slightly. But I mean how does your market research suggest that that market place is going to grow over the next several years?

Neil A. Berkett

Fast enough, such that negative subscribers don’t become an annual event. It is growing fast enough for us to acquire into that market whilst we eventually move away from those that don’t value that service. And I would see the market and it is a bigger market on net then it is off net just because you are more exposed to a digital world in an open area. I would see that continuing to grow. There will be a couple of other stimulants for it which are competitive stimulants which are good because they came after us. It’s always good to be first mover into a market and then allow others to do it, and obviously the father rollout is one of those. But the more customers that can get over 30 megabits per second, the better. As far as I’m concerned that means that more and more customers will get used to that and will demand it. It also creates, because it is wholesale pricing, it creates a bit of a floor in the market for father based pricing from £6 to £8 more expensive than (inaudible).

And the other stimulus is obviously YouView soon as it gets off the ground. I think it probably will sometime during 2012. Say you’ll have a connected TV that is for the mass market. So in the same way as DOCSIS 3.0 gave us first mover into super fast broadband and always the best place to be to be first mover and best mover which is where we’ll stay. I think TiVo gives us first mover and best mover interconnected TV. But I think the growth is scalable, massive, and clearly our strategy is going to leverage off the back.

Steve Martin – Areton Research

Thanks, it’s Steve from (inaudible). Can I just ask a question on gross ads which were obviously down 10% year-over-year? Give us a little bit of color on that - you know, what portion gross sales came from the recent network expansion? And then when you strip that out, what’s happening in the existing network and were there any particular channels that were stopped or any particular features of economy that give you cause for concern? Thank you.

Neil A. Berkett

I think the quarter; I mean seasonally the quarter is always a weaker quarter for us. As I said, Q2 2010 I think we did 7000 or 8000 ads in pride of that we were consistently negative 20 30, in one year 40,000 so you’ve always got that phenomenon. You’ve always, I’m picking that a little bit. There tends to be a net mover off net; unfortunately for us in that quarter. That’s one of the reasons that drive it and we saw that again i.e. people moving on net were less than people moving off net. And the other big event in there was students. We acquired students in September and they leave us in June and we make money in between. We sign them up on nine-month contracts, they pay twelve/ninth months and it skews the subscriber numbers but it doesn’t skew the cash flow. So that’s permanent feature. The other feature is it was a tough quarter. And it was a tough quarter for all of the reasons that every time you pick up a newspaper it tells you. And we can’t walk away from that. And I think that impacted, as you can see from our chart, it impacted our gross edge more than it impacted our chart.

But we don’t, and I think I said this in Q3 2010, you know, we are a financially disciplined organization. We do not chase optics but frankly and I think some organization chase optics; i.e. they don’t believe that some subscribers are more valuable then others and we do. So we’re targeting who we will, who we look to try and convert. And we saw activity in the quarter where competition increase is demand reduces and we didn’t. So there’s a bunch of things in there Steve, none of which I think… I mean you don’t like losing subscribers but when you stand back from it and you say net 36,000 left at £39 something, basis at 47, that means we’re acquiring higher than that. I was satisfied with the results.

Steve Martin – Areton Research

Given the points you’ve made about the potential cost-saving opportunities your customers are not going to the supermarket, not going to Blockbuster; are there other advertising opportunities you’re looking at to emphasize the value of the proposition a you said into this next quarter and moving forward?

Neil A. Berkett

I’ll take the creative onboard and have a chat with our CMO about that. Thank you for your contribution.

Executive

We will, I’ll take the creative on board and have it checked

Steve Martin – Areton Research

Steve Martin from Areton Research, I just wanted to follow up on the growth question I was asking. Are there any metrics you can give to the fact that you were applying all the discounts so that we can actually understand that when you weren’t chasing business as hard as other people how that plays through differently in the economics?

Neil A. Berkett

I’ll kick it off because I’m not sure there’s a whole lot I can add to it. Because we don’t give that level of granularity I can directionally say to you that our stack over the last eight quarters haven’t moved materially. So we are reasonably disciplined. We know what you can afford to spend on certain customers and that’s sort of where we stay. Clearly our stack this quarter will be higher. We’re above the line advertising because we’ve got something to shout about, and I think that’s the other part of the discipline – shout when you’ve got something to shout about.

And so you will see it come through in the combination of SG&A and RPU if we were to be applying discounts. This whole, this other discipline we run in parallel to POB is our NPS discipline, so we’re polling our customers to see what they think of us. And I can assure you when they don’t like us they tell us and there is a direct relationship to our NPS 4 and our churn. So we can see it coming, so we know immediately whether something we have done at a micro level has been good or bad for the customer or at the macro level whether it’s been good or bad for our customers. We can predict and are starting to learn to get better at it but our financial relationship between our net promoter score, efficacy over the fraction and in fact our lifetime value.

So that’s basically well known – you push your price up too much your churn will increase and your CLB or your MPV will come down. So it’s a reasonably robust model and are we going to get it right 100% of the time? Of course we’re not – we’re only human. But it’s our judgment that we’ve got it right. It’s our judgment to actually post the price increase we’ve put in place earlier in the year that we’ve got it wrong – we haven’t gone far enough, which is why when BP put their prices up online recently we followed them. So it’s a judgment.

I mean we’ve got many markers here, but whilst you are the master for our cash flows if we don’t keep our customers happy you’re not going to be happy either. So we do need to manage it and you know, at the end of the day we’re a Virgin company and we drive the Virgin values throughout our organization and values for money and customer service are a part of the brand. So it’s our core discipline. Our core discipline is customer management – it’s what we do. It’s all we do on the backs of some pretty [trash op] technology.

Nick Lyall – UBS

Good morning, Nick Lyall from UBS. Can I ask the operating costs were a lot better this quarter than the last quarter. Is it all MTRs or is there items in there like die costs from Q1? Could you just breakdown the cause of the improvement, please, and can you also tell us what percentage levels were looking up for consumer and business levels that are sustainable for the second half, just gross margins?

Eamonn O’Hare

There isn’t massive fluctuation in the costs there so there might be a few bumps from one quarter to the next but I’m not encouraging to be basing your models around where the cost base is going. There is an ongoing focus in the business about taking out what we call “bad costs” and that might be partially facilities and back office stuff and we’ll see a bit of that. For example, we just recently closed our big London office on Portland Street because it cost £100 a square foot at £10 million a year and we didn’t need to be here, and you’ll see that kind of cost coming out of the business; but you’ll see marketing costs going up. You’ll see Q on Q and year on year marketing costs going up and we think that’s good costs, it’s investments in the business.

So I encourage you to think about the cost base remaining relatively calm but you’re going to see those plusses and minuses going on in between. I’m sorry, Nick, I missed the question about the Q1?

Nick Lyall – UBS

It was more just about the potential. The percentage gross margins are pretty strong in consumer and business, but presumably that’s not sustainable for H2.

Eamonn O’Hare

Yeah, the way in business, I’d encourage you to think about the half year being much more representative about what the future’s going to look like than either Q1 or Q2 and similarly on the gross margins. Again, it’s all about the B2B revenue sitting underneath the total revenue for B2B, and similarly on consumer there’s no real major fluctuations ahead although we are expecting… We’ve done a price rise included in, as kicking in the 1st of August so you’re going to see a little bit of that kicking through in the second half of the year.

Neil Berkett

Is anybody on the phone?

Operator

Yes. (Operator instructions.) We’ll now move to our first question today from Matthew Harrington from Wunderlich Securities. Please go ahead.

Matthew Harrington – Wunderlich Securities

Good afternoon. Could you, I know this is glue rather than something that would have any increment to the margin in 2012, but could you talk about Spotify and how that tightens the relationship with the mobile side and more also with the virtue of studying feedback?

Neil Barkett

Sure. So Spotify was formed from a transaction we tried to do two years ago that talked about how hard it was for ISPs to work with the industry, the (inaudible) industry sometimes. And the whole concept is to provide our subscribers for a very, very low monthly subscription the full Spotify library. So if you’re a Spotify paying member I think you pay £10 and we’ll bundle it into our broadband for a significantly less amount than it launched at so you’ll see that when it comes out. And what we had to do was sign a deal with each of the music labels and a deal with Spotify, so why would they do it? What was the reason they’d do it? It’s so we would be more forceful when it comes to piracy and some of our peers would be competitive.

Part of what I think we can do, going back to being a Virgin company, I think it’s the right thing to do in terms of creating what we call digital competence from our suppliers and from our customers, but it’s a unique proposition for our subscribers. I’d love to do the same thing in movies but somebody else has control at the pay window.

Matthew Harrington – Wunderlich Securities

And do you feel that it helps Quad Flick?

Neil Barkett

I think it will significantly help the position we take around applications. So the reason we go application is connectivity can get commoditized. You want to have applications where they’re continually exploiting your connectivity advantage, so it’s another unique offer we can give to our subscribers and I think it’ll improve customer advocacy and in turn that will improve churn; and it will also improve the point you made around cost pay. Like TiVo which is a multi-platform piece of middle ware for video distribution, Spotify is a multi-platform application for distributing music. So there will be a Spotify app on your TiVo. There will be a Spotify app sitting on your PC, either within TiVo or on your PC and you’ll have one on your mobile phone. And we’ve got exclusivity for fixed; we won’t have exclusivity for mobile but our customers will obviously be able to use it because they are fixed customers. So it’ll be another piece of glue and you’ll see more of it. We’re at the beginning of creating applications that surround our customers.

Matthew Harrington – Wunderlich Securities

Thank you.

Operator

Thank you, and I have a question from Stuart Gordon from Berenberg. Please go ahead.

Stuart Gordon – Berenberg Bank

Yeah, just trying to understand what you’re saying about the customers you lost in low quality. From the information you’ve given us it would appear as if there was a one point set (inaudible) to use sub which would compound to £24 our view versus £95. So I was just wondering if you could clarify why you thought they were lower quality. I would have thought they would be quite high-margin customers. And in fact, if I could just sneak in a second one on the back of losing customers, you say your customers are very digitally aware and savvy, and while obviously [OffCom] still says you give its best bids, are you not a little bit worried that [OffCom] customers satisfaction stats still show you lower than BT and Skype? Thanks.

Neil Barkett

I’ll pick up the second half of that, Eammon, if you pick up the... And I’ll go in reverse order. So as I was talking about earlier we poll our customers every day. We’re acutely aware whether our customers are advocates or detractors. There is unfortunately for us a direct correlation between the MPS we were polling and both points of the [OffCom] survey. We were at an all-time operational MPS high at the poll before last and we were at an all-time operational MPS low at the current poll. We have since recovered and in terms of the way our customers feel about us over the last five months now since that poll was done and we’re back to where we were at the original poll. So it wasn’t surprising to us and whatever impact that would have on the base you’ve already seen because it was done five months ago and we’ve improved since then. I’m sorry, I forgot the first part of that – I should have written it down.

Eamonn O’Hare

What we’re trying to say is that when you actually look at the 170,000 customers who’ve shown up and the 206,000 customers that show your ware, and you look at the 36,000 in between, for us it was about actually moving forward the value of the customer portfolio. So when we talk about the lower value customers what we meant was a very big percentage of those net adds that were negative were single and dual customers, which I showed in my presentation – they were down 3.5% year over year. And the RPU of those customers was between 15% and 20% less than the average RPU for the business. That’s why they’re less valued customers for the business. Single product customers, dual product customers…

And I’ll give you a good example of it if you look at just some of our TV customers, we have one product, free TV customers and free TV customers actually have fallen in the quarter and customers that pay us for TV have actually risen – that’s just another example of the value of the customers that we have going forward are better than what we had previously.

Jerry Dulles – Jeffries

Jerry Dulles from Jeffries here, just a question on growth and operating leverage. We’ve seen OCF growth slow on a pro forma basis, actually MTV from about 14% to the beginning of 2010 to about 6% this quarter. It also looks as though while there’s still operating leverage it’s diminished. I mean the revenue growth x MPR, that seems to be the most appropriate one to focus on and that was 4.3% in Q2. Just wondered when you think the OCF growth rate could stabilize and turn the corner? Thank you.

Eamonn O’Hare

Well I would say stabilizing and turning corners is not something I would associate with the OCF, and actually the truth is we’re much more focused on the free cash flow and we have talked confidently to our investor base about moderate revenue growth driving significant free cash flow and we’ve talked a lot about we only need 3% or 4% top line growth to drive 20% free cash flow. And one of the pine notes of whether it sits up here or it sits down there, or whether there’s a bit of a mobile boom thing going on that we mentioned at the start of the year that sits up there or a CAPEX thing down here, it doesn’t freak us out too much. We’re actually very focused on making sure that the free cash flow is actually very robust and healthy and I think if you go back to 2010 and 2011 you’ll find that that’s kind of… There’s no real turning corners going on there.

Neil A Berkett

I think we’ll end it there. Thank you very much.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Virgin Media's CEO Discusses Q2 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts