BT Group F2Q07 (Qtr End 9/30/07) Earnings Call Transcript

BT Group Plc (BT)

F2Q07 (Qtr End 9/30/07) Earnings Call

November 8, 2007 5:30 am ET

Executives

Mike Rake - Chairman

Ben Verwaayen - CEO

Hanif Lalani - Group Finance Director

Ian Livingston - CEO, BT Retail, Director

Steve Robertson - Chief Executive Officer, Access Services

Analysts

Mike Williams - Citigroup

Martin Mabbutt - Nomura Securities

Graham Ruck - Merrill Lynch

Nick Lyall - UBS

Stephen Howard - HSBC

Paul Howard - Cazenove

Steve Malcolm - Arete

Hannes Wittig - JP Morgan

Christopher Nicholson - Oraca

Presentation

Ben Verwaayen

Good morning, everybody. Thank you for coming. Before we go into the presentation, I'm delighted to introduce Mike Rake, our new Chairman, and I would like to ask Mike to make some comments. So, Mike?

Mike Rake

Thank you, Ben. Thanks very much for that, Ben, and welcome, everyone. It really is a pleasure finally to be here, after all these months of preparation. This, to me, is an absolutely fascinating, complex and competitive industry, whose success, whose importance is critical to every individual, every sector of the economy, and operates within an incredibly fast-changing landscape of technology, globalization, regulation, sourcing and many other issues.

But the six weeks—today, actually--that I've been here, have really been stimulating, fascinating and interesting. I've been fortunate in the last few months, since the announcement, to be able to spend some time--particularly when I was traveling around the world with my previous firm--to really visit some of the BT operations around the world, in Hong Kong, Tokyo, the United States, in Belgium and the BT Centre here, spending time with a lot of the executives.

And I can tell you that I've been hugely impressed with the quality, the enthusiasm of BT's people, their commitment to BT, to its customers, their communities. This was actually very well illustrated, going to York for a regional meeting, meeting some of the engineers from Openreach who were involved in the floods that we had.

And the kind of level of commitment--BT wants to get something done against all the odds, I thought summed up the way I see BT in the short period that I've been here. This business, has quite clearly been transformed in the last five years--by Christopher, by Ben, and by the management team they've put together.

And I think BT will be extremely well positioned in this highly competitive and fast-moving environment to move forwards, as we continue to invest in customer service, in technology, in global capability, whilst putting, what to me I can see as an enormous commitment,\ into complying with the U.K. regulatory regime; one, by the way, that has clearly made the U.K. the most competitive environment in the world.

Lastly, before Ben goes on to deal with the results, I'd just like to say that given this highly competitive environment that we have, the investments that we've continued to make--I personally find the results for the quarter to be extremely encouraging. I am delighted to be here, and extremely enthusiastic and optimistic about the future for BT, for its people, for its shareholders, for its customers.

Thank you for coming. I'd like to hand over to Ben.

Ben Verwaayen

Thank you, Mike. Right. You have seen this chart before. As always, please read it at your leisure. Very interesting reading, maybe as interesting as this one, because this gives you a picture of the quarter.

Now, as you know, companies go always at great length to think about the headline that they need to use around the quarter. And you'll have people from different schools trying to position what the quarter is all about. And some people, if you read what we have said, we have said, I believe, solid or rock solid or something like that, and people read a lot into that.

The best way to judge a quarter, of course, is to look to the facts and see what is the composition of that one word that at the end a company is choosing. And the thing that I like to say here is the word is quality, because if you look to the quality of our revenues, you will see a marked difference from where we were a long time ago.

You can see that the journey that we had as a company, to go from hardware to software, from basic services to value-added services, from a focus on the U.K. to a global focus, from a dependency on technology to a capability to develop, has enhanced tremendously; and you can see that, in the highlights of the quarter. In and by itself, all of these elements do not tell the story, but the composition of the elements do tell the story, and do tell to you why Mike was so encouraged when he saw these.

If you grow 19% out of the U.K., 19% growth, that is a phenomenal number; if you have four years of drought in the consumer business, and you grow again--and you grow again, in addition to enhancing your ARPU, it tells a story. The customers that you have are of a higher quality. They're not here because they have no choice. They're here because they want to be with us.

And if you look to what the market share of broadband is telling you, in a market where the free story is still alive and kicking, you can see that, for example, the net adds of BT Retail are double that of Carphone Warehouse. So you can see there is something happening there. A lot of people would say, yes, but the EBITDA?

EBITDA is 2.1%, or so. It is in the same bandwidth as it was for the last couple of quarters. And it's based on two things. It's the quality of revenue and the cost savings, and we'll come back to both of them. EPS--it's 22nd consecutive quarter of EPS growth—is, of course, a story even by itself.

And then, 6% dividend up, for the interim dividend, is a clear sign of confidence that the Board has given. So you have seen this chart over and over and over again. This is about a transformation of the company.

And you see two things: a company that is much better capable of dealing with the decline in the Traditional--this one is actually 0.7 of a percent--and you can see that our New Wave revenue keeps growing. Let's look to both.

So, look to this defense of Traditional, and we said that when we were here. We talk about defending the Traditional and look to the trajectory of where it's going. If you look to the minus number now, it's made up of lines and calls--35 million.

It's made up of transit, which is very low margin, as you know, same amount, and on the upbeat the MPLS was really growing, 30-what…percent, 32%? So you can see that the numbers that we're dealing with are a factor lower, of where we were a couple of years ago.

And you can also see, if you look to the Traditional business, that it is becoming an embedded part of what we really sell to our customers. So I am almost at a stage to say, well, this tell you the picture, Traditional, New Wave.

It is much more capabilities that we sell, and you can see that if you look to this one. If you look to this chart, it tells you that we are growing our business substantially. It's now 38% of what we do, in the definition that we use.

38% is New Wave. 12% growth on ICT network services, 12% growth in broadband. These are phenomenal numbers. And it keeps growing. And why? Well, because what we sell as a capability to the market is in high demand.

So let's look to the high demand. BT Global Services order intake, $1.6 billion for the summer quarter is a very good number; 128 new names added to the list of corporations from around the globe.

And Hanif is always keen to say 60% of the orders were outside the U.K., and he's right, it's true. But even more important than that, I think, is the quality of the orders that we get. Look to here. You see DHL, which is DHL in Italy--180 offices.

Look to Arcelor--ArcelorMittal. It is 700 points of presence in 40 countries around the world. So look to what we do here with Novartis, an existing customer of Infonet. Build out to a $500 million contract--a Logica contract for seven years. And why is it? Why is it that we have such a great position?

Well, there are two things. The first is the capability we talk about, and the second is reach. Now, in the quarter, we have expanded our reach. We made acquisitions and you have seen them. Comsat International, in Latin America, gives us, for example, all of a sudden, a seat at the table with the Brazilian government to talk about Internet in the Amazon region.

i2i in India, which gives us a very strong position in the growing Indian market, and gives us a footprint that we didn't have before. We make a deal with Golden Telecom in Russia to get access to that backbone network, and guess what? Our customers want to be present in that market, and we have now a capability, cost-effective capability, to go and reach them.

So it's reach. It's capability. And you can see 12 months rolling going to $9.2 billion. And still, we're struggling to tell you the story, because how do you put it into context? Well, maybe we get help from Data Monitor.

What Data Monitor is doing is they take contracts in Europe that have a network element to it and they exclude the wholesale network, because that is Traditional telcos together. And they said, how many orders were there? There you see it; and who won the orders, and what's the value of the orders?

And there are two things here that are important. First of all, look to the list of competitors. This is a converged world. Interesting enough, number two and number three are suppliers to us-- classical suppliers to BT--turning out to be number two and three on the competitors list.

So, welcome to the world of friends and enemies. They don't exist any more. This is a world where you are working together, where it makes sense, and compete in other sites and be perfectly comfortable with that. And I want you to see the list, which is equally important, is that those classical competitors of ours, you have to go lower through the list.

Look to the numbers of orders. This is Europe. We have more orders than the number two and three combined. And if you know that the order for Siemens was one order in Germany, even with that in mind, we are almost double the size of that of the number two. And why is this important?

It is important when we're going to talk a bit later about the available market and pipeline and to see what's available to us, if we translate this into a capability that is very closely positioned with our customers, so we can take the global sourcing cost model into this order portfolio.

So, broadband. This is a story that everybody has seen coming and a few of you have doubted whether growth would continue. This is almost 500,000--479,000 to be correct--growth in DSL market. LLU stands now at 3.2 million lines, and will grow further; and you see the squeeze there in the light blue in the middle.

This is a growing market. And you know what? As long as it's growing on DSL, it's great news for BT. And the difference between us and cable over the last 12 months is a ratio of seven to one. Seven to one, so the comparison with any other market in the world, put that number in the back of your mind.

BT Retail did, I think, a terrific job. They did an absolutely terrific job. They positioned themselves as a value player and look to this. There are two numbers that I every time stress, and I will do it again. First of all, look to the growth number. The growth number is important because those are new people coming to the market, picking up a phone and say, “I want broadband.”

450,000 of them scanned the market, looked to everybody who was available and went for BT Retail. And all of them, 60% said, and I want value in Option 2 and 3. And of that 60%, three-quarters went to Option 3, which means, in normal language, over half of the people who buy from BT Retail buy Option 3.

And the recognition of what we deliver is not just measured by the numbers. It's also measured what people say after they bought stuff from us. So, we do care about the fact that Computer Shopper says that 86% overall rating for PlusNet is a differentiator in the market. And we do care when we get, for BT Total Broadband, the recognition from the Mac users, because it tells you that there is stickiness to what we offer. It is not just the time that you make a decision to buy. It is something that really has value for us.

Now, this is an interesting picture. I'll just refer to this, because there are two things that I'd like to say about this. First of all, these are the six largest players. And the six largest players amongst themselves have more than 100% of the net adds in the quarter, which tells you that the other 300 players or so are losing. There is concentration at the top.

And you can also see that the concentration at the top is such that, where Virgin was for a long time the leader in this market, and we would have given you this chart based on historic basis for many, many years, they would have been the number one. We have overtaken them, and we are growing very, very fast going forward, based on the value concept. And this is the value concept--this one. And whether it's working or not will be determined by customers.

I'll just give you numbers, so you get a feel for it. Security & Storage--we talk about all the time. Digital Vault, 300,000 customers. 300,000 customers. The homework of your kids, the photos on your computer; you want to have them safe, they are safe on the net, and you don't have to worry about it. Adds to the value.

VoIP. You remember that six months ago we talked about being at 1 million registered VoIP users early. I can announce today, 2 million. That really is growing very, very, very fast. And let's look to two others that are truly important, and I think will capture the imagination of our customers.

The first one is BT Vision. Now, we have set targets for ourselves. The problem with targets always the targets become the story. But before I go on to say something about how we're doing on the targets, let me tell something about the story itself.

BT Vision is an enhancement of the broadband platform. That's what it is. It's a capability that gives people an enormous amount of extras, over and above their broadband access line and it fits in that picture.

And yes, we have targets there with numbers, so let's talk a little bit of our targeted numbers. 70,000 installed, which is great and it, I think, fits perfectly the bill, but 100,000 sold and that's even better. But even better than that is 75% is now self-installed and guess what? People are using it. On average household on BT Vision, in September, 11 use what they pay for. And by the way, if you look to the movies, 60% of the movies are new releases.

That tells you that 40% is library, and that tells you that there is a wide variety of new services that you can think of that can be based on BT Vision. So, there are an enormous amount of data that's now gained by using real customers and their expertise and how they use it, and when they use it, and the capabilities that will go to enhance further our capabilities around Vision. And the number of 100,000 is pretty good.

Now, another pretty good one is this one. Fon was a brand name in the industry for a long time, clearly a leader in innovation, and guess what? They have done something spectacular. They have thought about something that is really helpful. And if you add to that the BT capability, it is creating the world's largest WiFi community.

Why does that matter? Well, it matters because it's an enhancement that you can really use. You get now, all of a sudden, hundreds of thousands of extra potential spots where you can use your WiFi phones, where you can be out and about and use your capabilities. And by the way, when we launched this, we launched it, we gave some publicity, no marketing yet, in the first four weeks 23,000 people signed up for it.

So, this is really a thing people recognize as value, and they want to create it, and they want to have it. And all of that is that broad smile, and every single quarter, the smile gets broader. It's the ARPU, and, in essence, that is the story.

The story is that we get customers who want to stick with us for reasons. It's not just that we are giving them an excess capability. It's the value that they create and they are willing to spend more and more with us. And this customer ARPU picture is telling the story in the consumer market.

Now, as exciting is this picture…four years, no growth, for all of the logical reasons. And it was fine. It was incorporated in our planning, and we understand it. We saw it coming. And it was perfectly okay in the development where we were on.

But I can't hide my smile when I see this one, because this is really terrific performance from our Consumer group. They really have now, in my view, made it clear to the market that we know how to compete, we know where to compete, we know where to put our emphasis, and this is a great illustration of that.

Equally important is the business market, the SME market. Now, I'll give you some numbers to get a feel. In the U.K., in the SME market, communications and infrastructure is 7 billion. And that was the market in which we played, a 7 billion market, a very respectable market, but 7 billion.

If you expand that market, because your capabilities expand and you look to hardware and you look to IT services, you add a whopping £10 billion to the market available to you. And if you then add to that applications and hosting, you add another 2 billion to it.

So instead of playing in a 7 billion market, you're playing in a 19 billion market. And that's the story about BT Business.

Now, in order to play, you need to have a license to sell. And the license to sell is that you have credibility to go and play that. So what have you seen? You have seen three things. The first thing that you have seen is us making acquisitions to gain that credibility, Lynx and Basilica in this quarter £61 million spent on that.

The second thing, you see is brand recognition is important therefore you then need to do marketing and our Gordon Ramsay campaign has worked tremendously. The recognition of BT, as a supplier of IT service in the business market went up from 51% in March to 71% today. That is remarkable.

And the third element is you need to have you're going to have brand recognition; you're going to have additions. You need to have products and services, and we do have them now.

If you take for example, Tradespace--Tradespace is a community platform that allows businesses to interact together and now, with the link to PayPal, also to make transactions, at the same platform. 20,000 user-- 20,000 SME markets, that's important.

And why is it important? Well, if you take the numbers of this particular market, just think about it. The SME employs 10 million people in the U.K. That is almost 50% of the total private workforce in the U.K.

24% of the U.K. workforce, works from home. Private workforce, 24% works from home. And if you look to the start-ups, 60% are started from home.

So what does it tell you? It tells you this is a fantastic market that's emerging. And what do they want? They don't want hassle, but they want to live in the 21st century. So they want to have the capability to communicate, to delegate, to go out in the world and find supplies, find customers and do that in a way that they concentrate on what they do best.

So what do you see in the numbers? You see our mobility going up 35%. It's an impressive number. You see ICT services going up 24%. You see our capability to sell our One Plan, 18,000 of them, when you bring everything together.

You see the hassle going out of this and the services that are coming into this. And therefore, this is not a surprise to see BT growing and the market potential is even bigger.

Now, under this, you also have Enterprise. You know that assembly of very nice things. Well, this is a kind of did you know. Did you know that BT had the largest, no, the fastest-growing conference business in the world?

And we signed up the Lloyds and Yahoo in the quarter, 11% EBITDA growth. Did you know that we have our Dabs channel now growing 10%? Did you know how we're doing in -- and you can see it on the chart, how we're doing in Ireland?

So the capability in the small business world and our Enterprise focus on where we are, are a great engine for growth going forward.

BT Wholesale has to deal with three elements, why you see a red bar here. The first element, and they were all but one, were known that they would come.

First one is, look to the broadband. It's LLU, and therefore, lower prices for the broadband part--that's one-third of it. The second one is transit business. I've said it before. Transit business basically is the spot market. You have it, or you don't. It's very difficult to predict very, very low margin, but still it contributes. And third one is—Wholesale--got hit by the premium-rate business because of the ban on TV.

So, if you look to this story and it's okay, we knew that we will be coming. It’s no surprise. What are you going to do about it? What's your story here? And the story is managed services. Because of the new market environment, we are very well placed to run a managed services wholesale activity. You see a few examples here.

Take the Post Office. 400,000 PSDN lines are transferred now to our platform. And the capabilities that we have to help them to go and sell broadband in their 13,000 post offices is done in a very, very short period of time. So a capability that, I think, will give us future positive input in our Wholesale business.

Our Openreach business had a fantastic quarter. Mike talked about the floods. We almost forgot about that last quarter we had the floods. We did. And still, Openreach had its best repair stats in 10 years.

The whole focus of management in Openreach is working. It is even working to the extent that the OTA report this time had some positive words in it. And everybody who is following the TSR knows that that's a first, very welcome though, and I think a 100% justified by the facts.

Openreach is doing a fantastic job, not just on delivering service better and faster than before. They also have to cope with a massive increase in activities. The LLU world of 3.2 million lines means that you have a 50% increase at your frame activity. You need to absorb that.

And in the old days, let's be perfectly honest about it, in the old days we would have paid through our nose for it. That would have been translated in worst performance. It would have been translated in a cost. Now, today, you can see that focused management and the capability is really delivering, and I'm very pleased with what Openreach is doing. It is a world-class performance.

Now, all of these things together, as you know, will be only balanced into a sustainable growth pattern of our results, if we manage our costs correctly. And here is the message, a very simple message. 600 million for the year, 275 million coming in half one, so you get 325 million coming in half two. That's the message and we will deliver that.

And then, if you look to the foundation of our cost saving, you can see it has names, rank and serial numbers behind it. We know exactly where it is and exactly how to execute it. The 325 million is what we're going to do in the second half of this year.

Now, I thought it was interesting. Let's give a view on where we are in half two. There are four things on revenues that I just want to reiterate. First of all, our ARPU is growing and will grow, because people buy more value-added services from us. That will translate in ARPU and our portfolio is coming through.

The second thing, we have talked about the expansion of the reach for BT business, and Enterprise in the SME market, because the SME market's capabilities for us are going up. There is more to hunt for, so to say. The third element is Global Service’s corporate contracts. Our pipeline of prospects has increased over the last three, four months by 25% to a level now of £29 billion.

And third—sorry--and fourth, I need to count, one, two, three, four…fourth, carrier services. Ethernet is a winning product, and we can see a huge demand for Ethernet. So we think, from a revenue perspective, where we are, that we understand where the business will go. So then is the question, of course, of margin. I already talked about the costs.

I already talked about the fact that we see a widening of the BT Global Services margin based on two things. First of all, there is a milestone plan with accounts. We understand those milestones and we understand where we are, we'll meet them. And second, we understand how we can manage with our costs. So, half two will see, a widening of our margins in Global Services.

And last, but not least, we did reorganize our business. You may have heard about it. And we organized in BT Operate and BT Design and the synergies are coming through. I have to say that it is, if you look to 21C and what progress we're making now on 21C, to take all those assets and put them into a logical order and say, instead of just simply executing what we had before, seeing how can we translate that in faster new services.

How can we translate that into more benefits upfront, so that we can get the 21C development translated earlier into benefits for customers, is a clear signal to me that our new organization and the line-up that you find between the different units is really working.

So, you know this one, you know the numbers here. I will not bore you to death, but it's too good not to miss. 15 quarters. It's a great number. Seven of EBITDA, 22 on EPS and, I think, a very healthy interim dividend. Hanif?

Hanif Lalani

Good morning. From Ben's presentation, it's clear that the positive trends continue. And so, if we look at the highlights of the quarter, revenue at £5.1 billion was 3% higher than last year, whilst EBITDA and EPS, before specific items and leaver costs, both rose by 2%.

Free cash flow is down year-on-year, and this is primarily driven by the specific items, and it relates to the restructuring program that we announced last quarter. The interim dividend, which we have said, taking into account business performance, will be 5.4 pence, an increase of 6%, and reflects our commitment to continue to reward our shareholders. Let's look at the profit and loss statement in a little bit more detail.

Revenue grew by £154 million, with a £24 million decline in Traditional revenue significantly outweighed by a £178 million rise in New Wave revenues. EBITDA pre-leavers grew for the seventh consecutive quarter and, at £1.4 billion, is £30 million higher than last year.

Operating profit rose £40 million to £755 million. And the operating margin improved by 30 basis points to 14.8%. That's the third consecutive quarter of year-on-year improvement. Net finance costs of £92 million reflect an increased average net debt, higher interest rates, as well as movements in fair value of hedges that do not quality for hedge accounting under IAS 39.

And, of course, the higher interest rates have also improved our IAS 19 position on pensions and, coupled with good performance in the equity market, means that our pension position is now over £2 billion in surplus--an improvement since last year of £5 billion. Earnings per share, pre specific items, pre leaver costs, of 6.1 pence was up year-on-year for the 22nd consecutive quarter.

And this quarter, specific items amounted to £182 million pre-tax, the majority of which relates to the restructuring program. And despite the ongoing investment in 21CN, capital expenditure in the quarter was £799 million, £13 million lower than the prior year. And by the end of the financial year, we expect CapEx to out-turn at £3.2 billion, a similar level to last year.

Let's look at free cash flow. Free cash flow in the quarter amounted to £171 million. This was £167 million lower than the prior year, primarily due to the cash costs relating to the specific items. And as you can see from this slide, our free cash flow profile has become more seasonal in recent years, given the new relationships that we have with corporates and large communication providers.

The Wholesale billing cycle results in skewed working capital inflows this is primarily due to the relationship between the 30-day bill-to-cash cycle and the number of days in each calendar month. The success in Global Services in winning new contracts means that we should see stronger working capital inflows from Global during the fourth quarter, as milestones on contracts are achieved.

Taking all of these factors into account, underlying Group free cash flow will again be strong in the fourth quarter. It will also grow more strongly in the coming years, as Global Services' working capital outflows become inflows as the contracts mature in the second half of their lifecycles. Let's move on to the performance of each line of business.

Firstly, Global Services. Revenue of £2.3 billion rose 6%, the highest rate of growth in six quarters. New Wave revenue has grown by 10%, more than offsetting the 8% decline in U.K. Traditional revenue. And revenue outside the U.K. grew by 19% gross profit of £651 million is 2% higher than the prior year.

Despite the need to invest in delivering global reach required by our customers. With SG&A costs broadly flat, despite acquisitions, EBITDA rose 5% to £240 million. Depreciation is 11% higher, primarily due to acquisitions, resulting in a £7 million reduction in operating profit, which was £65 million this quarter.

Recent actions in Global Services will contribute to the uplift in EBITDA margin during the second half of the year. We are winning an increasing number of contracts with a higher element of value-added services, such as resilience of firewalls, resilience of live area networks, and these services come with a much higher margin.

We'll continue to gain operational and competitive advantage from the benefits of scale, particularly in the Americas and in France, following our recent acquisitions. Global sourcing activity has increased. In the first half of the year, 1,800 roles were globally sourced.

And in the last few weeks of September, 500 managers left Global Services, giving rise to a pay saving of around £30 million, annually. More contracts are entering the second half of their lives. Approximately two-thirds of our 100 major long-term contracts will have done so by the end of this financial year. Therefore, the degree of certainty about the profitability of these contracts increases and that allows us to recognize more profit on those contracts going forward.

Let's move on to BT Retail. Revenue of £2.1 billion is £59 million better than last year, with New Wave revenue growing 18%, primarily driven by Broadband and Network IT services. A strong defense of our Traditional revenue reduced the year-on-year decline to just 2%.

Gross profit of £631 million improved by 7%, or £39 million, as a result of revenue growth, better product mix and cost efficiencies. This boosted gross margin by a full 1-percentage point to 29.5%. In addition, we've made further investments in customer service, and also in marketing vision, and this has increased SG&A costs by 5%.

EBITDA before leaver costs, of £257 million, has grown for the ninth consecutive quarter, rising 9% year on year. With depreciation broadly flat, operating profit in the quarter was 11% stronger, at £217 million.

Let's move on to BT Wholesale. As expected, Wholesale external revenue declined. About one-third of that 9% decline was Broadband related. The remainder resulted from lower transit, from lower premium-rate service traffic, both of which are low-margin products.

On the other hand, internal revenue grew by 2% on the back of Retail's continued success in the Broadband marketplace. In the quarter, total revenue was 4% lower, at £1.8 billion, while gross variable profit decreased by 1%, to £910 million.

Network and SG&A costs increased by 1%, as 21CN costs were partially offset by cost efficiencies. As a result, EBITDA before leaver costs decreased 4%, to £466 million. However, that decline was more than offset by a 14% year-on-year reduction in depreciation, mostly related to legacy assets.

Therefore, operating profit before leaver costs was 12% higher year on year, at £216 million. Finally, Openreach. Revenue in the second quarter increased by 2% to £1.3 billion, driven particularly by LLU and Ethernet services, and this boosted our external revenue by 28%.

Operating costs increased by 2%, to £836 million, corresponding to ongoing investment in service and an increase of activity volumes. EBITDA of £468 million represents an 8% improvement over last year, and it's the first quarter of growth since Openreach began reporting.

In the quarter, operating profit increased by £16 million to £298 million, as depreciation, at £170 million, decreased by £8 million. This is yet another quarter, which contributes to the positive EBITDA trend and establishes an encouraging growth record, quarter-after-quarter, during our ongoing transformation. EBITDA in the quarter of £1,448 million delivered the seventh consecutive quarter of growth. Another firmly established record is growth in earnings per share.

Our ability to balance investment risk right across the business, coupled with financial discipline, has delivered our 22nd consecutive quarter of year-on-year growth in EPS. Given the strength of our business performance and our confidence in the future, I’m pleased to announce an interim dividend of 5.4 pence. This is an increase of 6%, which will be paid to shareholders on February 11, 2008.

And during the quarter, we bought back 115 million shares for a total consideration of £362 million. Our distribution policy is unchanged, paying dividends after taking into consideration our business performance. And we will also continue with our £2.5 billion share buyback program, which is expected to complete by March 2009. Our transformation to a service provider is delivering benefits to customers and shareholders.

In recent quarters, we have firmly established a record of delivery, which continues to underpin our confidence in future performance. And we will grow revenue, EBITDA, EPS, dividends again this year. Thank you.

Ben Verwaayen

Thank you, Hanif. And before we go to questions, I would like to introduce Sally Davis, who is running our Wholesale division. Sally, maybe you can wave to the audience? And so you can ask a question.

And I ask you some consideration, Francois has catched a cold and has lost half of his voice--maybe three-quarters of his voice. So if he whispers, it's not because it's not a strong conviction, but it's just the throat.

Right. Questions. Over there?

Question-and-Answer Session

Mike Williams - Citigroup

Yes. Morning. It's Mike Williams, from Citi. Two questions with a regulatory flavor, if I may. Firstly, the regulatory consultation for Openreach is ongoing. The recent regulated accounts indicate that you're failing to make your cost of capital in ULL.

I wondered whether you'd comment on how realistic it is, from almost a political perspective, to start thinking about an upward revision to regulated pricing in that area.

And then, secondly, Ofcom's consulting on NGA at the moment. We had Virgin Media yesterday talk about moving DOCSIS 3 on a two-year view and 50 meg broadband, I wondered if you could just clarify about your position on NGA investment. Thanks.

Ben Verwaayen

Right. So let's start with public negotiations. Never a good idea, so let me phrase two things. We have a framework of understanding, and that is, two things; in the framework of understanding you have a 10% return as a kind of total target.

And the second thing you have in the framework, is that you need to ensure that you have proper markets developing. And between those two, I think there are ample opportunities to make sure that you do the right thing.

Steve and team are working with Ofcom, and we'll see. But I am very much focused to ensure that we have a principal based regulatory environment in the U.K. That was one of the things that, when we started the whole TSR process, was the underlying philosophy behind it, so you didn't get a kind of more tactical approach, product by product. It was much more on a principal base. And I think we are working towards that.

So, on NGA, it's exactly the same answer that you get. We have said about fiber many, many, many times. When you talk about fiber, it's about service and service capability. Now, there is of course, there is a component of fiber. There are also other components, other technologies. You mentioned one; you have the WiMAX discussion as well.

So you have to look at it into a more holistic view and say what's going to happen? And the underlying things are you need to have demand from the market. You need to have an ability to supply it, so you can't double the supply.

So if you do one you can't do the other at the same time. And you need to have an environment in which there's choice. And I think that is perfectly okay to develop over time, and we'll see that.

Martin Mabbutt - Nomura Securities

It's Martin Mabbutt at Nomura. And could you talk a bit about the cost-cutting program, particularly the charge made in Q2? And how much benefit would that give to the costs that we've just seen in Q2, phasing of the rest for the year and ongoing cost cutting as a result of that? Thanks.

Hanif Lalani

Sure. I think there are two key programs here. The first one is cost savings in each of the lines of business--business as usual, which we said we're going to deliver 600 million, 275 million/276 million in the first half, and that's going to grow in the second half by 325 million.

The second element is around the specific item, the £450 million. And as we shared with everyone, it covers a number of activities from property, rationalization, because you have vacant space appearing, it covers skill transition center, it covers leaver costs, it covers systems.

And the payback on the £450 million is within two to three years. So, if you like, it's within the third year. So the majority of the costs will be incurred this year. There'll be some into next year. And you should then start seeing the benefit coming through in years two and three.

Now, the key point here is, as the same comment I've made throughout the last five months, is that that will therefore lift up EPS forecasts for years two and three. And what you're now beginning to see is a lot of the reports coming into the market doing exactly that. So it's a payback within the third year. And I think people are beginning to reflect that.

Ben Verwaayen

All right. Over there.

Graham Ruck - Merrill Lynch

Graham Ruck from Merrill. What is the outlook for new ICT contracts? It seems that maybe it's getting easier to differentiate yourselves with the competition, but also maybe we could be in a tougher spot going forward with corporates potentially delaying.

And then, secondly, Mobility revenues jumped, finally, this quarter. I'm just wondering what maybe is finally going right with the Fusion phone?

Ben Verwaayen

Right. That will all be for Ian. By the way, if you look to Mobility, the corporate part also is very exciting. And if you look to the ICT market, it's a matter of definition for many, what it is. But it basically is the ability to globalize and the ability to increase productivity. That is what's the driving force.

I wouldn't say it's easier, but we are very focused. We are also not afraid to walk away from contracts if we don't meet our standard or our targets. And we are, I think, in a good spot, as I illustrated. Look to the pipeline of prospects and look to what we have done, I think we are in a good space. Fusion?

Ian Livingston

Mobility. Yes, Mobility did grow. Obviously Mobility has more than Fusion. We've made further progress on Fusion and we've recently launched, in the business market, the Office Anywhere. And we think there's going to be some exciting developments on Office Anywhere and a consumer version of that. But Mobility's a lot more than Fusion.

And we've seen good success, particularly in the WiFi market. We're doing now more than 20 million minutes per month on BT Openzone, which is tremendous. The corporate space, we're doing well in selling into the corporate market, some real successes, particularly on the global scale.

And also, BT Business, as you saw from Ben's numbers, a really big increase in the mobile proposition. I think one of the things that's quite clear in the business market generally, they're far more prepared to buy mobile and mobility services with all the other things, because they buy it in the same way.

In the consumer market, one is for individuals and the other stuff is for households. So I think we've seen our best success in the business market and we expect to see some more success as well, some more developments in consumer.

Ben Verwaayen

All right. Over there.

Nick Lyall - UBS

Morning. It's Nick Lyall from UBS. You mentioned demand for next-generation access. Could you also mention the sorts of savings you might find if you move to a next-generation access network as well?

Ben Verwaayen

Sorry, can you repeat that?

Nick Lyall - UBS

Any potential savings you might find in next generation access, any work you may have done on that, that could be interesting.

And secondly, international growth was very strong in ICT. Could you mention what dollar exposure, you might have and whether that's a significant issue for the second half? Thanks.

Ben Verwaayen

Steve, do you want to say something about next generation access as you expect…

Steve Robertson

Next generation access is a multifaceted thing, of course. And there's a big debate going on just now. There's fiber to the cabinet, there's fiber to the premise, etcetera. If we look at the Greenfield site, we've done a lot of economic analysis around Greenfield sites.

And we would expect to be making very significant operational savings. Of course, it's a balance. The upfront costs of fiber into the premise, an Edge suite, which we're doing in conjunction with line securities is greater. But the ongoing savings in terms of reliability is significant.

In other parts of the world, where we look at fiber to the premise, we can see, on the repair side of the equation, something like 80%, 70% to 80% reduction. Provision, it depends on the mix of new sites, because, obviously, if you've got to build that's a different issue. But once it's in the ground there's significant savings.

Other types of things that play technology that play into NGA, at the most basic level, you're automating the frames, you saw the frames activity. We're looking at automating our main distribution frame. That is very, very new technology. But we are actually in trial just now. And obviously that saves significant operational savings inside the exchange.

For fiber to the cabinet solutions, it's a very different picture. Really, the major benefit there is the up speeding of the servers. And when you're putting electronics out into the cabinet, there's much, much lower operational savings, because you've still got that distribution copper network still in existence.

So, it really depends on the flavor of NGA. And one of the critical things here is it is going to be a mixed economy. There is nobody can wave a magic wand overnight and say 'It's all going to be like this.

And I think, as Ben has emphasized, a critical component of this is going to be the service demands of end users and service providers as to how that mix actually works out.

Ben Verwaayen

All right.

Hanif Lalani

On currency exposures, particularly in Global services, we have a fantastic excellent treasury function. And if you need more details, Lesley's at the back. But in terms of performance, net of revenue and costs EBITDA is low single millions every quarter. So we've managed to cover the exposure that we have, both in revenue and in costs.

Ben Verwaayen

All right. Over there. Okay.

Stephen Howard - HSBC

Hi, yes. Hi, it's Stephen Howard here at HSBC. What I would like to know is whether anyone from the government, for example Steven Timms, has been on the phone to ask you why the U.K. has rather less fiber than some other markets internationally? And if that phone call took place, what did you tell him?

Ben Verwaayen

Well, first of all, that would be a situation that's not true because we have 9 million kilometers of fiber in the network. So, there’s a lot of stories here. What they actually mean is, if you look to the world map and you see specific countries with specific NGA type of trials and activities, how do we compare?

Well, Steve has given the right answer. There's a whole series of activities that you can say are trials and see how things are going. There's no way that we're going to carpet the U.K. with fiber. I mean, there's no way.

There is, however, a market out there. And if there are the right circumstances you could have in a market, incentives for us and others to go with a whole variety of bandwidth enhancing technologies.

But the end game has to be great services for people that are willing to pay for it, and that is fully understood. And I think Stephen Timms and others are, of course, eager to see what we or how we can stimulate the market further, and that's a great thing to have.

Stephen Howard - HSBC

If I could just follow-up on that quickly, you mentioned the key word there incentives. You've spent a lot of time articulating quite clearly what wouldn't persuade you to build out fiber access.

I mean, the question I think we're all interested in is what would persuade you to do that build? What incentives could they give you to persuade you of the business case?

Ben Verwaayen

I'm talking about a market and you’re talking about government? That's a pretty different conversation. I don't think there is an example, maybe with the exception of South Korea, where you have a government spending billions and go and build.

And in South Korean that's a kind of market economy that we don't have. We have a real free market economy in this particular sense, where there is all kinds of competition. So you have to ask yourself be careful what you ask for. Be very careful what you ask for.

And to our circumstances where the market doesn't function that you could add to the frame a support of government. But the core has to be the market, and then you can augment that if you want with other capabilities. But we are far away from that. Right. Over there.

Paul Howard - Cazenove

It's Paul Howard at Cazenove. A couple of questions. Just at the group level, some of the trends slightly deteriorated on revenue and EBITDA marginally. But you've given quite an upbeat H2 agenda I think you called it. I just wanted to know, you're basically indicating that you think the second half trends will be better than the first half trends in that respect?

And then secondly, just on Global services, I wonder if you can give us a better idea what drives the profitability between the IT business within Global Services and the other businesses within Global Services.

Perhaps, when you talked about the top 100 contracts, how profitable are those contracts today and as two-thirds of them swing into the second half, what's the swing in terms of profitability on that line?

Ben Verwaayen

I thought that you have a detailed slide on Global services, but not for Paul. So maybe you can expand on that. Let me take the first one. I always was of the impression that one of the jobs of an analyst was to take what we have here and to plot it forward.

Now, what you basically ask me to go and do is make your job so boringly and I think that's a bad idea. So I think, I've given you all the data and you draw your own conclusions.

The thing that I'd like to say, if you use the word deterioration, it's just as a fact. The difference between the EBITDA growth of 2.1 and 2.7 is a handful of millions on 1.5 approximately billion, so, just to put it in perspective.

Hanif Lalani

Paul, I don't want to go into individual contracts, but I thought I shared a lot more information and disclosure this time on the 100 contracts. And we all know about the S-curves and everybody's written about the S-curves.

And I think the new bits of information that everybody here has listed loud and clear is that two-thirds of those contracts go into the second half of their lifecycles. What that means is they're now going on that S, that the increase in their margin fees. And that will flow through.

Now, that is at the end of the year. If you were to look at the position today, it won't be two-thirds. It's more likely around 50%. So I think that that's sufficient detail. I really don't want to go into each individual contract.

Ben Verwaayen

Right. Thank you, over there.

Steve Malcolm - Arete

Steve Malcolm from Arete. Two questions, please. I'm afraid I'm going to carry on with the regulation, which I'm sure will send you to sleep.

Ben Verwaayen

I love it.

Steve Malcolm - Arete

You mentioned WiMAX auctions, and we've also got mobile broadband taking off. It seems like the risks in sort of copper-based broadband access are going up. So, I guess the question is are there any circumstances in which you'd accept a lower return than the one Ofcom's given you so far, i.e. 10% pre-tax nominal on copper, as you go into the review? That's the first question.

The second is on, equally boringly, Retail Broadband. And the market growth has slowed quite a lot again. The ads are down 25%, 23% year-on-year. Some of your bigger competitors, i.e. Virgin and Carphone, have clearly posted some quite aggressive growth outlook forecasts on broadband. Are you comfortable with your pricing position generally, going into a market slowdown where your competitors are looking pretty aggressively for more customers? Thanks.

Ben Verwaayen

Okay. I will ask Ian to be aggressive and I'll answer the first one. Why on earth would we? Right--Ian?

Ian Livingston

Pretty much the same answer as his. What you will see us doing is adding more value into our broadband proposition. The ARPU we get from new broadband customers today is actually higher than it was a year ago.

And I think that's great. We've put more in the proposition, I think phones are a really good example, it means our customers can come in and be part of the world's, web's largest WiFi community, 200,000 odd people around the world and growing at a huge rate.

That sort of stuff, actually, our competition can't match. And the proof of the pudding, to be frank, is in the eating just now. And we overtook Virgin, despite all their mergers, some time ago. We've increased our lead, I'm sure they're going to be aggressive. There's no question about it.

The U.K. broadband market is probably the most aggressive in the world, you've got a choice of hundreds of different suppliers. And we're doing okay in it just now, and we'll continue to do it, but we'll do it by innovation, and we'll do it by service and we'll do it by services. Trying to claim to be cheaper than the next guy is frankly a short-term mug's game, what is really important is value, not price.

Ben Verwaayen

All right. I'll take two more, one there and one there.

Hannes Wittig - JP Morgan

Yes. Thank you. Hannes Wittig from JP Morgan. Just a question on 21st CN, I did hear you guiding for £3.2 billion CapEx. I just wanted to see what your outlook is for the CapEx trajectory, maybe a couple of years out now. And how much do you think Global Service sorry, the 21st C is already contributing to the cost savings that you are making today? And when it's going to kick in, in full force?

Hanif Lalani

I think the guidelines on capital expenditure remain the same, so I think there's no change. I think the important thing about 21CN is that the way we're managing the program is you have a discrete set of people; you have a discrete set of expenditure. And if at any point in time you came to an end of a particular activity, then you know what the costs are that you can actually extract from the business, and those costs do not continue forever.

And if you continue to manage a business with that discipline, it means that when things finish, the business realizes the benefit and you can reward shareholders. So our plan is to carry on doing exactly that.

Now, as Ben mentioned, we're looking at a number of the OpEx items and saying can we bring some of those OpEx savings forward, and we're doing that. And at this point in time, between OpEx and CapEx, we've kind of delivered over £300 million of that.

Now, the difficulty with 21CN is, as you deliver savings in one area, you're investing in the rollout at the same time. The comfort I have is the way we're managing it, so that we can actually realize the saving at the end.

Ben Verwaayen

All right. Over there.

Christopher Nicholson - Oraca

Christopher Nicholson from Oraca. Two questions Ben, if I can. The first one is how long do you think you can continue to improve EBITDA margin faster than turnover growth, at 3% at the moment?

And the second question is, which comes back a little bit down to the fiber, prospects of fiber build out in the U.K. If you don't build fiber outside the major urban centers, then arguably you cut off the smaller centers from, and I'm talking about villages and this kind of thing, from economic development.

So you suck everybody into the major urban centers. I would have thought politicians would be very sensitive about that, and that there's a 10-year view on that. And then if you combine that with the fact that or arguably that the current government doesn't have any room to do any more major investment due to its previous, again arguably, overspending. How do you think they will react? Will they try and force you to do something?

Ben Verwaayen

Well, let me take the easy one, that's the last one. This is a so-called scenario planning game. Shell had a special department for that a couple of years ago. It's wonderful, because on a computer you can get all types of simulations. It's a fantastic intellectual game, it has nothing to do with the discussion that we have today in reality.

So probably another audience is better. We have companies looking in the future as a day job. And maybe that's a great conversation to have with that person, how we get urbanized and not urbanized, I don't think that's BT's call, to be honest.

Christopher Nicholson - Oraca

But my point, Ben, with it was, I agree, it's not BT's call. But it may be that the dynamics of government in the U.K. is such that it ends up being BT's call. Do you have any sense that that is possible?

Ben Verwaayen

No, because my imagination doesn't carry as far as yours. And if…

Hanif Lalani

On the first question, if you look at the EBITDA growth rate, what you see is for the last five quarters it's been between 2% and 3%. And this is at a time when everybody in the market, or most people in the market, have been saying it's going to be difficult to grow EBITDA in BT, because there's LLU, there's LLU migration going.

And we've consistently said we can do that because LLU migration will happen, it'll be a transition period. And we have a cost-reduction program that's kind of become business as usual.

So, if you look at the trends, you can see cost savings are going to increase as we go forward. If you look at the EBITDA margin, it's been between 2% and 3, I think the trend speaks for itself.

Ben Verwaayen

Right. On that a big note, thank you all 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: [e-mail].  Thank you!