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

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BT Group Plc (NYSE:BT)

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

November 8, 2007 5:30 am ET


Mike Rake - Chairman

Ben Verwaayen - CEO

Hanif Lalani - Group FinanceDirector

Ian Livingston - CEO, BT Retail,Director

Steve Robertson - Chief ExecutiveOfficer, Access Services


Mike Williams - Citigroup

Martin Mabbutt - NomuraSecurities

Graham Ruck - Merrill Lynch

Nick Lyall - UBS

Stephen Howard - HSBC

Paul Howard - Cazenove

Steve Malcolm - Arete

Hannes Wittig - JP Morgan

Christopher Nicholson - Oraca

Ben Verwaayen

Good morning, everybody. Thankyou for coming. Before we go into the presentation, I'm delighted to introduceMike Rake, our new Chairman, and I would like to ask Mike to make somecomments. So, Mike?

Mike Rake

Thank you, Ben. Thanks very muchfor that, Ben, and welcome, everyone. It really is a pleasure finally to behere, after all these months of preparation. This, to me, is an absolutelyfascinating, complex and competitive industry, whose success, whose importanceis critical to every individual, every sector of the economy, and operateswithin 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 andinteresting. I've been fortunate in the last few months, since theannouncement, to be able to spend some time--particularly when I was travelingaround the world with my previous firm--to really visit some of the BToperations around the world, in Hong Kong, Tokyo, the United States, in Belgiumand the BT Centre here, spending time with a lot of the executives.

And I can tell you that I've beenhugely impressed with the quality, the enthusiasm of BT's people, theircommitment to BT, to its customers, their communities. This was actually verywell illustrated, going to York fora regional meeting, meeting some of the engineers from Openreach who wereinvolved in the floods that we had.

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

And I think BT will be extremelywell positioned in this highly competitive and fast-moving environment to moveforwards, as we continue to invest in customer service, in technology, inglobal capability, whilst putting, what to me I can see as an enormouscommitment,\ 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 todeal with the results, I'd just like to say that given this highly competitiveenvironment that we have, the investments that we've continued to make--Ipersonally find the results for the quarter to be extremely encouraging. I amdelighted to be here, and extremely enthusiastic and optimistic about thefuture for BT, for its people, for its shareholders, for its customers.

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

Ben Verwaayen

Thank you, Mike. Right. You haveseen this chart before. As always, please read it at your leisure. Veryinteresting reading, maybe as interesting as this one, because this gives you apicture of the quarter.

Now, as you know, companies goalways at great length to think about the headline that they need to use aroundthe quarter. And you'll have people from different schools trying to positionwhat 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 peopleread 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 oneword that at the end a company is choosing. And the thing that I like to sayhere is the word is quality, because if you look to the quality of ourrevenues, you will see a marked difference from where we were a long time ago.

You can see that the journey thatwe had as a company, to go from hardware to software, from basic services tovalue-added services, from a focus on the U.K. to a global focus, from adependency 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, allof these elements do not tell the story, but the composition of the elements dotell the story, and do tell to you why Mike was so encouraged when he sawthese.

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

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

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

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

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

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

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

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

It is much more capabilities thatwe sell, and you can see that if you look to this one. If you look to thischart, it tells you that we are growing our business substantially. It's now38% of what we do, in the definition that we use.

38% is New Wave. 12% growth onICT network services, 12% growth in broadband. These are phenomenal numbers.And it keeps growing. And why? Well, because what we sell as a capability tothe 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 verygood number; 128 new names added to the list of corporations from around theglobe.

And Hanif is always keen to say60% of the orders were outside the U.K.,and he's right, it's true. But even more important than that, I think, is thequality of the orders that we get. Look to here. You see DHL, which is DHL in Italy--180offices.

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

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

i2i in India,which gives us a very strong position in the growing Indian market, and givesus a footprint that we didn't have before. We make a deal with Golden Telecomin Russia toget access to that backbone network, and guess what? Our customers want to bepresent in that market, and we have now a capability, cost-effectivecapability, 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'restruggling 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 isthey take contracts in Europe that have a networkelement to it and they exclude the wholesale network, because that is Traditionaltelcos 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 herethat are important. First of all, look to the list of competitors. This is aconverged world. Interesting enough, number two and number three are suppliersto us-- classical suppliers to BT--turning out to be number two and three onthe competitors list.

So, welcome to the world offriends and enemies. They don't exist any more. This is a world where you areworking together, where it makes sense, and compete in other sites and beperfectly comfortable with that. And I want you to see the list, which isequally important, is that those classical competitors of ours, you have to golower through the list.

Look to the numbers of orders. Thisis Europe. We have more orders than the number two andthree 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 numbertwo. And why is this important?

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

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

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

BT Retail did, I think, aterrific job. They did an absolutely terrific job. They positioned themselvesas a value player and look to this. There are two numbers that I every timestress, and I will do it again. First of all, look to the growth number. Thegrowth 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 themarket, looked to everybody who was available and went for BT Retail. And all ofthem, 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 ofthe people who buy from BT Retail buy Option 3.

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

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

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

I'll just give you numbers, soyou 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 thenet, and you don't have to worry about it. Adds to the value.

VoIP. You remember that sixmonths ago we talked about being at 1 million registered VoIP users early. Ican 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 capturethe imagination of our customers.

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

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

And yes, we have targets therewith numbers, so let's talk a little bit of our targeted numbers. 70,000installed, which is great and it, I think, fits perfectly the bill, but 100,000sold and that's even better. But even better than that is 75% is nowself-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% islibrary, and that tells you that there is a wide variety of new services thatyou can think of that can be based on BT Vision. So, there are an enormousamount of data that's now gained by using real customers and their expertiseand how they use it, and when they use it, and the capabilities that will go toenhance further our capabilities around Vision. And the number of 100,000 ispretty good.

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

Why does that matter? Well, itmatters because it's an enhancement that you can really use. You get now, allof a sudden, hundreds of thousands of extra potential spots where you can useyour WiFi phones, where you can be out and about and use your capabilities. Andby the way, when we launched this, we launched it, we gave some publicity, nomarketing yet, in the first four weeks 23,000 people signed up for it.

So, this is really a thing peoplerecognize as value, and they want to create it, and they want to have it. Andall of that is that broad smile, and every single quarter, the smile getsbroader. It's the ARPU, and, in essence, that is the story.

The story is that we getcustomers who want to stick with us for reasons. It's not just that we aregiving them an excess capability. It's the value that they create and they arewilling to spend more and more with us. And this customer ARPU picture istelling the story in the consumer market.

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

But I can't hide my smile when Isee this one, because this is really terrific performance from our Consumergroup. They really have now, in my view, made it clear to the market that we knowhow 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 businessmarket, 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 wasthe 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 ITservices, you add a whopping £10 billion to the market available to you. And ifyou then add to that applications and hosting, you add another 2 billion to it.

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

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

The second thing, you see isbrand recognition is important therefore you then need to do marketing and ourGordon Ramsay campaign has worked tremendously. The recognition of BT, as asupplier 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 needto 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 tointeract 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, ifyou take the numbers of this particular market, just think about it. The SMEemploys 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 youlook to the start-ups, 60% are started from home.

So what does it tell you? Ittells 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 wantto have the capability to communicate, to delegate, to go out in the world andfind supplies, find customers and do that in a way that they concentrate onwhat they do best.

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

You see the hassle going out ofthis and the services that are coming into this. And therefore, this is not asurprise 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 youknow. Did you know that BT had the largest, no, the fastest-growing conferencebusiness in the world?

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

So the capability in the smallbusiness world and our Enterprisefocus on where we are, are a great engine for growth going forward.

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

First one is, look to thebroadband. It's LLU, and therefore, lower prices for the broadband part--that'sone-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'svery difficult to predict very, very low margin, but still it contributes. Andthird one is—Wholesale--got hit by the premium-rate business because of the banon TV.

So, if you look to this story andit's okay, we knew that we will be coming. It’s no surprise. What are you goingto 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 managedservices wholesale activity. You see a few examples here.

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

Our Openreach business had afantastic quarter. Mike talked about the floods. We almost forgot about thatlast quarter we had the floods. We did. And still, Openreach had its bestrepair stats in 10 years.

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

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

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

Now, all of these thingstogether, as you know, will be only balanced into a sustainable growth patternof our results, if we manage our costs correctly. And here is the message, avery 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 willdeliver that.

And then, if you look to thefoundation of our cost saving, you can see it has names, rank and serialnumbers 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 wasinteresting. Let's give a view on where we are in half two. There are fourthings on revenues that I just want to reiterate. First of all, our ARPU isgrowing 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 talkedabout the expansion of the reach for BT business, and Enterprisein 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’scorporate contracts. Our pipeline of prospects has increased over the lastthree, four months by 25% to a level now of £29 billion.

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

I already talked about the factthat 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 thosemilestones and we understand where we are, we'll meet them. And second, weunderstand how we can manage with our costs. So, half two will see, a wideningof our margins in Global Services.

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

How can we translate that intomore benefits upfront, so that we can get the 21C development translatedearlier into benefits for customers, is a clear signal to me that our neworganization and the line-up that you find between the different units isreally working.

So, you know this one, you knowthe 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, avery 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 thehighlights of the quarter, revenue at £5.1 billion was 3% higher than lastyear, whilst EBITDA and EPS, before specific items and leaver costs, both roseby 2%.

Free cash flow is down year-on-year,and this is primarily driven by the specific items, and it relates to therestructuring 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 ourshareholders. Let's look at the profit and loss statement in a little bit moredetail.

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 seventhconsecutive quarter and, at £1.4 billion, is £30 million higher than last year.

Operating profit rose £40 millionto £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 financecosts of £92 million reflect an increased average net debt, higher interestrates, as well as movements in fair value of hedges that do not quality forhedge accounting under IAS 39.

And, of course, the higherinterest rates have also improved our IAS 19 position on pensions and, coupledwith good performance in the equity market, means that our pension position isnow 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 upyear-on-year for the 22nd consecutive quarter.

And this quarter, specific itemsamounted to £182 million pre-tax, the majority of which relates to therestructuring program. And despite the ongoing investment in 21CN, capitalexpenditure in the quarter was £799 million, £13 million lower than the prioryear. And by the end of the financial year, we expect CapEx to out-turn at £3.2billion, 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 millionlower than the prior year, primarily due to the cash costs relating to thespecific items. And as you can see from this slide, our free cash flow profilehas become more seasonal in recent years, given the new relationships that wehave with corporates and large communication providers.

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

Taking all of these factors intoaccount, underlying Group free cash flow will again be strong in the fourthquarter. It will also grow more strongly in the coming years, as GlobalServices' working capital outflows become inflows as the contracts mature inthe second half of their lifecycles. Let's move on to the performance of eachline of business.

Firstly, Global Services. Revenueof £2.3 billion rose 6%, the highest rate of growth in six quarters. New Waverevenue 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 indelivering global reach required by our customers. With SG&A costs broadlyflat, despite acquisitions, EBITDA rose 5% to £240 million. Depreciation is 11%higher, primarily due to acquisitions, resulting in a £7 million reduction inoperating profit, which was £65 million this quarter.

Recent actions in Global Serviceswill contribute to the uplift in EBITDA margin during the second half of theyear. We are winning an increasing number of contracts with a higher element ofvalue-added services, such as resilience of firewalls, resilience of live areanetworks, and these services come with a much higher margin.

We'll continue to gainoperational and competitive advantage from the benefits of scale, particularlyin the Americasand in France,following our recent acquisitions. Global sourcing activity has increased. Inthe first half of the year, 1,800 roles were globally sourced.

And in the last few weeks ofSeptember, 500 managers left Global Services, giving rise to a pay saving ofaround £30 million, annually. More contracts are entering the second half oftheir lives. Approximately two-thirds of our 100 major long-term contracts willhave done so by the end of this financial year. Therefore, the degree ofcertainty about the profitability of these contracts increases and that allowsus 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 Waverevenue growing 18%, primarily driven by Broadband and Network IT services. Astrong defense of our Traditional revenue reduced the year-on-year decline tojust 2%.

Gross profit of £631 millionimproved by 7%, or £39 million, as a result of revenue growth, better productmix and cost efficiencies. This boosted gross margin by a full 1-percentagepoint to 29.5%. In addition, we've made further investments in customerservice, and also in marketing vision, and this has increased SG&A costs by5%.

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

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

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

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

Therefore, operating profitbefore 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 externalrevenue by 28%.

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

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

Our ability to balance investmentrisk right across the business, coupled with financial discipline, hasdelivered our 22nd consecutive quarter of year-on-year growth in EPS. Given thestrength of our business performance and our confidence in the future, I’mpleased to announce an interim dividend of 5.4 pence. This is an increase of6%, which will be paid to shareholders on February 11, 2008.

And during the quarter, we boughtback 115 million shares for a total consideration of £362 million. Ourdistribution policy is unchanged, paying dividends after taking intoconsideration our business performance. And we will also continue with our £2.5billion share buyback program, which is expected to complete by March 2009. Ourtransformation to a service provider is delivering benefits to customers andshareholders.

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

Ben Verwaayen

Thank you, Hanif. And before wego to questions, I would like to introduce Sally Davis, who is running ourWholesale division. Sally, maybe you can wave to the audience? And so you canask a question.

And I ask you some consideration,Francois has catched a cold and has lost half of his voice--maybethree-quarters of his voice. So if he whispers, it's not because it's not astrong 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, theregulatory consultation for Openreach is ongoing. The recent regulated accountsindicate that you're failing to make your cost of capital in ULL.

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

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

Ben Verwaayen

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

And the second thing you have inthe framework, is that you need to ensure that you have proper marketsdeveloping. And between those two, I think there are ample opportunities tomake sure that you do the right thing.

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

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

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

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

Martin Mabbutt - Nomura Securities

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

Hanif Lalani

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

The second element is around thespecific item, the £450 million. And as we shared with everyone, it covers anumber of activities from property, rationalization, because you have vacantspace appearing, it covers skill transition center, it covers leaver costs, itcovers systems.

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

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

Ben Verwaayen

All right. Over there.

Graham Ruck - Merrill Lynch

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

And then, secondly, Mobilityrevenues jumped, finally, this quarter. I'm just wondering what maybe isfinally 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, whatit is. But it basically is the ability to globalize and the ability to increaseproductivity. That is what's the driving force.

I wouldn't say it's easier, butwe are very focused. We are also not afraid to walk away from contracts if wedon't meet our standard or our targets. And we are, I think, in a good spot, asI 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 Fusionand we've recently launched, in the business market, the Office Anywhere. Andwe think there's going to be some exciting developments on Office Anywhere anda 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 minutesper month on BT Openzone, which is tremendous. The corporate space, we're doingwell in selling into the corporate market, some real successes, particularly onthe global scale.

And also, BT Business, as you sawfrom Ben's numbers, a really big increase in the mobile proposition. I thinkone of the things that's quite clear in the business market generally, they'refar more prepared to buy mobile and mobility services with all the otherthings, because they buy it in the same way.

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

Ben Verwaayen

All right. Over there.

Nick Lyall - UBS

Morning. It's Nick Lyall fromUBS. You mentioned demand for next-generation access. Could you also mentionthe sorts of savings you might find if you move to a next-generation accessnetwork as well?

Ben Verwaayen

Sorry, can you repeat that?

Nick Lyall - UBS

Any potential savings you mightfind in next generation access, any work you may have done on that, that couldbe interesting.

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

Ben Verwaayen

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

Steve Robertson

Next generation access is amultifaceted 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 welook at the Greenfield site, we'vedone a lot of economic analysis around Greenfieldsites.

And we would expect to be makingvery significant operational savings. Of course, it's a balance. The upfrontcosts of fiber into the premise, an Edge suite, which we're doing inconjunction with line securities is greater. But the ongoing savings in termsof 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 theequation, something like 80%, 70% to 80% reduction. Provision, it depends onthe mix of new sites, because, obviously, if you've got to build that's adifferent issue. But once it's in the ground there's significant savings.

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

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

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

And I think, as Ben hasemphasized, a critical component of this is going to be the service demands ofend 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 ofperformance, net of revenue and costs EBITDA is low single millions everyquarter. So we've managed to cover the exposure that we have, both in revenueand in costs.

Ben Verwaayen

All right. Over there. Okay.

Stephen Howard - HSBC

Hi, yes. Hi, it's Stephen Howardhere 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 thatphone call took place, what did you tell him?

Ben Verwaayen

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

Well, Steve has given the rightanswer. There's a whole series of activities that you can say are trials andsee 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 outthere. And if there are the right circumstances you could have in a market, incentivesfor us and others to go with a whole variety of bandwidth enhancingtechnologies.

But the end game has to be greatservices for people that are willing to pay for it, and that is fullyunderstood. And I think Stephen Timms and others are, of course, eager to seewhat we or how we can stimulate the market further, and that's a great thing tohave.

Stephen Howard - HSBC

If I could just follow-up on thatquickly, you mentioned the key word there incentives. You've spent a lot oftime articulating quite clearly what wouldn't persuade you to build out fiberaccess.

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

Ben Verwaayen

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

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

And to our circumstances wherethe market doesn't function that you could add to the frame a support ofgovernment. But the core has to be the market, and then you can augment that ifyou want with other capabilities. But we are far away from that. Right. Overthere.

Paul Howard - Cazenove

It's Paul Howard at Cazenove. Acouple of questions. Just at the group level, some of the trends slightlydeteriorated on revenue and EBITDA marginally. But you've given quite an upbeatH2 agenda I think you called it. I just wanted to know, you're basicallyindicating that you think the second half trends will be better than the firsthalf trends in that respect?

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

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

Ben Verwaayen

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

Now, what you basically ask me togo and do is make your job so boringly and I think that's a bad idea. So Ithink, 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 betweenthe EBITDA growth of 2.1 and 2.7 is a handful of millions on 1.5 approximatelybillion, so, just to put it in perspective.

Hanif Lalani

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

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

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

Ben Verwaayen

Right. Thank you, over there.

Steve Malcolm - Arete

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

Ben Verwaayen

I love it.

Steve Malcolm - Arete

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

The second is on, equallyboringly, 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 outlookforecasts on broadband. Are you comfortable with your pricing positiongenerally, going into a market slowdown where your competitors are looking prettyaggressively for more customers? Thanks.

Ben Verwaayen

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

Ian Livingston

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

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

That sort of stuff, actually, ourcompetition can't match. And the proof of the pudding, to be frank, is in theeating just now. And we overtook Virgin, despite all their mergers, some timeago. We've increased our lead, I'm sure they're going to be aggressive. There'sno question about it.

The U.K.broadband market is probably the most aggressive in the world, you've got achoice 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 byservice and we'll do it by services. Trying to claim to be cheaper than thenext 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 Wittigfrom JP Morgan. Just a question on 21st CN, I did hear you guiding for £3.2billion CapEx. I just wanted to see what your outlook is for the CapExtrajectory, maybe a couple of years out now. And how much do you think GlobalService sorry, the 21st C is already contributing to the cost savings that youare making today? And when it's going to kick in, in full force?

Hanif Lalani

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

And if you continue to manage abusiness with that discipline, it means that when things finish, the businessrealizes the benefit and you can reward shareholders. So our plan is to carryon doing exactly that.

Now, as Ben mentioned, we'relooking at a number of the OpEx items and saying can we bring some of thoseOpEx savings forward, and we're doing that. And at this point in time, betweenOpEx 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 sametime. The comfort I have is the way we're managing it, so that we can actuallyrealize 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 cancontinue to improve EBITDA margin faster than turnover growth, at 3% at themoment?

And the second question is, whichcomes 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 cutoff the smaller centers from, and I'm talking about villages and this kind ofthing, from economic development.

So you suck everybody into themajor urban centers. I would have thought politicians would be very sensitiveabout that, and that there's a 10-year view on that. And then if you combinethat with the fact that or arguably that the current government doesn't haveany 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 todo 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 aspecial department for that a couple of years ago. It's wonderful, because on acomputer you can get all types of simulations. It's a fantastic intellectualgame, it has nothing to do with the discussion that we have today in reality.

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

Christopher Nicholson - Oraca

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

Ben Verwaayen

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

Hanif Lalani

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

And we've consistently said wecan 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 atthe EBITDA margin, it's been between 2% and 3, I think the trend speaks foritself.

Ben Verwaayen

Right. On that a big note, thankyou all very much.

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