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BT Group (NYSE:BT)

Q4 2012 Earnings Call

May 10, 2012 4:00 am ET

Executives

Ian Paul Livingston - Chief Executive Officer, Executive Director, Chairman of Operating Committee and Member of Pension Scheme Performance Review Group Committee

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

Gavin E. Patterson - Executive Director, Member of Committee for Sustainable & Responsible Business, Member of Operating Committee and Chief Executive of BT Retail

Olivia Garfield - Chief Executive of Openreach

Michael Rake - Chairman, Chairman of Nominating & Governance Committee, Chairman of Committee for Sustainable & Responsible Business and Member of Pension Scheme Performance Review Group Committee

Jeff Kelly - Member of Operating Committee and Chief Executive Officer of BT Global Services Division

Analysts

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

James Ratzer - New Street Research LLP

John Karidis - Oriel Securities Ltd., Research Division

Stephen Paul Malcolm - Arete Research Services LLP

Andrew Lee - Goldman Sachs Group Inc., Research Division

Carl Murdock-Smith - JPMorgan Cazenove Limited, Research Division

Maurice Patrick - Barclays Capital, Research Division

Nick Lyall - UBS Investment Bank, Research Division

Robert Grindle - Deutsche Bank AG, Research Division

Stephen Howard - HSBC, Research Division

Paul Sidney - Crédit Suisse AG, Research Division

Guy R. Peddy - Macquarie Research

Simon Weeden - Citigroup Inc, Research Division

Ian Paul Livingston

Good morning, ladies and gentlemen. Welcome to the BT Center Auditorium. Could you please make sure that you have all mobile devices switched off? There are no fire alarms planned for today, and in the event of alarm sounding, could you please leave the auditorium by the 2 fire exits at the front of the room?

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

Ian Paul Livingston

Good morning, everyone, and thank you very much for coming here. I'm pleased to be able to say that we've had another year of real delivery for all our stakeholders despite the economic headwinds and uncertainty. Financially, we have grown both profits and cash, and we have done this while continuing to invest in the business, including our GBP 2.5 billion fiber rollout program, which is one of the largest private sector commitments in the world without state support. This investment is taking fiber broadband to cities, towns and rural areas, bringing significant economic benefit to the United Kingdom. We've also invested by adding content to BT Vision, expanding into fast-growth economies and continuing to improve customer service.

I'm very pleased that we have agreed the 2011 pension funding valuation and recovery plan with the trustees, as well as contributing a GBP 2 billion lump sum into the scheme, more than half the total deficit, giving greater certainty to the fund, our pensioners and to our shareholders. We have done all of this and seen an improvement in our credit rating, which we expect will continue to improve through further strengthening of our balance sheet. We believe we also have a responsibility to give something back to the communities we operate in through 50,000 days of employee volunteering, through our environmental and energy savings and through supported charities, such as Sport Relief, and digital inclusion projects in the U.K. and around the world. We do contribute to making a better future for our communities.

So now to the business of the day and our results for 2012. Revenue for the year was down 4% but on an underlying basis, excluding lower margin transit revenue, revenue was down 1.9%, an improvement on the 3% decline last year. In terms of profitability, EBITDA was up 3% and we delivered double-digit growth in profit before tax, earnings per share and free cash flow. Net debt had been on the decline during the year but after the GBP 2 billion payment into the pension fund in the fourth quarter, net debt for the year ended up at around GBP 9 billion. Reflecting our performance in the year, the board is proposing a final dividend of 5.7p, up 14%, giving a full year dividend of 8.3p, up 12% compared with the 7% increase last year. As we have said before, we have committed to progressive, sustainable dividends. And as such, we plan to grow dividend per share by 10% to 15% each year for the next 3 years. We are also announcing a share buyback of around GBP 300 million in the current financial year to counteract the dilutive effect of employee share plans maturing this year and to add to shareholder returns.

To look at our 3-year performance, these results show strong cumulative performance over the last 3 years, with earnings per share up by over 2/3 driven by the transformation of our cost base. Free cash flow more than tripled despite the significant investments we have made in the business. And despite making GBP 3.6 billion payments of deficits into the pension fund, we were still able to bring debt down by GBP 1.3 billion. This performance has been reflected in the share price, which were the dividends paid, has yielded a total shareholder return of 224% over the period.

So, before I hand over to Ian and Tony, who will take you through the results in detail, I wanted to remind you of what we were doing for London 2012. We are the official communication services partner, delivering a single communications network across 94 locations, including 34 competitive venues. We are providing 4x the infrastructure capacity of the Beijing games, making London 2012 the most connected games ever. And with 78 days to go, we are on time with our delivery. Take a look at what we've been doing.

[Presentation]

Ian Paul Livingston

There's always an advantage of being the Chairman, you get the best videos. Now onto the results. About a year ago, I stood here and we talked about what we are looking for, our outlook for next year. And I thought it was worth reflecting on that and how we've done against it. First of all in revenue, we gave you a range of revenue down 0% to 2%. Well, we come within that range, clearly, with 1.9% result, at the bottom end of the range but within the range. And I think that reflects the difficult economic conditions we've been operating in. But against that, we've over-delivered on the other lines, we've over-delivered strongly. We said that we would beat the previous year's EBITDA of GBP 5.9 billion, we've come in at GBP 6.1 billion. We said actually we'd be over GBP 6 billion in the year we're now entering, and clearly we delivered that a year early. And in free cash flow in particular, I think, we had strong beat. We said we'd beat the previous year number of over GBP 2.2 billion. We've come in with a very strong number, I think, this quarter and this year at GBP 2.5 billion. And what we'll talk about is so we expect to take that base and to move it forward.

So firstly, the quarterly results. Revenue down 2% x transit in the quarter. We'll go through the individual lines of business and talk about where it was up and where it was down. At EBITDA, one of the strongest quarterly performances we've had, up 4%, I think a good number, and profit before tax up 13%. It's interesting to reflect that's, I think, 10 consecutive quarters we've actually seen double-digit or 10% plus growth in PBT and EPS with 10 consecutive quarters of that. And free cash flow up in the quarter 47%. Of course, free cash flow will tend to bounce around quarter-by-quarter, but they contribute to that very strong year-end total year number.

Now let's look at the individual lines of business. First of all, with Global Services. Underlying revenue x transit is down 2%. We'll talk about some of the growth areas and what's going well, but it's fair to reflect that we are seeing the impacts of what's happening in Europe, no great shot [ph] and maybe in 1 or 2 of the sectors, I think, the banking industry is a bit weaker, and things like trading systems. So whilst -- and we'll talk about it in a second, what we've done on order book is encouraging in the quarter. Clearly, the markets are -- the economy is just more difficult. In terms of net operating costs, we have seen an improvement in net operating costs, down 3%. But I think given the -- that environment we're operating in, really that pushes us to intensify our efforts even more, and we absolutely will be doing that, really particularly on the difficult stuff, like combining networks, taking them out, it is a very difficult task to do that. And we are doing it, and we are achieving it, but it just takes time and effort. And we'll see the benefits over the next few years of having done so. But also in the areas such as procurement, process improvement, taking -- which will result in us taking people out, there remains a lot more we can do in terms of improving the efficiency and effectiveness, and I think the environment means we probably have to.

That being said, we delivered GBP 183 million in free cash flow. Now that's roughly in the range of around GBP 200 million we said. Now the part of the difference, and we're talking here are very small differences, is because we sold the business called Accel Frontline, that actually generated profits and cash and revenue, and that accounts for part of the difference. But again, if you look a couple of years ago, if you remember what we said, we said this year we'd be cash flow positive. So we've come a long way with Global Services, and we think there's a long way still we can go, and we'll talk about the outlook for Global Services.

Turning to some of the metrics of Global Services, I think some really encouraging metrics. First of all, and I appreciate it will always bounce around quarter-by-quarter, but the order book, GBP 2 billion pounds, in the quarter, that's up 8% year-on-year. And the interesting thing about that is actually the fact that there wasn't one big order. Actually, it was -- there was a very strong volume of orders. Normally, it would have been over GBP 2 billion we've relied on a GBP 4 million, GBP 5 million, GBP 600 million order to get there. Actually, and it's a very good thing, the largest order we had was sub GBP 150 million. Then the next large order was only about GBP 50 million. So what we've got is a big volume. It also reflects what we've been saying to you, the very big, big deals just don't seem to be there at the moment. And that's not a bad thing in many ways. And I think it reflects the strength and depth of diversity of our order book. And actually, the other factor, and you see it in the full year orders, was full year orders are down slightly year-on-year. More than all of that is accounted for by the fact we had less renewals this year. This is why I said to you a couple of quarters ago, if you looked at the profile of our renewals, there was actually going to be very few renewals this year and actually next year. For instance, basically, in each of the year, only 2 of our top 20 contracts actually were due for renewal. So actually, in new contracts with new names and growth orders with existing names, we've actually seen a year-on-year increase. And there's some really good names in there. Anglo-American, I want to call out, very important in terms of what we do in the EMEA region. NATO, vitally important, and we're glad to see NATO not only renewing with us, but expanding the business with us. National Traffic Control, I think that goes without saying, you want us to do a good job there, and we do. And of course, Etihad, for another good name. So good diverse range of names, lots of contracts, and I think that's an encouraging thing.

And talking about the year, as we said, we'd expand. We talked a couple of years ago about expanding in Asia-Pacific region, and we're doing just that. We've been hiring people, we have expanded our product range and we really are seeing the reaction in terms of customer wins and also our positioning in that marketplace. Then we said after that, Latin America we do the same, and we've got particular strength from Latin America EnVisas, [ph] but we have a number of very large customers down there and we're seeing good growth. And then we said very recently that we would do the same in Turkey and the Middle East and Africa. We think there's real opportunity, and it's a very fast-growing region. And across all these regions, we've put it all together. But first of all, we're seeing some of the impact. Full year revenues are up 16% across these 3 regions, but probably more critically, the order book is up over 60%. And we think we can add about GBP 0.5 billion of business in terms of revenue over the course of the medium term in these areas. So have a material effect overall, and it reflects both our existing customers expanding in these regions, but also new global multinationals actually expanding out to these regions, and we will help both of them.

Very pleased with this chart. This is something that was announced just a few weeks ago. What it shows is by Gartner, and for those of you who know Gartner, they are probably the organization that CIOs look to most of all. And they do a survey by actually talking to customers about who is making the right moves in the progress, and I'm delighted to say, if you look at the chart on the left, as you look at it, that's the global managed network service provider. We have -- we are right now as the absolute leader in global managed network services across the globe. We've overtaken actually a number of our competitors in that field, and that's happened over the course of last year. And I think the investments we're making and the success we're having is showing through what the customers are saying. And that is very encouraging, and the situation's also true for Europe. I think you'd expect to be strong in Europe, and we are. So 2 very encouraging charts and apparently, I'm not allowed to point you were Cable & Wireless are, but if you want to go to the bottom left in both charts, you'll probably see them.

And now turning to retail. Retail going to revenue was down 3%, which, an improvement in the number of the trends. I'll talk about consumer and business in more depth, but I just like to pick up on Enterprises. Enterprises, as you know, is a stand-alone businesses like conferencing, Redcare, payphones that we do. And it saw a 2% growth really on the back of very strong conferencing business. Both audio and video conferencing have done well, and that was encouraging. But I think the real sand [ph], that has to be Ireland. That's a business in the whole of the island of Ireland, and for revenue to be up 4% and strong EBITDA growth as well. Well, it shows a couple of things, actually. One, it shows in the Republic we're doing very well. We're winning large contracts with both -- on the government and the corporate sector. And it shows that -- and we've got to remember this, most economies may be difficult, and the Republic of Ireland economy is difficult. You can absolutely override that if you do really, really well, and the team there have. But also, the other area and accounting for about half of the growth is actually in fiber, in fiber Northern Ireland. We've got regularly 9 out of 10 homes in Northern Ireland that are actually fibered, and you can see the impact we're starting to see on the business. And I'll talk more about our public, private partnerships that we are doing in some of these areas. So that's encouraging.

I think also encouraging is net operating costs down 5%, and that's driven effectively the EBITDA growth in retail. That's 7 years running. We've achieved good cost reduction that shows what can be done, and the retail team will tell you they haven't stopped yet. And we've done that whilst we're taking complaints down, we've taken failure out of the process and improved our processes, and that really is vital for us. It's a little microcosm of what we're trying to do across the business.

Turning to some of the operational metrics in consumer. I mean it's worth saying, first of all, that the performance in terms of revenue from consumer is one of the best for some time, down 2%. It's an improvement. And that's come really off the back of these operational metrics. First of all, our active consumer line losses are 30% better for the full year. I've got to say, Q4 was a bit worse than that. That was a result of what happened in 1, 2 and 3, but we certainly did see some impacts, some very aggressive pricing and advertising by Sky, and that meant Q4 wasn't as good. But these numbers will bounce around quarter-by-quarter. And in particular, first half of Q4 where saw that. And we did, however, deliver a 44% broadband market share. Now that means for the year as a whole, over 50% market share, 600,000 new broadband customers in the year, so it's basically a 10% increase in our base. And actually, we saw basically 10% across retail increase in broadband revenues. So really strong numbers there. And I think we've seen the same story, which is if you take Sky and BT together, you basically get over 100% in the market. So the rest of the market, on average, although there will be some winners and some losers, are struggling.

Another area where people often look at is actually BT Vision. Over -- sorry, I forgot about Infinity, first off, apologies. First of all, Infinity. Really good numbers for Infinity, over 550,000 customers in Infinity. That's up 38% year-on-year and a lot of the base that's being built by Openreach has really come on stream just very, very recently, so we certainly got more to go for going forward. But we are encouraged by what we're seeing in Infinity and encouraged also by take-up in particularly, we're working private-public partnerships.

On BT Vision, we've gotten now to over 700,000 customers on Vision. And it's just worth reflecting, that's up 23% in the year. And actually, the net ads in this quarter are higher than Sky and Virgin combined. So we are actually doing pretty well on Vision. In the reasonably difficult TV market, but interactive TV is very much the way of the future, and there's a lot still happening on Vision. YouView is coming later. But in the meantime, we have Vision 2.0, which is going to be far more interactive and recommendation search engines and things like that, that will really help the viewing experience. Multi-casting will be later this financial year, and that will give us ability to stream a lot of programming. So there's a lot happening on Vision, and of course, a number of new contracts we sign for content. So a lot happening in Vision, and we expect to see that build, building overall.

And consumer ARPU continues up. It wasn't so many years ago that people said, "Can you ever increase ARPU?," and we're continuing to do that, and that really is in the back of the RGUs being purchased in terms of broadband in Vision. And that's been a big driver.

In the SME market. The SME market does remain tough. No great surprise there. But however, that -- the revenue number that we've had has been impacted by the decision we made in Q2 last year. We've decided to withdraw from very low margin, hardware trade sales. And that's something that we -- we decide to really focus on the core business. And because of the Q2, it's going to affect Q3, Q4 and you've seen that in the numbers, and it will affect Q1 and Q2 of next year. In the premium context, it accounted for that together with the flow-through of MTRs, and our pricing accounted for about 2/3 of decline in our SME business. So it was pretty important part of it. And actually, if you look at the rest of the SME business, we've seen good growth actually in IT services in Q4. But also, good growth in our core metrics -- or rather good performance in our core metrics against declining market. We've actually gained market share in coals and lines and broadband has done well. So some encouraging things. And whilst we know the first couple of quarters are going to be affected by that withdrawal from the trade sales, we remain very positive about the future for our SME business.

Wholesale. Wholesale numbers are a bit better than they have been. We said, this was going to be a tough year for our wholesale and absolutely been the case. And you can really see it in the chart on the right-hand side, the line of EBITDA as to what's happened with it. And you see it is flattening out more now. And in terms of revenue, revenue x transit, there were -- most of it down 2%. It will be down 1%, but we had to take a GBP 13 million retrospective charge relating to regulation. We just took that through normal profits, normal revenue. And that made the revenue decline a little bit worse. Against that, 750 million of orders, that's one of the best numbers for some time, so that was encouraging for the full year. Most net operating costs are down in total. If you exclude transit, they're not, and it's exactly the same thing I said for a number quarter. What we are seeing in Wholesale is a move away from some higher-margin to lower-margin products because basically, our technology changes. And that is something we're just going to have to accept is happening and it's something that just flows out the system, and it's not any different really from what we expected. But also, we've got some double running, of course, and that will move out the system in the not-too-distant future. So overall, Q5 EBITDA, if you exclude this regulatory charge, down 5% and that's an improvement in overall trends. I think next year will be a better year for wholesale than the year we just gone.

In terms of up Openreach, really good year for Openreach, good quarter it finished off with. Revenue up 4%. Ethernet growth coming through very possibly, and there's a little bit of a trade off between Wholesale and Openreach in that. LLU, obviously, growing and then you've got a [indiscernible] on the other side, but can I call out fiber? We are seeing the impact of fiber in the business. But we're also seeing the impact of copper growth, 74,000 net adds in the quarter in terms of copper. And if you look at the chart showing the sort of moving annual total of copper. I mean it wasn't so long ago, we are losing 500,000 copper lines a year. And now, we're north of 100,000 a year positive. And that's very encouraging. I think the 2 reasons for that. One, fixed broadband is what people are choosing, and I think it's quite clear for this bandwidth requirements, they need that. But secondly, the U.K. -- U.K. population is increasing, and I think that's one of the longer-term factors, the U.K., unlike a number of other European countries, we're going to see population growth in the U.K. over a long period. I can't guarantee that copper will increase every quarter, but we will see actually a much higher population, higher population more households, more households, all things being equal, should be a push in the right direction. So that, I think, demographics are a bit more encouraging for the U.K.

Operating costs are down, still more to be done on operating costs, but they're down 3%, and that's mean a very good EBITDA, up 12%. Now it's been a really good year for Openreach, but something I want to highlight is the impact of the regulatory controls that have been announced. Now whilst we are appealing a number of them, assuming they go through as they are today and you've all seen them, it's going to hit Openreach by GBP 200 million plus, both in revenue and profit. And that is a headwind by any definition, and I just wanted to talk -- to tell you that beforehand. And probably, it's not surprise to most of you, you'll be in your numbers in terms of what it is. And of course, on a group-wide basis, we can manage that and all our estimates include that.

Fiber. Well, we are absolutely delighted to say we now have fiber passing more than 10 million homes in the U.K. Now the team have been working very hard over the last quarter. We've basically done not much, about 3 million fiber lines in the last quarter, so it's a real step-up in pace. And I think that's now over 1/3 of the U.K. has fiber, so that's encouraging. And now retail and all the other CPs can start selling to that base. We still believe there's a potential over a 5-year period to get to about 90% of homes in the U.K. if BDUK money is made available in the right way. And we are doing pretty well in BDUK. We announced in March that we were preferred bidder for Rutland. We said in April that we'd been appointed by Lancashire, so we're very pleased with both of these. We won't win all BDUK contracts. Let's be very clear. It just is a way of things. You will not win all of them. But I think we've shown in what we are doing that actually we can really deliver. Look at Northern Ireland, 9 out of 10 households. Cornwall is going really well. And you compare and contrast that with some of the other public-private partnerships or even just public, and we're actually really delivering in a big way. And we've got industrial scale, so we will be bidding heavily for that and looking at the opportunities.

And there's a lot of other things happening on fiber. We, of course, doubled the speeds up to 80 megs, 20 megs, upstream in April and that's gone pretty well. And if you'll just start selling to that base, so obviously, the quarterly numbers don't reflect that in terms of the adds. But we'll be launching shortly 330 megabit service, so that's a very fast service. And that will be a commercial launch, and we'll also, later this financial year, about sometime within the next calendar year, be launching the FTTP on-demand service. I think that's a real opportunity. Basically, where this fiber to the cabinet, if you want fiber to the home with 330 meg speed or whatever speed we do later, it's -- be available to you. And I think that's a really good compromise between some people who want the really fast speed and the other people who want a lot of coverage, because for most people, as we stand today, 80 megs is more than enough, but there maybe some businesses, et cetera, who want fast speed, fine, it's available to you. And I think that's a -- it's a really exciting move forward.

Another we've announced, and it's very long term, is that we will do our first fiber-only exchange. Now let me explain why that's important in the long term rather than the short term, is if you were designing a net -- a fiber-based network today, you would probably have not much more than 1,000 points of presence. We've got 5,600 exchanges. Now I want to be really clear, that does not mean you move from 5,600 to 1,000 exchanges because you're not doing it from that clean sheet of paper. However, it does suggest in a fiber-only world, you will ultimately need a lot less exchanges. And what we want to do is start practicing and start actually bringing to customers the sort of products and services you can do, get the experience of it. It's going to be a number of years before we do it in Dettington [ph], and then gain that experience and the learning from it then look to do it to other places. A long-term thing, but we really want to mention it to the industry in advance and give them lots of notice because they will have to make some of their own decisions about technology in the future.

Pension fund. Well, the trustees funding valuation, pleased to say it was finalized. We announced that in the results today. Remember, what we said 6 weeks ago was we had a provisional valuation and it had to be just finalized, and it has been finalized. Actually, in finalization, it's come down slightly from GBP 4.1 billion to GBP 3.9 billion, so that's good news. It doesn't change the next couple of year's payments. That remain at GBP 325 million. We agreed to keep that whatever. But what it does mean is the payments beyond that, the ones that were GBP 325 million, goes down to GBP 295 million.

IAS 19, all of our favorites, and the number may be a bit less than some of you had, and that's really because we -- we've adopted, we've made a few changes in both directions, but we have adopted what's now best practice in terms of the calculation of the discount rate, which basically uses the discount rate of various -- it matches the maturity a lot better of the pension scheme, and so it's a better way around of looking at it. Otherwise, the assumptions are -- is there. The thing I would say, CPI, CPI 0.7%, 5% below RPI and then 1.2% thereafter. The offset budget responsibility is forecasted differential 1.3% to 1.5%, so we're certainly on the more conservative end in the OBR. If the OBR is right, then obviously, one would get a lower valuation price, 19, and also frankly, for other things in the pension.

So looking at the outlook. First of all, on revenue. We do expect to see improving trends on revenue, and that's despite the challenging economic environment. It is more difficult than when we thought a year ago plus with the economic environment. The other thing that's impacted, as whilst we expect some effects of regulation that's being worse than we thought is regulation will hit to the GBP 100 million to GBP 200 million group-wide, it's a bit more [indiscernible] if we get some of it back in the rest of the group in terms of revenue both in the year we're in and next year. And also, the withdrawal I mentioned that will affect the first half rather the second from IT hardware trade sales. The last 2 factors are together probably about 1% of revenue. So they're significant. That being said, we still expect improving trends in our overall revenue.

On the EBITDA. EBITDA, we expect to see growth in 2013, 2014 very simply, improvement for the numbers. And that really comes from a number of places, but I should highlight that, in GS, we expect continuing solid EBITDA growth. And I did mention earlier, offsetting that a bit is the regulatory impact in Openreach, although they'll be working hard to offset that themselves.

And free cash flow. What we've tried to do with free cash flow, if we -- as it's stood, the definition of free cash flow, which included the pension tax credits, we'd actually have the free cash flow going up to nearer to GBP 2.9 billion before coming down again. We tried to say, well, that didn't really reflect the underlying business. And so what we tried to do is talk about normalized, i.e., take out the impact of the lumpy pension tax credits. And as you see, these are the numbers when you restate it. We've gone from 2011 at GBP 2.076 billion. We actually increased it to GBP 2.307 billion, so that's what I mean. That's a really good number for 2012. And we're going to hold the number next year. We're saying it could broadly level, so at that higher level, higher than your expectations, we'll hold it there. And then we'll increase it beyond GBP 2.4 billion the following year. Now what that means, put another way, is given we've got pension payments of around about GBP 300 million is we're already hit the level where we are even post-pension payments GBP 2 billion a year plus in free cash flow. And that's a very different level from where we've done in the past. And what we're seeing, we've overachieved in cash flow this year. We're going to hold it and then we're going to grow it. And within that, one thing we just want to point out was Global Services. Its cash flow will be lower next year, a lot of that's due to working capital before returning to growth again in 2014.

So, you've seen this chart before. I'm not going to talk through it, except to say we're doing what we said we would do. There's still a lot of operational improvements available in the business, and that's what we're still driving for. You will see improving revenue trends, and you will see continued improvements in our EBITDA in dividends, in cash flow, all the good stuff coming through. We think there are many opportunities for us, and if we execute particularly on our investments and fiber and also in the Far East, we also remain convinced that we can become a growing business again at top line as well as continuing to grow at the bottom line.

Thank you very much. Over to you, Tony.

Anthony Everard Ashiantha Chanmugam

Thank you, Ian. Good morning, everyone. I'll take you through the results of the fourth quarter and full year in a bit more detail.

Starting in the top of the income statement on revenue. Revenue declined by 4% in the quarter. This includes the impact of a GBP 47 million decline in transit revenues and a GBP 27 million decline for the disposal of our investment in XO front line last August. Consequently, underlying revenue, excluding transit, was down 2%. This reflects the lower revenue from calls and lines that has continued throughout the year, as well as the challenging economic environment we're seeing. It also reflects our active decision during the year to move out of some lower-margin IT hardware trade sales, as well as the impact of the GBP 13 million retrospective regulatory charge in wholesale.

For the year as a whole, as Ian mentioned, our revenue decline was within the guidance range we gave at the start of the year. We delivered another quarter of growth in EBITDA, which was up 4%. This reflects our cost transformation programs, which led to cost declining by 7% in the quarter. I'll say more about these later. Depreciation was down 2%, which contributed to operating profit growing 9%. Profit before tax rose 13%, which in turn, drove a 10% increase in our EPS to 6.8p. Specific items were a credit of GBP 107 million, mostly due to the impact of the recent change in the corporation tax rate on our deferred tax balances, with a further GBP 14 million of restructuring costs in Global Services, taking the total for the year to GBP 64 million. This was slightly more than our outlook of GBP 50 million, reflecting the complexity of our network rationalization program. Additionally, it's taking bit longer than we originally envisaged. And for 2013, we therefore expect around GBP 40 million of further restructuring costs in Global Services, relating to our Internet and Radianz networks. If you remember, we acquired these a number of years ago, and we're in the process of migrating customers off these legacy platforms. We expect to generate further savings as this process completes.

Turning now to next slide in free cash flow. Free cash flow for the quarter, cash CapEx was GBP 63 million lower than last year, reflecting the timing of supplier payments. Interest and tax were together broadly unchanged against last year, with lower interest being offset by an increase in tax, reflecting our higher profits and an increase in the effective tax rate. Working capital in novice [ph] showed GBP 162 million improvement compared with last year. Most of this reflects the phasing of working capital within the year, but it also reflects lower regular with the pension contributions. You may remember that we said these would be lower this year after we made some overpayments last year.

The cash cost of specific items was GBP 53 million, bringing the total for the year to GBP 204 million. This was more than our GBP 180 million target largely due to the cash payment relating to a historic regulatory decision. For 2013, we expect a cash outflow of around GBP 100 million for specific items relating to the global certain services network rationalization and the ongoing cost of the property rationalization programs.

Turning to the next slide, which is about free cash flow for the year, of GBP 2.5 billion, this was well ahead of the target at the start of the year and ahead of GBP 2.4 billion target we gave last quarter. It has risen by GBP 300 million or 13% over the year, with the main drivers being growth in our EBITDA and lower interest costs as a result of lower gross debt. Cash CapEx was GBP 70 million lower, benefiting around about GBP 40 million from the timing of cash payments -- CapEx payments, which boosted fourth quarter cash flow. These improvements were partly offset by an increase in cash tax after we benefited from larger tax losses in the previous year. Working capital and [indiscernible] were broadly unchanged.

Turning to 2013 for the next slide. As Ian mentioned, we are now providing our outlook for cash on a normalized basis. This removes the impact of a tax benefit that we get when we make pension deficit payments. Because of the GBP 2 billion payment in March, our cash tax will be much lower in 2013. And therefore, our reported cash flow much higher. Stripping out this benefit, therefore, gives a better view of the underlying cash generation and trends within the business. Our 2012 free cash flow of GBP 2.5 billion becomes GBP 2.3 billion when presented on this new normalized basis.

I'd like to highlight some of the moving parts in cash flow that we expect in 2013. Firstly, cash flow in the year will be impacted by the timing of CapEx payments, which I've just mentioned. This represents a year-on-year swing of around GBP 80 million. Our cash tax will also be higher as a result of our expected growth in EBITDA. Our regular cash payment pension contributions will be around GBP 55 million higher as they return to a more normalized level. And finally, on Global Services, the timing of the contract-related payments means that 2013 won't see the same level of working capital inflow that we saw in 2012. These 4 effects will broadly offset the underlying cash improvements we expect to make in the year. And as such, we expect our normalized free cash flow to be broadly level when compared with 2012.

I also want to touch on the phasing of our cash flow over the year. Our cash flow is typically weighted to the second half, reflecting the phasing of payroll cost and the timing of some large recurring supplier payments that we made. While we are making efforts to slew [ph] the profile, this phasing will be particularly evident this year for a couple of reasons. Firstly, the timing of our working capital in Global Services that we -- means we expect the operating cash flow for this division to be lower in the first 2 quarters compared with the year ago. And secondly, the cash phasing, which I've already mentioned, means quarter 1 cash flow for the group will likely be slightly lower than last year, with this being made up later in the year.

Moving on to the next slide as far as costs are concerned. We continue to make progress in reducing our cost base. In the quarter, we reduced our operating cost by GBP 242 million. That's a 6% underlying reduction. And for the year as a whole, we reduced our cost by over GBP 900 million, also a 6% underlying decline. Excluding the levers, the labor cost reduced by 2% in the quarter, about GBP 112 million or 2% for the full year. This was partly offset by higher lever costs, which increased by GBP 40 million, mainly because of higher participation in the Openreach lever schemes. Around 40% in reduction of our cost base for the year reflected lower transit revenues and associated costs. The remainder reflects the underlying progress we've made in reducing costs across all categories.

Let me give you a few examples. We've reviewed our consumer sales and provisioning process with a particular focus on bundled products. The program has delivered significant improvements in the right first-time measure, and it's reduced the cycle times as well. As improving the customer experience, this generated savings of around about GBP 20 million in the year. When it's fully implemented, the program will deliver savings of around about GBP 50 million in the year.

In addition, a review of our learning and development activities delivered savings of around about GBP 40 million in the year through improved supply management, the introduction of a new centralized training model and a more effective and efficient training program for our field engineers.

Turning to the next slide. As a result of these type of activities, we've been able to deliver big reductions in our cost base over the last 3 years. We've now reduced our operating cost around about GBP 2.9 billion over the period, and including our CapEx, our costs are down by GBP 3.4 billion. As we look forward, we still see plenty of opportunities to make further cost reductions. We'll continue to focus on reengineering BT-centric processes with the aiming of removing failure. This will deliver better customer experience while at the same time, reducing our costs.

We'll further rationalize our supplier base, and we'll ensure that we work in partnership with our key suppliers. And we'll carry on reviewing our resource strategy to ensure that we utilize our existing resources more effectively. Overall, through a continued forensic analysis of our cost base, we still see plenty of opportunity for hundreds and millions of savings in the coming years.

Okay, moving on to the debt. We finished the year with GBP 9.1 billion of net debt. This was an increase over last year caused primarily by the GBP 2 billion payment that we made into the pension scheme in March, which offset the cash flow generation during the year. Looking at our financing requirements for the year, we have around GBP 1.7 billion of term debt maturing this year. And we'll also be buying back around GBP 300 million of shares, as well as paying dividends. In terms of financing these, we start the year with cash and investment balances of GBP 800 million. We'll obviously be generating cash over the year. We also have GBP 1.5 billion committed facility. Despite all that, we will continue to look at opportunities in the debt market. It's worth making a point that when you're thinking about our interest charges for the year, the timing of our maturities means that our gross debt will only come down materially in the fourth quarter. The maturing debt also has an interest rate below our average, so this will push up our effective interest rate in the following years. Again, we'll continue to look at opportunities to reduce this where it makes economic sense.

As you know, reducing our net debt has been the focus for us, and this remains the case today. We're a prudent company, and we want the financial strength that comes with a solid investment grade. That's why we're targeting a BBB+ or a Baa1 rating, which we aim to achieve through further debt reduction over the medium term.

Turning to the next slide. For the current year, there are few additional times I'd like to draw your attention to. As Ian said earlier, we expect our underlying revenue, excluding transit, to show an improving trend this year. We've exited 2012 with a revenue decline of just under 2% and from April, we have had the impact of the new charge controls on WLR and LLU to contend with. Quarter 2 also faces a tough competitive as a result of the timing of contract milestones within GS last year. As such, we expect the improvements in revenue trend to be weighted towards the second half of the year with an overall improvement in revenue trends for the whole year. We expect transit revenues to decline by around about GBP 200 million to GBP 300 million this year. Transit revenue is very low margin and can be volatile, as it's impacted by regulated changes in the mobile termination rates. For this range -- for this reason, we're providing a range on that.

CapEx for the year came in at GBP 2.6 billion. It's in line with our target. It's now been at this level for around about 3 years, and we expect this to be the case again in 2013.

Finally, on tax. We expect the effective tax rate in the income statement to around about 23%. This is slightly below the statutory rate, reflecting the utilization of historic tax losses. The GBP 2 billion pension deficit payment we made in March this year, together with the expected GBP 325 million payment next March, should reduce our reported cash tax by around about GBP 560 million.

So to sum up, this has been a solid year. We have achieved or beaten the outlook we set on the start of the year on revenue, EBITDA and cash even though the environment was much more challenging that we expected. Despite these challenges, we expect to continue to improve our underlying revenue trends over the next 2 years. The visibility we have on further cost-saving opportunities means that we're confident in our ability to grow EBITDA and our free cash flow over the same period. Our prudent approach to capital structure allows us to keep investing in the long-term future of the business, while at the same time, reducing our debt and rewarding our shareholders. Overall, our aim is to continue to do what we're currently doing. We've made progress, but there's much more to do.

Thanks for listening. We'll now take questions.

Question-and-Answer Session

Ian Paul Livingston

Thank you. As usual, wait for the mic to come and if you can give your name and institution. And we'll start off there, and can we try and get it to 1 or maximum of 2 questions and that includes sub parts.

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

James Britton from Nomura. Just a question really about intentions on mobile in the context of Vodafone's deal recently. Would you consider -- was it the right time to consider a new partner in mobile now that Vodafone will become the biggest competitor in the business segment? And then can you just give us some clarification on how many of your business clients you actually sell mobile services into? To how many of your business clients is an integrated fix and mobile product set where you're delivering today?

Ian Paul Livingston

Okay. I mean Vodafone, as you say, Vodafone are a big customer, big supplier and a big partner. I think you all know that Vittorio said he would give me a call as soon as he finished his acquisition presentation, and he was absolutely good, true to his word and even said that next time, you'll probably arrange it through the secretaries rather than the world press. They did, and we'll carry on working closely with Vodafone. But we also work closely with other mobile players. I mean Everything Everywhere or 2, 3, they're all big customers of ours. And we have a good [indiscernible] arrangement with Vodafone today, and we'll -- we'll carry on working with them. I think in today's society, in our industry, you can absolutely have someone who's your partner can be your competitor, and I think there's a level of maturity, and I think Vodafone see that as well. So we'll obviously see what's happening in that place, but we're not going to make any rash decisions. And probably, In the meantime, we also look to see what opportunities also this takeover, if it actually completes. I'll leave it to you, guys, what has. In terms of our -- the mixed mobile and fixed, I mean whilst Jeff has some businesses that are -- we intend to introduce the -- there's very little word of the mobile gives you the fixed. And it's really in the SME business, where we've got a far more combined package. And Gavin, do you want to say anything about that?

Gavin E. Patterson

Well, it continues to be very much a key part of the strategy for us in SME. And we've got a couple 100,000 users of our fixed and mobile services at these customers at the moment. But I see that as a potential for future growth. So it's really all I wanted to add.

James Ratzer - New Street Research LLP

It's James Ratzer from New Street Research. I had 2 questions, please. The first one was just regarding BT Vision. Are you interested in giving that a bit of a kickstart by reaching commercial agreement with Sky on the remaining sports channels? And the second question is a slightly more philosophical question looking at Openreach. It's obviously quite strictly regulated by Ofcom on a rate-of-return basis. You're clearly being much more efficient on your fiber rollout, you're talking about long-term plans on moving to fiber exchanges. That presumably means, long-term, your capital employed is going down. How do you balance the near-term efficiency gains with the risks that longer-term, lower capital employed base could mean lower overall returns?

Ian Paul Livingston

Okay. On the second one first, I mean, I think our bigger problem is not so much of our capital employed going down, because actually, we put a lot of expenditure in things like fiber. It seems that some of the decisions don't recognize some of the capital employed we've actually got. That's more of a challenge. Actually, fiber, bear in mind that fiber is not regulated. Ofcom made it quite clear that they looked at the great debt before we started the fiber rollout that they weren't seeking to regulate it, particularly on the grounds, the fact, that they sell copper as an alternative. And they didn't feel it should be regulated. I mean to be honest, actually, if it was, given if you take the sort of cost of capital and returns criteria, probably the prices would be a lot higher than they are today. And so from that point of view, it's always a challenge of having a regulated business. If you take the prices down, if you take -- as you become more and more efficient, at some point, some bit of that comes back to the regulatory looks at that and maybe to a degree, the -- some of the price changes that we -- cost changes that we've seen reflects some of that. I don't know, Olive, if you want to add anything to that?

Olivia Garfield

No. I mean, I guess, all we've done in the last quarter is get ourselves ready what were price changes, I guess, a cup so I think we've got enough sales in line. And I don't think we get enough sales necessarily as the staffing stands now.

Ian Paul Livingston

Yes. And on BT Vision, we'd absolutely love to enter into a commercial agreement with Sky. Sky is one of our biggest customers. We merely wish to be one of theirs. And so my door is always open. And I'm sure Gavin's is as well. We would love to take Sky channels, and not having Sky to report personally is a bit of problem with Scottish football. And clearly, that's very -- that's critical. But yes, no, we absolutely -- there is an asymmetry and that's frankly why we've gone to court. And we await the court decision, but we absolutely want to be a customers of Sky in the same way that Sky are a big customer of ours. And that would seem to be converging. Well, it's absolutely the right outcome. Okay.

James Ratzer - New Street Research LLP

Follow-up if you think fiber will be regulated. And if so, when that might be?

Ian Paul Livingston

Well, I think I said that Ofcom looked really careful at this and they were very clear as to why not. And I don't hear any sign from Ofcom that they think that was a bad decision. And they made it very clear that they see copper as an alternative less [indiscernible].

Unknown Executive

And we have opened provision.

Ian Paul Livingston

Yes. And absolutely, absolutely. It is equivalent. Everybody pays the same price, which again, something I would recommend that Sky could look at internally. If you can pass it along the -- pass along the rows, and then we'll go -- can you give it to him as well?

John Karidis - Oriel Securities Ltd., Research Division

I'm John Karidis from Oriel. Just a couple of questions, please. The first one is relative to BT Retail, where are the other big subsidiaries in terms of their cost cutting journey approximately? And then secondly, are there any exceptional revenues or costs or CapEx related to the Olympics, please?

Ian Paul Livingston

On the second one, we have been accruing the costs of the Olympics. There will be a bit more costs this year, particularly so -- on the rights activation, but we have been providing as we've been going along for it, so there will be -- but there will be some extra costs this year -- especially about the cost and both questions, Tony, do you want to add some?

Anthony Everard Ashiantha Chanmugam

Yes, sure. In terms of the first question, I think it's good to look at BT overall. Three years ago, we were on the fourth quartile in terms of the benchmarking within the telecom sector. We're now at the bottom the second quartile. Inherent within certain activities, if you look at what we're doing in terms of IT in network operations, we're in the third, fourth quartiles. So there's plenty of opportunity there. And our focus very much on -- if you say, "Where we are on retail?" Not that I'm talking about discussing Gavin's budgets and targets next year, but he's got hundreds and millions of pounds of savings that he needs to do next year. The other -- I can see he's delighted by that, and -- but what I'm saying is within the other lines of business, we're at different stages of the evolution cycle. And we've got plenty of opportunities there, both in terms of this generic processes that go across BT as well as specific activities within the lines of business. We're not sure of opportunities. In terms of the Olympics, we're going to incur more cost this year than we did last year. But there's no one-off items that we are going to be declaring as specific. It's simply a cost of doing the business and hopefully, we'll get the benefits of that moving forward in the later years.

Ian Paul Livingston

Pass to Steve there.

Stephen Paul Malcolm - Arete Research Services LLP

It's Steve Malcolm from Arete. A couple of questions, one for Gavin and one for Tony, please. First of all, just on retail pricing. I mean, I guess, we've seen sort of general modest inflation and things like line rental for the last 2 years or 3 years, but that, to a degree, is being supported by general modest inflation, the wholesale prices. That clearly disappears this year and next. So how do we think about the retail pricing environment on the back of lower wholesale prices? And then secondly, for Tony, just on your sort of points on liquidity and debt. I guess you've given very clear guidance on cash flow dividends and buybacks and you [indiscernible] do the maths. And at the bottom, appears about GBP 2.3 million, GBP 2.4 billion of surplus cash to use one phrase over the next couple years. Do we assume that, that's used primarily to pay down debt? It's obviously one way of sorting out your interest is just simply retiring debt, not borrowing money at a higher rate than the average rate.

Ian Paul Livingston

Okay. Gavin, do you want to talk about pricing? You've got some great deals for Steve out there?

Gavin E. Patterson

Yes, of course. I mean you're right to observe it's a very price-sensitive market at the moment. There's no question about that. And we've seen a number of our competitors go very aggressively in the last quarter, really chasing volume. And we're not necessarily going to follow that where it's uneconomic. So it will, I think, be -- it will move around a little bit. More generally, in terms of the scope to drive pricing more strategically, shall I say, we do see inflation coming down. And I think that provides less of an umbrella. And we have made a commitment at the same time to hold our prices until 2013, and I think we're seeing the benefit of that come through in more stable operations, better value for money scores, higher satisfaction, so I think that was the right thing to do. Beyond that, I think, the answer for us really lies in bundling. We are under-indexed on bundles still versus our competitors. And bundles allow us to provide great deals to customers with strong structural economics, much better churn characteristics. So I think that's where we'll focus our efforts going forward.

Ian Paul Livingston

[indiscernible]

Anthony Everard Ashiantha Chanmugam

It's very difficult to retire existing debt economically. But if you look at the math of what we're doing at the moment, we've got GBP 1.7 billion in the maturities coming through this year, the bulk of it in January 2013. Our weighted cost of the term debt at the moment is 7.5%. The debt that retires is at 5.8%. What that actually means then is the weighted average cost of our debt goes up to 8%. But economically, it's very difficult to impact that in a commercial sense.

Stephen Paul Malcolm - Arete Research Services LLP

And last question, what are we looking for the next couple of years? How much gross cash would we assume that you need to run the business with then? I mean you have 0.8 at the end of this year. Do we assume that you run on about GBP 1 billion for of working capital and other purposes? And we make our own conclusions on what you do with the extra cash that drops out?

Anthony Everard Ashiantha Chanmugam

Well, I'd say having surplus cash in the current climate doesn't give you much return for that. So we've got further debt maturities, nothing in 2013, '14, but more in 2014, '15. We've got the buyback, so we may go into the market where we -- if we go into the market, I don't want to be saddled with long-term debt with a high-cost to carry.

Ian Paul Livingston

The other question was where we think we'll do something if we had the debt and we have the cash sitting there? No. So was that a question about [indiscernible], no. But we'll nibble where we can at buying back some debt. It's really very tough, it's very tough, very tough because price is gold. Do you want to pass it down?

Andrew Lee - Goldman Sachs Group Inc., Research Division

It's Andrew Lee from Goldman Sachs. Just a question first on your guidance. Clearly, visibilty on the top line is more tough and therefore, you've set directional guidance, which is necessarily broad. You've been pretty explicit on your free cash flow guidance. And just trying to get a sense of your confidence in that free cash flow guidance. I mean if your revenue declines improved to 1.8% rather than 1.9%, are you still confident you'll deliver the free cash flow number? And then just secondly, you highlighted fiber in many times through the presentations. Just wondered what your thoughts on the fact that your competitors haven't been pushing fiber yet and whether you expect that fiber push to accelerate through 2013, and if that's in your guidance as well?

Ian Paul Livingston

Sorry, what's the...

Andrew Lee - Goldman Sachs Group Inc., Research Division

If the a competitor push of fiber in 2013 is what you expect and if that's in your guidance?

Ian Paul Livingston

Right. I mean, we live in an uncertain world. But I'd just say on free -- as you go down the P&L and to cash, these things are more within one's control. I think our ability to deliver more efficient business within our own control, and we may be at the bottom end of the range on revenue, although we were in the range, and we beat the cash flow quite handsomely. I think that should tell you something about our level of -- continued level of confidence.

Anthony Everard Ashiantha Chanmugam

We said more than 2.4.

Ian Paul Livingston

So we -- and on fiber, we'd be delighted to work -- I mean talk have started, I think, do a lot more in fiber and fibers there. As I said at previous meetings, we will lead the way, frankly. If our competitors don't push it, BT Retail does well, the competitors do push it, Openreach does well and either way, we win on that. But it's not for us to disclose what they are saying to Openreach, because that's up to them. But it's available to everyone to use, and my [indiscernible] would be to do so.

Carl Murdock-Smith - JPMorgan Cazenove Limited, Research Division

It's Carl Murdock-Smith from JPMorgan. Two questions. Firstly, Ian, just why do you think the broadband markets, overall, is growing faster than it was a year ago? And then secondly is for Liv. On the pace of the fiber rollout, very impressive. How did you manage it with seemingly no impact on OpEx or CapEx in Openreach? And what should we be expecting for the pace of the rollout going forward?

Ian Paul Livingston

I think it might be for Tony rather than -- on what you're expecting. But on broadband, I think the -- the U.K. is actually the most, one of the most connected societies anywhere in the world. As much some newspapers like to sort of do the U.K. down all the time, if you look, there was a recent survey from Mackenzie's [ph], I think was BCG that had the U.K. as the Internet was the largest proportion of the economy in the U.K. in the world, beating places like Sweden and South Korea. But the reason -- and the -- so people using it particularly for e-commerce a lot in the U.K. Also, pricing is really effective. If you just open any newspaper, the degree of advertising is immense. And thirdly, we're offering more and better, and I think the fiber is part of that. So you would think in today's economy that broadband would tail off, and it's surprising. I think it's surprising it's been as strong as it has been, but encouraging. And of course also, on our network, the market share of the BT network and especially wireless compared to cable is very, very strong. And certainly, what we're seeing is, I think, our network doing very well relative to cable. And in terms of the Openreach teams doubling effort in delivering 10 million, Liv?

Olivia Garfield

Yes. So I sometimes say they come together, don't they? Right. So a lot of work in Q3 came out in Q4, so there's definitely a bit of spine work [ph] goes in, takes a while to come through. So that's fair. We also have to begin to push ourselves harder to make sure that we were ready for the BDUK bit as they come through. So part of it was a sense for ourselves. We're delivering efficiently. We're right on track for our financials for fiber program, and we're good at deploying at scale. Will you see it continue? So you're not going to see every single quarter they're at the same scale, it does depend on which areas. We're going to go to less dense areas. That's the reality. We've done a good chunk of the U.K. now. We're going to begin to go to slightly more troublesome places. We're also going to begin to see some of the BDUK activity come through. Again, they've got intervention funding for that reason. And of course, we did lots of FTTC. So we have a fantastic machine now doing FTTC. We're gaining that same level with FTTP. We're going to need to do more in the coming year, so you will see the pace beginning to slip around. So it will move through the quarters like it did this year.

Maurice Patrick - Barclays Capital, Research Division

It's Maurice Patrick from Barclays. Question on YouView just around the sort of how you think about the timing of it and if all the investment in that is included inside your EBITDA [indiscernible] just checking?

Ian Paul Livingston

Yes, it is. I mean because you do a lot in Vision. I mean I may ask Gavin to talk about YouView but yes, as I was stressing, there's a lot of things happening on Vision already and we're doing pretty well on the net ads. But yes, our investment is included but, Gavin?

Gavin E. Patterson

I mean to your point, Ian, I mean YouView is only part of the TV story for us. We're rolling out Vision 2.0, as Ian referred to in the presentation itself, which has much better search and recommendation capabilities and that's beginning. As I say, we've got several thousand customers on that, and that will grow over the next few months. We've got multi-casting, in other words, being able to stream many channels over our network coming later in the year. And then we've got YouView. So we've got some boxes, which are in pretests at the moment. We would expect that to continue to go through a testing regime over the next few months. And to answer the final question, yes, the investment is in our numbers.

Nick Lyall - UBS Investment Bank, Research Division

It's Nick Lyall from UBS. Can I ask, firstly, just on the dividend, why not higher at the moment? Why the progressive divi, why not push it up earlier? And then secondly, back on YouView, like Maurice's question, is there -- it doesn’t seem to be a sense of a delay in YouView, if it is a delay, affecting the launches. Is that the case? And are you in a position, do you think, because YouView is possibly delayed and more outmoded of maybe talking down or negotiating down your investments in advertising others for YouView. Would you consider that?

Unknown Executive

What do you guys [indiscernible]

Ian Paul Livingston

Yes. I mean on YouView, no, I mean YouView has always been part of what we're going to do and absolutely, we are not talking down investment. We remain excited about it. But I mean, anything you want to add to that, Gavin?

Gavin E. Patterson

No, not really. It hasn't fundamentally been delayed. I mean it's going through a normal process of testing. It will -- I fully expect it to come out over the summer months. So I think there's been 1 or 2 stories in the press recently that it's delayed again. I didn't see that. There are few more things to resolve, but we have got boxes. We've got them upstairs here, and we're trying them out. We've just got to iron out the wrinkles as do the other partners. And it's a decent -- it's a really good product ultimately. When you get to see the EPG and what it will do, putting together backwards-looking programming, links into portals that allow on-demand, both paid and unpaid, it will be a revolution in the TV market. So we certainly believe it's worth waiting for. And we will invest in it.

Michael Rake

Yes, I think in the question you raised on the question on dividend. What we think the most important thing as we've been saying for some time now is the dividend should be sustainable and progressive. And we think you should be able to rely on a dividend increased of 10% to 15%, and we think that is a good value to the shareholders. And this is after the continuing need to continue to invest in our infrastructure, in our business for growth, to continue to deal with the pension fund deficit and reduce its volatility and impact on us and to be able to retain a conservative balance sheet that allows our credit rating to improve and over time, for our future cost of funding to reduce. And I think when you see also what's going on in the Eurozone at the moment and the uncertainties we face for some considerable period of time, I think we do need to be conservative. And therefore, at the end of the result of investment, the end of the result of really reducing the deficit and the pension scheme is a sort of dividend of that sort of level, we think, is absolutely the right thing to do at this point in time.

Ian Paul Livingston

I think it also reflects what our shareholders said to us. I mean you said we want to be able to take it to the bank. We want to see growth, yes. We want to be rewarded. Some of them said they want to see some modest share buybacks, and I think we've reflected that. We had to make our decision, but we listened to them. So I think very much reflecting about taking it to the bank, looking long-term consistent increases, and that's what we'll provide.

Robert Grindle - Deutsche Bank AG, Research Division

Robert Grindle from Deutsche Bank. It was actually a follow up on the use of cash, actually. The Mexicans see distressed value in Holland. The Chinese see distressed value, if you listen to the press, on your doorstep in Ireland. [indiscernible] sees distressed value in the U.K. You do have a strong balance sheet. You are generating a lot of cash. Would you not look at distress value as a way of using some of that cash? And I'm afraid I have to ask a pension question. The Pension Regulator has got a bit grumpy about or suggesting companies don't change the actuarial valuation date. You had good reasons to do that because of your top-up, but there was a side benefit to that in terms of the valuation. Is there any knock on impact from what Pension Regulator has been saying or is -- we just address this again in 3 year's time?

Ian Paul Livingston

Well, actually, though, what Pension Regulator said didn't want people changing it just to reduce the Payment stream, if you read the whole sentence. And we have not reduced the payments, quite the opposite. We've increased it. We've actually paid off more than half of the deficit in one shot. So no, it's entirely in keeping with what the Pension Regulator said. So I don't have a problem in that sense.

Robert Grindle - Deutsche Bank AG, Research Division

Well, the follow-up then is it did clearly impact the deficit. Would it be possible to know what the deficit would've been at the...

Ian Paul Livingston

Well, last time we said it really depends what assumptions one made about future, because one of the real problems was working what is exactly would've been future guilt yields and what was the assumptions you can make around it. And clearly, deficit at that point would have been higher. But since then, even despite recent days, guilts have gone the other way again. So the guilt market is -- everybody knows the guilt market affected by QE [ph] that's not -- no great shock. And we'll see in 3 year's time as to where we are with it and -- but what we have done in the meantime is in one lump, put in over half the deficit funding, and the great news is because we can. And it's been -- I think that's been worthwhile for everyone. In terms of distressed assets, often, distressed assets are distressed for reason. And I still think that the majority of the -- and maybe over 100% of the benefit we can give to shareholders is by really good operational execution, I think, but Mike, do you want...

Michael Rake

No, I mean I give -- we should focus on what we do well. We should not be distracted by things that might look cheap. We stick to our core business, improve our customer service, get our growth going, continue with this reduction of debt and get the dividends to you guys right, the shareholder value up. That's what we should do.

Ian Paul Livingston

Yes. We've always said we have a strategy, not an acquisition strategy. And if there's ever little things that you want to put in to do that. We've done that in the past, we'll do it again. But really, looking to say do you -- if you can't improve the business as a result, that's got to be your key measure. And we'll leave it to you guys to be the investment houses and things like that. That's not our job. Our job is to run a really good communications business, and that's our aim. [indiscernible]

Stephen Howard - HSBC, Research Division

It's Stephen Howard at HSBC. I just wanted to return to the topic of regulation. If you look at the charge control review for LLU and WLR, I was just wondering whether you were disappointed or maybe, actually, I should just ask how disappointed were you in that particular document? And there's one sentence that really stands out for me, and I may be guilty of selective editing here, I warn you in advance. But they say, "Fortunately in the U.K., we are beyond the point of initial incentives to encourage investment in new technology. Accordingly, our main focus is to protect consumers at a time the technology could change." What I'm wondering of course is, admittedly, you're not price-regulated on fiber today. But what insurance policies are you putting in place to ensure that once the capital is deployed, shareholders' interests are protected for the long term? In other words, how can shareholders be confident that you can convince the regulator that investment is for life and not just for Christmas?

Ian Paul Livingston

Look, I think one of the most important things is look at pricing. Actually, the wholesale pricing is really low. That's available to everybody at the same price. As I said in the presentation, I suspect if you actually started regulating fiber, the price would go up quite considerably. But any European international comparison, we've got -- the reason we've gone for it is very simple commercial reason. We want to get volume. And once you got fixed cost, you want to get that volume and that's really what we're going after. And Ofcom also recognized that, as I said earlier, they looked very careful at this issue and said, "Well, we recognize that copper is an alternative asset that people can take." And frankly, and that acts to effectively create a much larger market, so they didn't -- we didn't feel the need to regulate it. And that maintains the position, and there's no indication from Ofcom that they'd get any different view from that. And in terms of -- I don't know whether you're asking for, I'll answer the first bit, which is how disappointed we were. Do we go between -- Liv, why don't you say how disappointed we were?

Olivia Garfield

Yes. Not [indiscernible], so pretty harshly disappointed, and I think there's lot of stuff [ph] that was missed out on the cost base, that we feel quite hurt about, that we think should be considered. And I think we don't agree with some of math equations in terms of some of our costs, our real costs, such us repair charges factored into it. So obviously, we'll make sure that we make that very clear in the ongoing debates that come off. And I think there's some real merit to some of the arguments that we have.

Stephen Howard - HSBC, Research Division

If I can just follow up. There's an interview with one of your leading wholesale customers, but retail competitors on Tuesday in which they are suggesting that Ofcom should move the charges on wholesale fiber down, one presumes sharply, as soon as the first phase of the build is complete in 2015.

Ian Paul Livingston

Yes, I read that interview as well. I think to which I would quite clearly see. Given there's a double-digit year return, if she was wanting to invest in fiber, I assume it's [indiscernible] view you're referring to, we would be delighted to buy from her at a cheaper prices. So we'd be very, very, very happy. So we look forward to them making the investment and we'll buy, because normally, their timescale is a lot shorter than double-digit return. And look, you, guys, do to the analyst -- analytics in this, you know the price of U.K. fiber and you'd know the comparison with the rest of Europe. The U.K. is in a really good position. We're talking about fiber being retailed at GBP 18 per month. And that is a really good price. So I don't think there's really an issue. As I said, I think if Ofcom had regulated the base in the cost of capital assumption just now and returned on assets, the price would be substantially higher than it is today. That's the truth of it. Go behind, and then can we get one into the -- over there, because I've left the...

Paul Sidney - Crédit Suisse AG, Research Division

It's Paul Sidney from Credit Suisse. Two questions, please. Compared to 12 months ago, given the outlook that Global Services remains challenging, have you plans to accelerate the cost-cutting program in that division versus what you thought 12 months ago? And just secondly, given the launch of YouView and the potential explosion in video content, do you see that potentially being a problem for your network?

Ian Paul Livingston

Well, I'll do the second one, and then I'll ask Tony and then Jeff maybe talk about GS. No, we don't see it being a problem. We have a very good content distribution network. We've invested heavily in that. Maybe, I don't know, Niglel [ph], if you want to say a few word on it, but -- and that allows us the cash stuff [ph] locally, and that's been a big help. And if you see with iPlayer and on our TV, lots and lots of demand, it's a great service, no buffering because it's local caching. And so I mean there'll be lots of reasons why data usage in our network will increase and unquestionably, it will do. And that's a good thing. Being able to charge for it all the time would be even better thing, but it's a good thing that's increasing because there's a big demand and we can scale our network as well. We talked we had 21C [ph] network. It wasn't necessarily all that was made out to be. The one thing it was, was a really strong IP core to our network and that's -- and that's made our measure [ph] of bandwidth really a lot easier for us. And Tony and then Jeff, you want to say something about...

Anthony Everard Ashiantha Chanmugam

Yes, sure. I think it's worth reflecting that over these last 3 years, we've had a 7 -- over GBP 700 million swing in cash in Global Services. Some of that's come through revenue, some of that's come through cost savings, and -- but when we look at what needs to be done, it's not acceptable that we've got a business worth GBP 8 million generating less than GBP 200 million, it's not acceptable. We know we need to move that on. Part of moving that on will be continued focus on cost savings. Sometimes, you don't see the impact of the cost-saving activities because when you look at costs, you have your gross savings, you then have a movement associated with margins. You then have the investments. So within Global Services, we've had investments, as Ian highlighted, in AsiaPac, in EMEA, in LatAm. And you also have the impact of inflation. So we see a number, you see a small number, but it doesn't mean that cost savings aren't taking place. That said, we had a 1% reduction in the year, 3% in the quarter. I think that 3% in the quarter indicates the sorts of trends that we need to move on to.

Ian Paul Livingston

Jeff, do you want...

Jeff Kelly

Yes. I would add to that we referred in the presentation to the network consolidation, those are long programs, very complex, so we'll see the benefits of things like RXN and the Internet closures across the world. Another example I would use to get to what Tony was talking about, we still have certain back office functions, CDSS is a great example of that, where we take our consolidated inventory management, billing systems and we take the contracts and move that to a, in essence, a shared service. And we've got a both an in-source, where we're taking that captive, and we also a supplier that we use. We focused on the top 40 contracts. We've got a lot of other contracts around the world that can take advantage of things like that.

Ian Paul Livingston

Okay. Great, and one other thing we should say about, Jeff, I think, is also we'll be pushing for RNs because people talked a lot about regulation in the U.K. We would wish regulation around the world to be regulation in the U.K. And that's certainly one of the areas where we'll be pushing very hard, and I think the U.S. is high, absolutely high on our list. And we spend a lot of time with the FCC and the coalition of partners, the [indiscernible] alliance that really costs should come down in a lot of these areas. It's not in our existing plans that we're a bit something that we really are looking for going forward, because there was a regulatory imbalance. And certainly, we offer a lot of these incumbents, the sort of their prices and availability in the U.K. that they don't offer, and it's about time we had a bit of that going up.

Michael Rake

The EU as well.

Ian Paul Livingston

Yes, and -- yes, absolutely.

Guy R. Peddy - Macquarie Research

It's Guy Peddy from Macquarie. Just a couple of quick questions, please. Firstly, on Infinity, by the sounds of it, you're obviously sort of discounting or subsidizing their product currently. So do the economics for the BT Group work without a wholesale -- a successful wholesale product? And secondly, a question for Gavin on BT Vision. Can you just give us a breakdown of what people are actually doing currently with BT Vision? I mean how many are watching premium channels, or what actually is the consumer doing?

Ian Paul Livingston

No, we're not subsidizing Infinity. Actually, we got a good ARPU uplift with Infinity. It's one of the -- people get a little bit confused between how we market the product, which is very clearly, we've set the prices linked to our option 2 and 3 broadband. But understand, we've actually got 3 levels of broadband, option 1. We don't have an option 1 Infinity as it were -- it's called option 1, but it's price is the same as option 2 broadband. So you get a really good mix change. Quite apart from the fact we expect to have significantly lower churn from Infinity. So it's -- and we're making -- we will make good money out of Infinity at retail levels. So no question about that. And the extra costs from Openreach, the vast majority, even before you get to the churn are actually covered by the higher ARPU that we achieve on Infinity. So I think the question is wrong from the start, to be honest. But Gavin, do you want to add anything -- add anything to that and also, what are people doing with Vision?

Gavin E. Patterson

I'm not sure there's much to add on the Infinity question. I think Ian's answered it. In terms of Vision, it's a multitude of things, to be honest. It's not a silver bullet, Guy, in that respect. What I would call out, Catch-up as a service is very, very popular be that on iPlayer, where I think the BBC would consider us to be one of the best, if not the best example of iPlayer deployment across the country. That's been very successful for us in the last 12 months. But also things like the movie services is continue to grow, particularly new releases. We've got a good selection there and added HD and 3D in the last 12 months, and those have proven popular. There is a significant group who take premium channels, like Sky Sports. We'd like it to be more. We'd like to broaden the offer by adding 3 and 4, as we were talking earlier. And as I look across the year ahead, I think the more we can weave linear and non-linear programming together, I think we'll begin to bring more and more competitive advantage to the service. So it's not going to come altogether, but if I look at the collection of Vision 2.0 with its better search and recommendation capabilities, if I look at YouView with its reverse integrated EPG, and then I look at multi-casting, where we'll be able to significantly increase the range of HD and SD channels that we offer, I think you're beginning to get a really, really strong offering that coupled with fiber, I think really ups our game and gives us something that is very, very competitive against cable and Sky.

Simon Weeden - Citigroup Inc, Research Division

It's Simon Weeden from Citigroup. A question first on the stock buyback, if I may. Just wondered whether or not the stock buyback you've announced is going to count against the agreement with the trustee about how much cash you distribute to shareholders over the next 3 years. And also whether you can give us the average exercised price for the options that you're seeking to count to the dilution of? Do you understand what I mean? And then second question, because that was only one. Balance sheet...

Ian Paul Livingston

It's not one at all. You've forgotten what the first one was.

Simon Weeden - Citigroup Inc, Research Division

BBB, BBB+, what was the standard credit metrics? What are you required to get that roughly, do you think, in terms of credit metrics against BBB+?

Ian Paul Livingston

Okay, I'll ask -- that definitely is 3. I'll ask Tony to talk about BBB+. In terms, the buyback, we're actually in agreement with the trustees, the buyback of shares related to employee shares schemes was excluded from the metrics. The average price of -- we've got an SEYE [ph] scheme that comes due, and that's going to be the majority of it, I think from our collection, 78p, 68p?

Anthony Everard Ashiantha Chanmugam

68p.

Ian Paul Livingston

68p, so. And the great thing is we'll have 20,000 employees who will, on average, as of today's share price, make a profit GBP 8,000, GBP 8,500 each. So a there's a lot of team members who will do really well, and I think that's a really good thing that they will share in the benefits. Tony, the BBB+.

Anthony Everard Ashiantha Chanmugam

Yes. The way the rating agencies work this, it tends to work on a ratio, a ratio of net debt to EBITDA. Incorporated in the net debt, so we've got GBP 9.1 billion in net debt, that -- bad debt is in operating leases, and that's, roughly speaking, about GBP 4.7 billion on the gross pension deficit, that's GBP 2.4 billion. That comes to GBP 16.2 billion. What they'll then do is look at the EBITDA number and then it will add back GBP 0.3 billion for the operating cost and the operating leases. That will get you to a ratio of around about 2.5:1. That's at the bottom end of the range that we're currently on. To get to a -- up one notch with this Baa1 or BBB+, you have to get that ratio near enough to 2:1. So if everything else stays equal, that would mean that you'd have to a debt number with the 6 in front of it.

Ian Paul Livingston

Any last question? Or are we -- 10:30 finish? Excellent. Great time then. Thanks very much, everyone. Thanks for your time, and have a very good rest of the week.

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Source: BT Group Management Discusses Q4 2012 Results - Earnings Call Transcript
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