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

Virgin Media (NASDAQ:VMED)

Q1 FY08 Earnings Call

May 08, 2008, 09:00 AM ET

Executives

Richard Williams - Director, IR

James F. Mooney - Chairman

Neil Berkett - CEO

Charles Gallagher - Sr. VP, Finance

Analysts

Mitch Resnick - Fortis Investment

David Gober - Morgan Stanley

Paul Howard - Cazenove

David Kestenbaum - Morgan Joseph & Co.

Stuart Stanley - Invesco

Operator

Good morning and good afternoon, ladies and gentlemen and welcome to the Q1 2008 Virgin Media Inc. Earnings Conference Call hosted by Richard Williams, IR Director. My name is Wendy and I'll be your coordinator for this conference. Throughout the presentation you will be on listen-only. However at the end of the call, there will be opportunity to ask any questions. [Operator Instructions].

I will now hand you over to Richard Williams to begin today's conference. Thank you.

Richard Williams – Director, Investor Relations

Thanks, Wendy. Good morning or afternoon to you all and welcome to Virgin Media's Q1 call. On today's call, we have Jim Mooney, our Chairman; Neil Berkett, our CEO and Charles Gallagher, our SVP, Finance. Please, can I draw your attention to the Safe Harbor statement on slide two and remind you that some of the statements made today may be forward-looking in nature and that actual results may vary significantly from these statements. I would also ask you to refer to our latest filings with the SEC for applicable risk factors.

Now I will turn over to Jim.

James F. Mooney - Chairman

Thanks, Richard. I’d just very briefly say that the Board and I are very pleased with the excellent and ongoing progress the team is delivering. Neil and his new management team have been very effectively focused on fixing the fundamentals, delivering on our key network advantages and building a solid growth platform. You can see this in reduced churn and you will hear about that today and strong RGU growth. Our ARPU has nicely stabilized, our broadband mix is improving and VOD continues to grow rapidly. This has driven our OCF and as we continue to drive RGU growth and the efficiencies throughout the business, we will see the benefit in cash flow growth. So, an excellent start to the year, we are very excited about the balance of 2008 and beyond. So to hear more about that, let me turn it quickly and immediately over to Neil Berkett, our CEO. Neil?

Neil Berkett - Chief Executive Officer

Thanks Jim, and thanks everybody for joining the call. I'm pleased to say that we've had a really solid Q1. We continue to make strong progress and build on the positive trends of the fourth quarter. I remind you our strategic priorities are the first to lead the next generation broadband market in speed and quality and hence move away from the commoditized DSO and secondly to lead and redefine the mid-market TV experience through our on-demand. We continue to make great progress on these in the first quarter.

Our 4 megabits to 10 megabits per second broadband upgrade program is underway and we plan to launch 50 megabit this year. And even more importantly, we are building a reputation of quality of service. We also significantly enhanced our TV offering with the launch of the BBC iPlayer. Broad usage remains strong and we expect the iPlayer launch will have a dual effect of boosting broad usage and freeing our peak-time capacity on our broadband platform.

In terms of operational progress, reducing churn remains one of our top priority and in Q1, this is down to the lowest level since 2004 at 1.2%. We have continued to effectively manage our back book using cross-sell and up-sell to mitigate pricing pressure. Over half of our customers are now triple-play and our top tier product mix continues to grow. Broadband growth continues to be strong and the percentage of subscribers on the current top 20 mid-tier continues also to grow Within Mobile, we're focusing on contract cost sell into our cable base. We saw strong net-adds this quarter, up 25% on the fourth quarter.

Our efforts to repair subscriber losses in telephony through smart pricing and bundle continue to deliver success and I'm pleased to say we had 29,000 on-net phone subs. That compares to a loss of 63,000 in the same quarter last year. As I've said before we are managing our long-term value and we are well on track to measurably grow the MPV of our customer base by January 1, 2009 compared to as it rolls on January 1, '08. Therefore giving us a greater impetus going into 2009. And finally we are benefiting from integration cost savings and broad cost savings across the base. We continue to focus on rightsizing our business and to get the right cost and organizational structure to position us for long-term cash flow growth.

So let's go into the detail on the next slide. RGU growth was 204,000 driven by strong performance in all products headed by broadband. Gross additions were relatively flat compared with Q1 last year and was seasonally down versus Q4. Our primary focus has been churn rather than gross adds. Therefore customer net additions of 5,000 are largely as a result of that reduced churn. This was achieved alongside the continuing success of increasing triple-play penetration, which has now increased a record of 51% with dual penetration over 80. As a footnote we disconnected 33,000 off-net RGUs they were on a now defunct ex-NTL billing platform and this has obviously affected the total RGU growth shown on the chart.

Moving on to churn, as you can see from the chart we have had a great quarter. Churn is 40 basis points lower than the same quarter last year, which is a great achievement, it's also 20 basis points lower than Q4 and is in fact the lowest since 2004. The biggest improvement has been in voluntary controllable churn. We've achieved this through improving the key touch points with our customers. The lack of a single fit-for-purpose billing system covering all of our customers had in the past impeded the quality of service provided. That is now largely behind us.

I have also restructured the organization to reinforce the importance of product reliability and first-time resolution. Both had quarterly [inaudible] and in-fill rates has measurably improved in the last year. The third element affecting voluntary churn is value for money, which we are successfully addressing through effective management about our backbook. Non-Pay Disconnects are also down, driven by improvements in our credit control processes and in our sales channels. Our network addresses around 50% of UK homes. Consequently, roughly one-third or 0.4% to Q1 churn was due to customers’ moving to a non-serviceable address. Stripping this out, our controllable annualized churn was less than 10%.

As you can see from the chart there is usually a seasonal increase in churn in the second and third quarters. The students come to the end of the academic year and we are impacted by general increase in house moves over the summer. The typical Q1 to Q2 increase in churn is around 20 basis points. Targeting churn remains my number one operational objective and reducing it is the biggest driver of value in this business. Churn reductions improve margin and value. So reducing churn in 2008 compared to 2007 should give us a greater growth impetus going into 2009.

Moving on to ARPU, which is now more stable than a few quarters ago. First quarter ARPU was down slightly on Q4, which is included about 20p of seasonally higher phone usage and pay-per-view revenue which did not occur in Q1 as we signaled. The reminder is because of customer shifting to lower price bundles as we work through our backbook. We were able to offset this, the impact of this by encouraging customers to take more products or upgrade to the next tier of service. Our success is clear from improving triple-play penetration and improve TMX. As I said last quarter, we are managing a long-term value not just ARPU. This means that ARPU would not necessarily increase every quarter, it will go up and it will go down some quarters as we manage the backbook and other impacts. What is important is that we are being more affected in managing the underlying value of our customer base and hence creating value.

I have been very pleased with the ARPU performance over the last two quarters as we got more effective of managing the backbook and as the competitive environment is stable. The year-on-year decline in ARPU has hence slowed. This is very encouraging and we continue to target roughly stable ARPU for the rest of 2008. Obviously, reduced churn has been the bigger driver of long-term value in the last couple of quarters. As promised, we are on track to measurably grow the MPV of our customer base by January 1 '09 compared to January 1 '08. Therefore giving us a greater growth impetus going into 2009. Now that we have radically improved both churn and the customer proposition and we believe that the competitive environment is more stable, we feel that we can pass through some price increases.

We have made significant investments to differentiate our TV and broadband products, our unique VOD offering has been substantially enhanced over the past year, and the addition of Setanta Sports as well as broadband speed increases provide better value for money for our customers. This allows us to increase the price of our bundles by 1 pound and our extra large TV by 1 pound 50. These price rises would take effect from the June 1, so you anticipate the full benefit in the third quarter. These price changes were communicated to customers of the start of April and so far we have seen no significant churn impact.

So, let me turn to Broadband. As with customer growth, broadband gross adds were seasonally lower than in Q4, which explains the sequential decline in net adds. We added 88,000 on-net customers in the quarter, which is at a similar level to that of last year. However, we believe that we have taken an increased share of net adds and more importantly that the tier mix has improved. We now have 80% more subscribers on the top tier compared to a year ago. This is being driven by our 20-megabit upgrade as well as our improved focus on up-sell. More and more customers are joining us, because they want the high adds and most reliable speed available. Our current mid-tier upgrade from 4 meg to 10 meg and our 50 megabit launched later this year will help improve further and drive improved tier mix. We are building a reputation for quality and deliver a high proportion of the advertised speed versus DSL. We regularly come top of speed site surveys such the one that was carried out in March by Broadband Choices and Broadband Expert. We specifically look at the delivered speed versus the headline speed.

On my next slide, I will talk a little bit more about broadband advantage. We live in a world where there was an ever-increasing demand for bandwidth. This is being driven by the availability of video and audio streaming sites such as iPlayer and iTunes. The explosion in the use of social networking sites such as MySpace, Vivo and bandwidth using devices in the home such as gaming, consoles, laptops, second PCs have also contributed to this phenomenon. As you can see from the slide, our usage has been growing sharply driven by this. Our average usage per customer is 8 gigs per month. This is about 70% increase since February last year. I think Carphone and Sky have quoted a figure of round about 3. So, we can see that our customers are taking advantage of our greater speeds and quality to do more with their broadband service. You provide it, they take it.

In this world, our ability to promise and more importantly delivered higher speeds at peak times becomes a key differentiator compared with competing technologies. Because our network is more able to provide higher speed and higher quality, our average peak usage is about 44 kilobits, which is double that of Carphone Warehouse. BT's copper infrastructure and distance from the exchange means that even after billions of pounds of investment in 21CN, only half UK households will be able to receive at least 6 megabits to 9 megabits per second via ADSL2+ and only 10% will be able to get at least 12 megabits to 16 megabits.

In addition, due to capacity constraints, many DSL competitors have to deploy extreme traffic shaping measures and throttle back speed at peak times. To offer faster broadband, further significant and arguably prohibitive investment in fiber-to-the-curb is required by the DSL operators. Wireless broadband has its own speed and quality challenges. Coverage is not universal. It is dependent on the 3G Network and as with your mobile phone even within the coverage area, its service is not guaranteed. Mobile broadband is not a perfect substitute for fixed-line broadband. As broadband requirements grow both usage and speed limit become key constraints. This is of course the segment of the market with low usage requirements we made value portability over speed and usage. But we firmly believe that this is a complimentary service to fixed-line broadband. Of course, we could offer this ourselves through our own Mobile division for those who wish to access broadband on the move and indeed we are looking at this option.

There has been a lot written about future wireless broadband developments recently following the 4G spectrum sales in the US. The suggestions that theoretical download speeds of 100 megabits per second and upload speeds 50 may be achievable with Mobile LTE, long-term evolution. In reality, there are significant network and cost implications of deploying this technology. It requires new base station technology in the excess layer and a move to an all IP core, both of which entail significant upfront cost. In addition, running costs would be higher as more power would be needed to run the network. It is likely that realistic speed based on cell congestion and back-haul capacity will not be anywhere near this.

We already have a next-generation core and access network with the capability of offering super fast broadband. By the end of the year, Virgin Media will offer 2, 10, 20, and 50 megabits per second. This will reinforce our speed advantage. A relatively modest investment in customer equipment and CMTS ports for channel bonding is required to do this and is included in our current CapEx guidance. During 2007, we increased our access network capacity by 25% and in Q1 alone we have increased it by another 15%. This has all been done within our existing modest CapEx levels, which are in line with our guidance.

Next year, our 20 megabit and 50 megabit customer will move to the DOCSIS 3 platform. This will significantly improve the quality of service provided to all our broadband customers. At the 2-megabit and 10 megabit customers will have more bandwidth specifically dedicated to them. This will help us push real world delivery speeds as close as possible to their advertised headline speed. We currently only use two 8-megahertz channels to serve all our broadband customers. The DOCSIS 3, this will be tripled. Each additional channel will be freed up by switching off a single analog channel. Clearly, it will not be long before we're in a position to switch off analog completely and this will free up significant bandwidth at even higher broadband speeds. We could easily provide 100 megabit per second if we chose to do so. We have a huge broadband advantage over competing technology for speed, quality, reliability, and cost. Within our existing network and analog switch off, it's an advantage we will maintain for many years to come.

So moving on to TV, where we had another great quarter. TV net ads remained strong, we focused our acquisition efforts on our higher-end tiers and we continue to see a mix shift to our extra large TV, which now makes up around 50% of our digital base. We are seeing the benefit of the market changing continent initiatives that we've undertaken to differentiate our pay-TV service. Our key points of difference are our unique on-demand service, inclusion of premium sports contents in our top basic TV package, and our market-leading DVR V+. We had our strongest quarter ever for DVR growth with a 102,000 net adds. Our research shows that DVR customers churn less than other customers. Even with such strong growth, we still only penetrated 11% of our digital base, so we feel there is still a huge growth opportunity here.

Finally, we are seeing increased usage of our video-on-demand service demonstrating that the steady transformation and the way people watch and interact with their TV is continuing unabated. Monthly views have grown to 36 million in the quarter. This is whopping 150% increase over a year ago and a 10% increase over the previous quarter. The services used regularly by 48% of our digital base and average views per user per month have grown to 24 compared to only 11 a year ago. Our huge library of content and the quality of service are not easily replicable and we believe this is playing an important role in both customer retention and acquisition.

Lastly, BBC iPlayer was added to our VOD service. This service carries BBC programming from the previous seven days. That's around 350 hours of content. Developments like this give VOD a new impetus and help establish on-demand as a genuinely mainstream TV service. iPlayer has been heavily promoted on the BBC channel as a PC service. It is so popular that, it is one of the major factors of increasing bandwidth demand here in the U.K. Being able to offer this on our dedicated on-demand digital TV platform is a huge advantage for us compared to our DSL competitors, who do not own their own network and who are suffering the cost and performance consequences of this type of bandwidth hungry content. With our super fast fiber-optic broadband service and our market-leading VOD service, we are best placed to benefit from the consumers increasing consumption of on-demand content.

Now turning to Mobile, starting with contract. Our strategy here is to use our favorable economics to cross-sell into our cable base and we’ve had a very successful quarter with an improvement in net adds of 59,000. This is just less than 10% of our overall market… in terms of market share. The overall mix of customer... contract customers is growing significantly from 2% to 10% since the mobile acquisition and we are focused on growing this much further. Contract is an important element of our proposition allowing us to offer appealing bundles to our customers at low acquisition cost. The churn profile also improves as the number of products taken by our cable customers increases. Contract customers have much lower churn and higher ARPU than prepaid customers. This means that the lifetime value of our contract customer is about three times higher than a prepaid customer. And the lifetime value of a cable customer is about six times higher than that of a pure contract mobile customer. So you can see why we want to focus on contract within mobile and why we want to use mobile contracts as an attractive products for a cable customers.

Moving to Prepay, where our base has been affected by increased market competition. We've seen an increase in churn resulting in a 128,000 net disconnects during the quarter. We've also seen an overall decline in usage, which has negatively impact service revenue and overall mobile ARPU. Under the leadership of Mark Schweitzer, our Chief Commercial Officer and Graeme Oxby, our Mobile MD, we are putting in place a range of initiatives to address prepay shared and stimulate prepay usage. Mark and Graeme both joined us towards the end of last year and have significant mobile experience from their time at Sprint and 3 respectively. We are able to successfully address similar issues. We are making prepay tariff adjustments to address market competitiveness and grow ARPU.

We are also identifying at risk customers and approaching inactive customers earlier with offers such as our new daily bonus tariff to reengage and retain them. We know that cheap handset prices also lead to early inactivity so we will be increasing these upfront costs. Our focus on profitable acquisitions, which will result in a more aggressive push behind sim-only offers and an increased channel mix to shift to Virgin managed channels away from the third-party distribution where commissions are significantly higher. The combined impact of these initiatives should help us slow the decline in our prepay base and help us to restore mobile OCF.

Now turning to business, as you can see revenue was $161 million, down 1% year-on-year due mainly to lower voice and wholesale revenue. Consistent with our strategy, we continue to see a mix shift in retail revenue from voice to data. Retail data is up 9% year-on-year and we expect further growth in this area in 2008 compared with 2007. Retail other revenue is lumpy in nature and the majority of our current project revenue is from our LAN solutions infrastructure contract at Heathrow’s airport new terminal five. This contract will finish in Q2 '08 and we see… and will see a reduction in this category through 2008. However, this contract has an extremely low margin, so we did not foresee any material impact on OCF. Wholesale revenue was flat compared to the previous quarter, but we anticipate that this will fall in '08 due to continued reductions in our ISP subscriber base and contract decline in mobile accounts. As a result of all of this, it is likely that total business revenue will fall in 2008, although we expect the important retail data revenue line to increase and provide impetus for growth in 2009.

Now, turning to the Content division. The MTV revenue was up 4% sequentially due to the increased advertising revenues. Revenue was down 3% on Q1 last year relating to the loss of rights revenue from our Minotaur licensing business, which we sold in July of 2007. As expected, sit-up was seasonally down on the previous quarter, the revenue growth was up 7% compared to the same quarter last year, which is a strong performance in a competitive market. Content OCF was 5 million pounds. As expected, this was higher than in Q4 due to the seasonally lower programming costs partially offset by seasonal decline as sit-up. As compared to Q1 '07, OCF was down $7 million. This is mainly because Q1 OCF… Q1 '07 OCF benefited from the settlement of a legal claim.

Let me now hand over to Charles to run through the financials before I return to summarize. Charles?

Charles Gallagher – Senior Vice President, Finance

Thanks, Neil. Let me start with the summary income statement during Q1, 2008 versus Q4 and Q1 2007. As you can see, revenue was down 2% on the same quarter of last year generally due to the decline in consumer and then sequentially for mainly seasonal reasons driven primarily by our sales division. Operating costs were up 2% on the same quarter last year, mainly due to higher mobile handset costs and VMTV programming costs. Again this was done sequentially, mainly for seasonal reasons. SG&A was down by 19% on the same quarter last year mainly due to reduced branding and marketing expenses and integration cost savings. Integration cost savings also contributed to the 9% decline quarter-on-quarter. This resulted in OCF of 324 million pounds in the quarter, up 6% year-on-year and represents an OCF margin of 32%. Margin has increased by over two percentage points since the same quarter last year.

Our accrued CapEx on the quarter was 137 million pounds or 13.7% of revenues. We expect that accrued CapEx for the full year will fall within our previous guidance of 13% to 15% of revenues. I also showed cash CapEx on the slide of 125 million pounds. Last year, cash CapEx was around 40 million pounds lower than the current figure just the use of finance leases. We expect that cash CapEx will be lower than accrued CapEx this year for the same reasons.

Turning to my slide, you can see the revenue split between the segments. Consumer revenue is down 3% year-on-year as a result of the very competitive pricing environment that affected us in the first half of 2007. It is important to note however that this revenue decline has slowed as the competitive environment has stabilized and as we have become more effective of backbook migration and improved our up-sell and cross-sell propositions. Year-on-year consumer revenues declined, peaked at 5.4% back in the third quarter of last year. As you can see, the sequential decline this quarter was only 4 million pounds. This is a result of returning to modest growth of high-quality customers and stabilizing the ARPU within a narrow range. Again it was a good revenue growth platform for 2009 and beyond. As you have heard from Neil a moment ago, business revenues has been slightly down with annual declines in wholesale voice partially offset by growth in retail data.

Mobile revenue is flat year-on-year as growth in contract mix with higher ARPU values has been offset by increased prepay churn and declining usage. The sequential decline is primarily done through prepay [inaudible] and Neil has outlined the steps we are taking to address those. VMTV has been relatively flat. The decline in revenue from Sky satellite platform that occurred in Q1 '07 has not been in numbers over a year and thus is in the year-on-year comparisons. Finally, sit-up has seasonally done up their strong fourth quarter, was also showing good annual growth of 7% due to the strong selling volumes.

Turning now to costs where we can see some encouraging trends. Operating costs were down sequentially by 32 million pounds due mainly to seasonally VMTV programming costs and lower sit-up cost of sales. Operating costs were up year-on-year due to the higher handset volumes in Virgin Mobile and higher VMTV programming costs due to the launch of Virgin 1 in Q4. SG&A is down by 50 million pounds compared to the same quarter last year. Q1 '07 had included branding and marketing expenses associated with the launch of the Virgin Media brand. We have also continued to achieve cost savings resulting from the merger and integration and you can see that in a sequential movement. The result is that SG&A was just 22% of revenue compared to 26% of revenue a year ago.

In the second quarter, we expect to make a modest investment in SG&A. We have decided to increase our consumer marketing expense, another way of achieving… getting our churn down to more accessible levels. This focuses around TV campaign featuring Samuel L Jackson, the promoter video-on-demand service. We will, of course continue our focus on only adding high value customers in our RGUs.

On my final slide, our debt position as of the end of the quarter and on a pro forma basis is of our recent convertible bond issue was in place at the quarter end. As you know in April we issued the $1 billion convertible bond and we used the proceeds to prepay some of our outstanding bank debt. As a result we do not have any material bank repayments till now until March of 2010. As you can see pro forma growth debt is 6 billion pounds and 271 million pounds of pro forma cash, net debt is 5.7 billion pounds or 4.4 times annualized OCF. As a result of the convertible issue, a coupon of 6.5% our weighted-average cost of debt is reduced slightly to 7.9%.

At this point, let me hand you back to Neil to wrap up before we take your question. Neil?

Neil Berkett - Chief Executive Officer

Thanks Charles. So let me summarize with this final slide. You can see from the results, the last couple of quarters that our disciplined focus on execution is bearing results and driving improved fundamentals. In particular, we focused on driving down churns for a range of operational improvements. It is now at it's lowest for four years. We have been effectively managing our backbook pricing issues through improved cross-sell and up-sell. As a result, we've seen RPU begin to stabilize and position ourselves to return to revenue growth. And we've seen the benefits of integration cost savings come through and start to drive improvements in our bottom line. We have an amazing asset in our network, which we are focused on exploiting. We've a clear technical advantage and an economic advantage in the broadband and on-demand space alongside our obvious economic advantage of owning and running our own network.

Growing consumer demand for bandwidth quality and on-demand consumption is clearly playing to our strength. The competitive environment is more stable and it has been for some time as the market pricing changes have now been in the market for one to two years. We feel comfortable enough with the competitive environment and the strength of our brand and our products that we are raising prices in the second half of the year. Finally, we’ve some attractive hidden assets, which we feel are often overlooked and undervalued, specifically, our content, business and tax assets. So we're pleased with how 2008 has begun and our prospects for the future.

And with that we'd be happy to take your questions. Back to you, operator.

Question and Answer

Operator

Thank you. [Operator Instructions]. Our first question comes through from Mitch Resnick [ph] from Fortis Investment. Please go ahead.

Mitch Resnick - Fortis Investment

Thank you very much. Good afternoon. Just a question regarding slide five, regarding the 3,000 disconnects from NTL, was that one-time in nature?

Neil Berkett - Chief Executive Officer

Yes, was Mitch, it was due to our billing migrations. So that was absolutely a one-time.

Mitch Resnick - Fortis Investment

And the customer net ads, is that net of the loss from the prepaid customers on the mobile side.

Neil Berkett - Chief Executive Officer

The customer net ads of 5,000 is [inaudible] only it also excludes contract mobile services. It doesn't include mobile at all.

Mitch Resnick - Fortis Investment

Okay. And then just a question on the... on the Content business. Your... can you clarify your ability to sell your participation in the joint-venture with them, the BBC. Are you able to sell that through free and clear?

Neil Berkett - Chief Executive Officer

If we were so disposed there are no obstacles to such a position.

Mitch Resnick - Fortis Investment

And if that... if you chose to go down the route, can you clarify what your priorities would be... in terms of uses of cash?

Neil Berkett - Chief Executive Officer

I think I will just stop it at the back. Sorry, Mitch.

Mitch Resnick - Fortis Investment

All right, I have to ask. And then just the one last question on the business side, regarding the decline in total revenue, it sounds like your data is, the data side is improving in difference of declines in voice, which leads to an overall lower revenue, but can you talk about what the margin differences between the data side of that versus the voice side? So for example, you are losing revenue, how will that effect...

Neil Berkett - Chief Executive Officer

No, in terms of the transition, we are reasonably margin neutral, and you'll see that growth in broadband continue. We've just invested, you know, to increase the sales force by approximately 20% in the business area. We're really very comfortable with the position we hold in terms of retail data in particular. So we're looking forward to seeing that number continue to grow.

Mitch Resnick - Fortis Investment

Okay, that's all from me. Thank you very much.

Neil Berkett - Chief Executive Officer

Thanks Mitch.

Operator

Thank you. Our next question comes through from David Gober from Morgan Stanley. Please go ahead.

David Gober - Morgan Stanley

Thanks, guys, good morning.

Neil Berkett - Chief Executive Officer

Good morning.

David Gober - Morgan Stanley

I was just wondering if you guys could talk a little bit more about the competitive environment and kind of the promotional environment. We notice that obviously your churn was very good this quarter, but it was also accompanied by much lower spending, or what seem to be much lower spending on marketing and additionally it seems that there was lower churn throughout the pay TV industry in general on the first quarter. Has there been a substantial decline in promotional activity or has there been any change in move trends over the last quarter?

Neil Berkett - Chief Executive Officer

From a competitive point of view, let me just work our way through that David. From a competitive point of view, I think you're starting to see some stability around pricing. I don't think anybody is holding back from a promotional point of view, but certainly there's a lot more stability which is one of the reasons that you're seeing an overall reduction in churn. Our improvements in churn relative to the market though, as you quite rightly pointed out quite marked. So, we do see us taking quite a substantial benefit from that going forward. If you were... if you take off the move as element, which we sized about 40 basis points, we are well below the 1% mark, well below in fact, 10% mark on an annual basis.

David Gober - Morgan Stanley

Okay, thank you.

Operator

Our next question comes from Paul Howard from Cazenove. Please go ahead.

Paul Howard - Cazenove

Thank you for that. Couple of questions. Firstly just on the backbook, I think you sort of, I have asked this perhaps before but how far do you think you're now through that and when does it stop being a drag on consumer revenue?

Neil Berkett - Chief Executive Officer

Position is unchanged, we're on target in terms of moving our way through that. We will be always said that we felt that we would, we would end up with some, normal incumbent pricing, backbook pricing by the end of the year but the effect of drag on ARPU would be finished by the end of 2008.

Paul Howard - Cazenove

Okay. And then just some questions around broadband and speed, you've obviously explained very clearly the advantage, you think you have in the access network, is there any pressure now on the core network in terms of the amount of bandwidth that's driving through that now, any increased CapEx associated with that? And secondly associated with that given the various regulatory and government reviews of next generation access, do you see any increased risk of you being forced to open up your access network?

Neil Berkett - Chief Executive Officer

In respect to the first one, Paul, no, we are quite comfortable with the capital guidance that we've given, whether that is a need to invest in the core or in the access. As I pointed out, we've managed to increase capacity in the access quarter substantially and as Charles pointed out well within our capital guidance, I see no concerns there. In respect to the regulatory position, obviously there is a range of discussions going on at the moment. My general feeling is that in our position with the regulators is NGA is still an untested market, it’s not defined as a separate market from the overall broadband market. If at some point in time we have, substantially capitalized on that position and we need to think about ourselves, actually, alternate revenue streams through wholesales, and I'm sure we'd explore that, but at this stage, I don't see change in the regulatory framework.

Paul Howard - Cazenove

Okay. Thank you.

Operator

Thank you. Our next question comes from Stuart Gordon [ph] from Merrill Lynch. Please go ahead.

Unidentified Analyst

Yeah, hi. A little bit of it was just covered there, I mean obviously with due respect to networks growth story for cable and Virgin Media as well saw then, but we still can't escape from customer numbers are not really doing much year-on-year, RGUs while it was increasing, it looks as if they're being given away to prevent churn and your revenues are still down if we add back re-branding OCF, the growth is down despite good synergy extraction. Can you give us a little bit of a play on the outlook in terms of when you can really expect this to start rebounding? I mean, clearly the UK is very competitive. But if we look across the Netherlands, it remains a very competitive market, and there was fairly impressive OCF growth from one of the cable operators there overnight? Thanks.

Neil Berkett - Chief Executive Officer

Stuart, let me just try and work my way through your series of segments there. Historically, over the last couple of years, UK cable has focused on the mergers that created Virgin Media was not in a position to grow its overall customer values and in fact, as we've seen in the competitors [ph] going back, RGU growth was modest to say the least. And that performance was principally driven by churn. Hence, number one priority, drive down churn. We've achieved that. I'm actually very, very pleased with that achievement and I think the market generally is appreciative both the efforts of the management team has made in that regard. There is absolutely no point whatsoever in aggressively going for gross ads when you are stabilizing your platform, when you're improving the level of service you got and as you start to differentiate ourselves across the board. And what we have outlined in terms of our broad guidance for 2008 is one of stabilizing that position. I repeat, we are on target for that. And are now gone on record for three consecutive quarters where I had said we are on target with the combination of ARPU, RGU and churn to provide a greater value of the annuity stream at the end of '08 than we had at the beginning of ‘08. Hence we will see revenue growth. I do not anticipate substantial movements from the overall operational statistics that we performed in the first quarter around our net ads position. I would not see that occurring until moving into 2009 when we really start to put our foot on the schedule. In respect to OCF growth, this is the strongest underlying OCF performance that you have seen from Virgin Media or NTL Telewest. So I'll just hand over to Charles and he'll pick that up in terms of both the movement around our costs and also the underlying position from gross margin.

Unidentified Analyst

Okay, thanks.

Charles Gallagher - Senior Vice President, Finance

Yes, really, to both of those points, as I said in my comments, the rate of erosion of both the revenue and the margin is slowing quite dramatically. We expect to see that improve continually throughout the rest of the year. So as that pressure year-on-year continues to get better and we continue to see the benefits from an SG&A perspective, obviously some of that improvement year-on-year was just a branding, but it was certainly not all of the 50 million pounds and SG&A margin of 21.7%, we've really made dramatic improvements there. So, there is a combination of the slow down of the erosion of price, the working off of the backbook, the turns to positive customer growth, albeit a modest in the last couple of quarters, all contributes to a much healthier outlook for our OCF than it has been any point in the near future, recent past I should say.

Unidentified Analyst

Yes, okay. Then I appreciate that, I appreciate what you've done over the course I think as you've highlighted it's very much down to when you can take in the customer growth. Thanks.

Charles Gallagher - Senior Vice President, Finance

Yes

Operator

Thank you. Our next question comes from Mark Valen [ph] from Henderson . Please go ahead.

Unidentified Analyst

Okay, just had a couple of questions. First one was just on the churn numbers. I guess my sense was that earlier this question about kind of getting that number below 10%, just wanted to kind of confirm that that's what you're looking to kind of hit on a long-term basis. The other question was about the video demand piece of the business, just in terms of the effect on ARPU there at the end of the day, is that ultimately going to have an effect on ARPU or isn’t that not part of the plan to kind of generate increases in ARPU. All right. Thank you.

Neil Berkett - Chief Executive Officer

Cheers Mark. On churn, obviously we don't give guidance on the churn. I was pointing out the element of our 1.2% monthly churn in the quarter that was impacted by movers, obviously covering 50% of the homes, which was 40 basis points. The standalone Telewest, I think had the best churn performance at 1.1% a month and that was in quite a different environment. So, you know, my objective now is to stabilize the business at this level of churn before we see… before we see an improvement perhaps going forward. I also would have highlighted obviously the seasonal impact in the second and third quarters, which will see an increase. In terms of VOD, VOD absolutely has an impact on ARPU. VOD is... the way we look at VOD is not in a transactional way but in a subscription way. The economic models of VOD is a fixed cost model. And therefore you need to drive a fixed revenue i.e. subscription revenue to match your revenue on cost play. Obviously, it is a little bit of transactional in the type of view. So, we embed VOD in our tiering [ph]. It’s being one of the major reasons that we've been successful in 50% of our TV-base being at the extra large or our upper tier and clearly there is a quite nice ARPU differential between medium, large and extra large. So, it’s principle play in respect to VOD is in driving tier subscription rather than in what is quite modest in terms of pay-per-view. And obviously VOD’s role advertise in the churn stakes as well as we’ve spoken about.

Unidentified Analyst

Just one other question on the prepaid part of the business, just in terms of your sort of future view for where that part of the business is going to go?

Neil Berkett - Chief Executive Officer

Look I think prepay is obviously a key part of cash. I went out and spoke about obviously MPV of a prepay pound versus that of a contract versus that of a home, but it will continue to be an important part of our business. We're starting to look at prepay into the home in a similar, but lesser way than we run with contract. I'm quite comfortable that Mark and Graham and the team have all ready instigated a lot of the actions to correct the position that we saw in the first quarter. So I would look forward to better set the results in the second and certainly the third quarter of this year. But our focus in the mobile space is very much in growing contract and growing contract into the home. The first stage of that is clearly an economic proposition for both us and the customer. Second stage is, we would see some, some tariff convergence in terms of, you know, 500 minutes take it anyway you like, fixed or mobile. And ultimately obviously the mobile becomes the screen and you’re remote to the Internet and we're going to be well positioned from that. So, as we continue to grow contract mobile, circa 60,000 this quarter, we'll have a very nice population of customers over 400,000 now that have both the mobile and the fixed line from us. Over 90% of our contract mobile is sold into the home. So that's absolutely our focus Mark, but clearly we can't take our eye off the cash flow of prepay.

Unidentified Analyst

Great. Thank you very much.

Operator

Thank you. There are no further questions at this time. [Operator Instructions].I have a follow-up question from Mitch Resnick from Fortis. Please go ahead.

Mitch Resnick - Fortis Investment

Hi, I'm not sure you'll be able to answer this question but I got to ask it anyway. Are there any segments or groups within your segment that you would describe as sort of non-core... non-core operations, but then how about less than core?

Neil Berkett - Chief Executive Officer

Now, we have outlined out and where we see our assets the objective of doing so. So that people can take an independent view of some of the parts. But we clearly run a business with the assets as we present them.

Mitch Resnick - Fortis Investment

Okay. Fantastic. Thank you.

Operator

Thank you.

Neil Berkett - Chief Executive Officer

And operator is there any other questions.

Operator

I do have four more have come through now. Would you like to go ahead with those?

Neil Berkett - Chief Executive Officer

Yes, we would do those. Thanks

Operator

Over next one comes from the line of David Kestenbaum from Morgan Joseph. Please go ahead.

David Kestenbaum - Morgan Joseph & Co.

Okay. Thanks. Can you just talk about the off-net strategy where that's going forward, as you lost subs this quarter just because of the write-offs, but is the business profitable at this point or where do you plan to take it? Thanks.

Neil Berkett - Chief Executive Officer

Yes, business is profitable, it will become even more profitable as we take out circa 350,000 of net subs onto SMPF and the cable and wireless wholesaling. So we will be doing that through the summer, we will also be launching our wholesale alignment through this summer, so that our beyond cable proposition would be a triple play mobile, our wholesale line rental and broadband. As we said in the third quarter of last year, we de-emphasize off-net as a strategy not because it's not important, it is just that we felt for a high period of time, there was a greater return by investing in and leveraging our superior network on net. As you will see it, as we through the balance of 2008 start to readdress where we go on off-net, we've made no decisions in terms of whether we would restart an IP TV build but that is clearly a possibility. So, hopefully you are seeing under the new leadership team here are an absolute focus on delivering those areas of the business and those areas of strategy where we have an advantage. Off-net has a place. And I think you will see us move more aggressively in this space in 2009 once we have done sort of upgrade we’ve spoken about.

David Kestenbaum - Morgan Joseph & Co.

Okay. Thank you.

Operator

Thank you. Our next question comes through from Tom Keegan [ph] from Collins Stewart. Please go ahead.

Unidentified Analyst

Great. Thank you very much. I guess the first question is on the UK broadband market. Sky added about 230,000 subs, you added a good number as well. Where do you think, you're taking share from, is this from other broadband providers, is it from… how much of it is from dial-up and how much if any are from any new years or so, then I have a follow-up? Thanks.

Neil Berkett - Chief Executive Officer

Sure. We are tending to take market share now and taking revenue share. I think it is going to become quite blurred in the overall RGUs as you look at the UK broadband market. Bottom tier, which is by far the majority of DSL, i.e. up to 8 meg is completely commoditized. Sky gave it away and therefore it is an RGU, it’s not an RGU. As I said earlier, we have had an 80% growth in our 20-megabit tier. So, we will absolutely concentrate on taking the value position in terms of our overall broadband. I couldn't really comment on any of our competitors' performance given that really in a quite a different marketing position and different product.

Unidentified Analyst

And then just secondly, what do you think the impact might if any on the announcement this morning about Best Buy and Carphone Warehouse?

Neil Berkett - Chief Executive Officer

I think there is analyst call on now, you probably better off asking, they are going to do with the money.

Unidentified Analyst

I just meant, what do you think it doesn't… what impact it may have on the marketplace, that if any on you guys?

Neil Berkett - Chief Executive Officer

Look. The Carphone’s retail strategy is pretty public on moving more and more into being a seller of range of digital services, they are an important distribution channel for us. So any strengthening of that position would be to our advantage. Everybody seems to think they are going to invest that and have stated that they’ll invest some of those proceedings in their fixed line network. If that is a consolidation play, again that’s nothing new. We would expect there to be a consolidation play within the resellers. [inaudible] is clearly in play as we speak. So, we don't see the today's news as being of major consequence to…

Unidentified Analyst

Great. Thank you.

Neil Berkett - Chief Executive Officer

Okay. Cheers Tom.

Operator

Thank you. Our next question comes from Stuart Stanley [ph] from Invesco. Please go ahead.

Stuart Stanley - Invesco

Okay. Thank you. Just one question, I've got here out of two. Just on your interest rate, it looks like your interest charges are going up quarter-on-quarter almost to the same level as your CapEx. So somewhat substantial there will be your EBITDA. What kind of measures are you taking to reduce your interest, was that part of the rationale for you to convert and then also what percent of your debt is fixed? And you're suffering then from the higher LIBOR charges?

Charles Gallagher - Senior Vice President, Finance

Yes. We are just looking through the information here. So we don't believe the interest expenses are actually going up substantially quarter-on-quarter but I'm sorry could you just run through the second part of question again?

Stuart Stanley - Invesco

Well, are you suffering, are you seeing higher LIBOR charges on your… whatever bank that you have that might be floating. What part of your bank that is indeed floating versus fixed?

Charles Gallagher - Senior Vice President, Finance

Yes. If you obviously can see it from the schedule of '08 in the deck today the senior credit facility A,B and C all are LIBOR plus rates, which are obviously subject to market fluctuation. The senior notes and the convertible notes are all fixed anywhere from 9.8 to 6.5. The interest expense line that we're looking at is actually $123.4 million in the first quarter, which is down from the fourth quarter of $139.7 million. Obviously that's subject to fluctuation time from the period to period but it is not increasing dramatically and we don't expect it to an point in the future.

Stuart Stanley - Invesco

So the year-on-year increase is, what, due to what then?

Richard Williams - Director, Investor Relations

There is a small year-on-year increase because today's small refinancing during 2007. So we did see a slight increase in the cost of interest on some of [inaudible]. But that was in April, May last year.

Stuart Stanley - Invesco

Okay. This is certainly different, the Tiscali assets, were part of the Virgin is reported be interested in those assets, is that correct?

Neil Berkett - Chief Executive Officer

Stuart, I wouldn't.. it wouldn’t be appropriate for me to comment on that.

Stuart Stanley - Invesco

Okay. Okay. Thanks for that.

Neil Berkett - Chief Executive Officer

Okay, Operator, I think we have time for one last question.

Operator

Thank you. Then our final question comes through from Sandy Bruce [ph] from Commerce Bank. Please go ahead.

Unidentified Analyst

Yes. Good afternoon. I just wondered if you can give us some kind of up date on the ongoing dispute with Sky in terms of the channels, Sky One and Sky Sports News which you have not been that customers and not been able to receive for a while.

Neil Berkett - Chief Executive Officer

Yes. Sandy, the doors are repeatedly opened at Sky they keep saying and they are here. We've had dialog from time to time but as of today, we still have no conclusion. So there is no real new news at all to report.

Unidentified Analyst

Okay. Fair enough. Okay. Thanks.

Neil Berkett - Chief Executive Officer

Okay. Thank you very much everybody and thanks for your support.

Operator

Ladies and gentlemen, thank you for joining today's conference. You may now replace your handset.

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

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

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

Source: Virgin Media, Inc. Q1 2008 Earnings Call Transcript
This Transcript
All Transcripts