Virgin Media, Inc. Q2 2008 Earnings Call Transcript

| About: Virgin Media (VMED)

Virgin Media, Inc. (NASDAQ:VMED)

Q2 FY08 Earnings Call

August 7, 2008, 9:00 AM ET


Richard Williams - Director of IR

Neil Berkett - CEO

Charles K. Gallagher - Sr. VP of Finance


Wilton Fry - Merrill Lynch

Jerry Dellis - J.P. Morgan

David Gober - Morgan Stanley

Matthew Walker - Lehman Brothers

Richard Williams - Director of Investor Relations

Good morning or afternoon to you all and welcome to Virgin Media's Q2 Results Call. On today's call, we have Neil Berkett, our CEO; Charles Gallagher, our Senior Vice President of Finance; and Jim Mooney, our Chairman.

Please can I draw your attention to the Safe Harbor statements on slide two, and remind you that some of the statements made today maybe 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'll turn to you over to Neil.

Neil Berkett - Chief Executive Officer

Thanks Richard and thanks everybody for joining the call. I'm pleased to say again that we have delivered another solid set of results.

Let's start by looking at some of the key improvements compared to a year ago. We've delivered our best ever underlying OCF of ₤330 million, which is up 6% year-on-year. SG&A is down 9% year-on-year.

Our actual Unite ends [ph] are up a 132% and as promised, we've kept churn low at 1.3% which is down 50 basis points in the last 12 months. In fact, slightly better than we expected it to be. Triple-play is now at a record 53%, that's up 8 percentage points up on this time last year. We are also the only major broadband provider in the U.K. to grow net ads compared to the same quarter last year. We've grown our broadband base by 11% over the year. More importantly, we've grown our 20 megabit top tier by 82%.

Our video on demand usage has virtually doubled at a 92% year-on-year growth. And we've grown mobile contracts that brought subscribers by 64%. So let's also look at our strategic progress and how that fits in with our role operational progress.

Our strategic priorities are firstly to lead the next generation broadband market and speeding quality. And lead and redefine the TV experience through our on demand platform.

Thirdly, to leverage our position to mobile as the third screen. We continued to make progress... great progress in quarter two at 4 to 10 megabit broadband upgrade program is now 70% complete and will be finished in the next couple of months.

Our plan is to launch 50 megabits in the fourth quarter remain on track. And we have also significantly enhanced our TV offering, the launch of BBC, iPlayer. Video on demand usage remain strong and the iPlayer launch has had a dual effect of using VOD usage and freeing up peak time capacity on our broadband platform.

We continued to see strong growth in mobile contract customers to the cross sale through our cable base. And we are leveraging our position in mobile with the launch of a mobile broadband service later this year. In terms of operational progress, reducing churn remains our number one operational priority. This was down 50 basis points year-on-year. As expected, the June price rise did not result in a material increase in churn.

Broadband net ads continued to be strong. The number of 20 megabits subscribers is growing well, so is TV. We are pleased that our efforts to repair subscriber losses in telephony through smart pricing and bundling are continuing.

We are effectively managing our best book of customers, using cross sale and up sale to mitigate pressure along with the press rising June, just narrowed the gap between the back book and front book pricing. Well, over half of our customers are now triple-play, is contributing to improvement in year-on-year revenue trends.

As I said before, we are managing a long-term lifetime value. And we are well on track to measurably grow the lifetime value of that customer base of the first of January 2009 compared to the beginning of 2008. Therefore giving a great growth impetus going into 2009.

Finally, data fitting from substantial cost savings, particularly in SG&A just speeding through into improved margins in OCF. We continued to focus on right sizing our business and hit the right cost and organizational structure to position us for long-term cash flow growth. Particular this quarter, we have agreed a new wholesale deal with T-Mobile in our mobile division, it sees us receive immediate and future cost benefits. But most importantly, it allows us to offer more competitive mobile data products.

Going forward, we will continue to target substantial cost reductions in a number of areas as we continue to reengineer the business. With the number of ongoing work streams to help deliver this, and when we are in a position to share more detail with you, we would do so. We clearly have an opportunity to expand OCF margins in the next few years.

Well, let's get into the detail. Our top priority is reducing churn. And it was 50 basis points lower than last year, which is a great achievement. Of course, Q2 last year did include the impact of a lot of sky basics but as you can see, there is still considerable year-on-year improvement. The biggest improvement has been in voluntary controllable churn. There are several contributing factors and I'll highlight just three. We've achieved substantially improved key touch points with our customers. Now have a single fit for purpose billing system covering all of our only customers. And that has defeated some of quality of service issues we used to have.

Secondly, I have also restructured the organization to reinforce the importance of both product reliability and this time resolution. Both that cool answer statistics and all right have measurably improved in the last year.

Thirdly, value for money that pick some voluntary churn and we are successfully addressing this through effective management of our back book. In addition, non-pay disconnects are down 27% year-on-year that thing improved credit controls and focus on quality growth. As expected, churn is up by 10 basis points sequentially due to a seasonal increase in movies churn, which includes student churn and rental moves.

You can see that non-pay churn is down on the previous quarter, despite the softer economic environment. Put through a price rise in June and as predicted have not seen any material increase in churn. As usual, we do expect the seasonal churn increasing Q3 which is typically 20 basis points. But we expect it to remain lower than Q3 last year. A churn improvement is sustainable. Targeting churn remains my number one operational objective and reducing it is the biggest driver of value in this business. Churn reductions with margin and value so reducing churn in 2008 through to 2007 should give us a greater growth impetus going to 2009.

Turning now to gross additions. You can see that these are down by around 13% year-on-year and also down sequentially. Post Q2 last year benefit from the significant marketing effort around our brand launch, partially offset by the loss of sky basics from our plate. Also it shifted towards more quality gross ads as reflected in our now improved non-pay churn and increasing triple-play penetration. Driving MPV at the discipline through the business through the business has been critical.

Sequentially, we are down by about 14,000. This is a typical seasonal trend as you can see from the 2006 figure. If I just mentioned the 2007 trend, just picked it by the brand launch. There is probably also some impact from the software macroeconomic environment difficult to isolate, but as we see before, gross edge is where we would feel any weakness affected.

I will explain in a moment why we feel we are positioned to address the effects of a weaker economy well positioned. These lower gross ads combined with the seasonal increase in churn but as expected we have negative net ads, which came to a minus 20,000 which is still a substantial improvement on this time, last year.

But I want to be sure to focus you on what is really more important than a hit line customer number. The quality of our customer base improving. By way of example, we have 24,000 fewer owned only subscribers, low value subscribers than we did a quarter ago. Partly through those low quality customers churning and partly through us cross selling other products. In fact, we now have a 132,000 fewer fine only customers than we did a year ago, at 31% reduction.

And we look forward to improving gross additions in the rest of the year. As in pervious years we expect gross ads to be higher in the second half of the year.

So turning to RGUs, we've seen continued good growth despite the seemingly lower gross ads in prior churn and we've remained well ahead of the same quarter last year. This was achieved alongside the continued success of increasing triple-play penetration, which has now increased to a record of 53% with due penetration of 82%. This is helping to drive improvements in customer quality, lifetime value and low churn. We expect to see improvement in RGU net ads in the third quarter to have found similar levels of Q3, 2007.

Moving on to cable ARPU, which as we said last quarter, remained in a narrow range at around £42. ARPU was down slightly on Q2 due to lower telephony usage and customers shifting to lower price bundles as we worked through the back book.

Improved quality of our products and service and therefore we have enhanced our cross selling and up selling ability to help maintain ARPU. For example, we've increased some broadband tier speeds. We have partly improved our VOD offering. We've been rolling out V+ DDR to better obtain to Sport XL TV customers.

Our success is clear from our improved triple-play penetration and improved broadband mix. I'm very pleased with the ARPU performances of the last two quarters. We are managing the business for long-term value, not just ARPUs. And therefore it may move up or down in any one quarter, as we manage the back book more effectively and as the competitive environment has stabilized. The year-on-year decline in ARPU has slowed. It is very, very encouraging. Of course Q3 ARPU should benefit from the June price rise.

What is important that we're being more effective in managing the underlying value of our customer base and creating value. Obviously, reduced churn has been the bigger driver of long-term value in the last few quarters. As promised we are well on track to measurably grow the lifetime value of our customer base this year, therefore giving us a greater growth impetus going into 2009.

Moving on to my next slide. As you're all aware, there is no doubt that the macroeconomic environment in the UK is softening as oil and fuel price and food price should I say driven inflation, it's compounded by the ongoing credit costs. As a largely consumer facing business, we are not immune to this and we are probably seeing some impact in our level of gross additions by way of example.

However, for a number of reasons we feel that we have well positioned ourselves to face an economic slowdown. Firstly, feel that the home entertainment and communication bundles that we provide a great value for money. Many of our services are increasingly becoming bond discretionary.

Broadband and pay TV are becoming huge parts of people lives are available in the home everyday if people are choosing to go out or shoplift are very cheap compared our alternative entertainment all day of choices. It also helps to our subscription business. Our existing customers are not having to make a transaction choice with each time they interact with XL services. This is not the case in other sectors such as retail for example. A high triple-play penetration, which also help lot of churn.

Limited exposure to the advertising market, just 3% of revenue is coming from advertising. Even so, our VMTV business had just outperformed the wider market by growing Q2 ad revenue by a 11% year-on-year as it grows it's market share. Though not immune to it, we think our risk from customers spin down is limited but low premium channel penetration. We also do not charge a subscription for HD. It's in 20% of our TV subs are subscribed to Sky Premium channels.

In broadband, the vast majority of customers are on the entry tier, so the focus here is on up sell rather than trying to limit to down spin. The evidence is that we have been very successful at both up sell and cross sell in the last quarter, as triple-play hit a record and our broadband mix continued to show strong improvement.

Friction of our 10 megabit upgrade and a 50 megabits launch are also going forward. Continued to improve value and quality for customers, for example, we are upgrading our four customers into 10 megabits for free. We recently launched iPlayer, which is free to all our TV customers and at not available on any other TV platform.

But its tend to sports for free to our TV extra large pack to fix around 50% of our TV subs paid the monthly fee for top tier V+ sells. Finally, with a huge amount of free video on demand TV and music content available to those XL subscribers.

Now churn remains low and we expected it to remain low and lower than last year. That shows that we're demonstrating resilience. Price rise we put through in June has stuck with bad debt remaining low. As you know we get a mitigating impact of lower movers churn in a slower housing market.

Despite all this, we are far from complacent and continued to manage the risk of our consumer slowdown materially affecting us. Managing our back book in many ways, including leveraging our mobile business and cross setting great value mobile contracts into our cable base, gently helps our customers save money.

I've already talked about the continued migration of our back book. Again, here we are saving customer's money or giving them better value deals. At the same time as improving revenue trends and growing cash flow and life time value.

We're being careful about how we mange our marketing investments to focus on those channels and media that have the best returns, both in terms of response and customer quality, and lifetime value.

And finally as I hinted before, we continued to examine ways on improving efficiencies rather further as we reengineer and reorganize the business to reduce costs as we move forward. So, with that let's have a look at broadband.

Here, you can see both a continued growth in subscribers, but also the improved mix as we continued to upgrade speeds and focus on up selling customers. We live in a world where there is ever increasing demand for bandwidth.

This is being driven by the availability of video and audio streaming sides such as iPlayer, iTunes and YouTube. The explosion in the use of social networking side is MySpace, Facebook, and Bibo and bandwidth using devices in the homes such as gaming consoles, laptops, and second PCs have also contributed to this phenomenon.

Our usage has also been growing sharply as a result. Our average usage per customer is over 8 gigs per... 8 gigabits per month. This is about 75% as the rev has grown about 75% should I say, since Q1, 2007. Actually, I think Carphone and Sky have quoted a figure of around about 3 gigabits. So, we can see that our customers are taking advantage of our greater speeds and quality to do more with their broadband service. Why, because they can.

As a result, we've driven an 82% increase in the number of top tier customers over the last year and the ongoing 10 megabit upgrade is also driving an improved mix. We are taking an increased share of the economic proper pool as we target higher quality growth. More and more customers are joining us or upgrading because they want the highest and the most reliable speeds available. There is a real segmentation in the overall broadband market between quality, Virgin Media and commodity read DSL.

In our marketing messages, we are positioning the superior quality aspects of cable over DSL Copper with some success. We've been running edge with the strap line of the mother of all broadband and have again being using Samuel L. Jackson in both radio and TV ads. And broadband continues to feature heavily in our compelling value bundles.

Broadband is a key element of our mini bundling strategies and we're building a reputation for quality and delivering a higher proportion of advertised speeds versus DSO. We regularly come top of speed side surveys, which specifically look at the delivering speed versus the head line speed. In this world, our ability to promise and deliver highest speed at peak times becomes a key differentiator compared with competing technologies.

Now, turning that technical and speed advantage into a real advantage for the customer in providing a non-commoditized push is critical to our future growth. Our overall on net broadband net ads were 55,000. Like our competitors, we saw a seasonal slowdown in the second quarter, but we were able to show good year-on-year growth. In fact, we were the only major broadband provider in the UK and to grow in net ads compared to the same quarter last year.

I would like to spend a little bit of time while highlighting some of our technical network advantage over the competition, both today and just as importantly in the future. Today, there are two fixed line broadband networks in the UK, ours and BTs. There are of course several resellers to provide broadband over BT's network.

We already have a next generation core and excess network with a capability of offering super fast broadband as you can see from the middle diagram. Carry fiber to the street cabinet and then we use for copper for voice in call extra broadband and TV. The distance from the street cabinet to the home did not impact broadband speeds as it doesn't... as it does for DSL.

By the end of the year, we will offer 2, 10, 20, and 50 megabit tiers, reinforcing our huge and quality advantage. Our current CapEx guidance includes the relatively modest investment in customer equipment and channel bonding port require to do this. During 2007, we increased our access network capacity by 25% in the first half of this year we've increased it by another 30%. This is all being done within our existing modest CapEx levels, which are inline with our guidance.

On the right hand side, you can see that the channel allocation that we use on our coax cable. On average we have 750 megahertz of capacity available which is divided into about 75 usable, 8 megahertz slots of carriers. Today, we use just two of those 75 slots to drive 2, 4, 10, and 20 megabit broadband in the middle of the diagram.

The fourth quarter up 20 and the new 50 megabit customers who remove to a DOCSIS 3 platform, which we'll use an extra four slots thereby tripling the capacity reallocate the broadband. This will significantly improve the quality of service provided to all our broadband customers as the 2 and 10 megabit customers will have more bandwidth specifically dedicated to them on their own two channels.

This will help us push real world delivery speeds as close as possible to their advertised headline speed. We also use about 27 slots to carry digital TV and around 9 slots to carry VOD the bottom half of the picture. You can see that towards the top, the largest single portion of the spectrum is the 30 slots we currently use to carry analog TV. And yet, we have less than a 190,000 analog customers and net numbers reducing by about 15,000 each quarter through migration to digital and some churn.

A 140,000 of those analog subs are in digital capable areas and so we will continue to migrate them to digital thus far switching off analog in digitally capable areas. This will allows us to free up huge amounts of extra capacity which we can use for broadband, digital, VOD, HDTV and other applications that may become prevalent overtime.

As you can see from the diagram on the left, BT's network run copper from the local exchange to the street cabinet and then copper a gains to the hunt. BT runs voice, video data, retail and wholesale products over this single prop-up line.

With the natural property of the copper wiring that used that the ADSL signal quality degrades as the distance. This is a problem for DSL providers because BT's exchanges are on average over three kilometers away from the customers home. A coax cable offer superior performance for broadband and for television. This means that even after billions of pounds of investment in 21 CN, only half of UK households will be able to receive at least 6 to 9 megabits per second via our ADSL 2 plus. And only 10% will be able to get speeds of at least 16 to 20.

In addition, due to capacity constraints, many DSL competitors have to deploy extreme traffic saving measures and throttle back speeds at peak time. As you know BT have announced the four year program for a limited build out of fiber to the cabinet and some fiber to the home. This endorses our own view that bandwidth demand will continue to grow. And that there will be increasing consumer demands for super fast broadband. Clearly, there will be some overlap with that cable areas but it won't be a 100% overlap.

BT had targeted 40% of UK homes and we think they might come under some pressure or even in same device to make some investment in non-urban areas. Even by 2012, we will still have an advantage to BT's fiber to the cabinet. With the extra bandwidth freed up, by analog switch off, we'll probably be able to offer over 200 or certainly up to 200 megabits broadband if we so chose. By contrast, BT has committed to 40 megabits, limited by the exchanges.

In most areas, BT will still be reliant on the single copper drop from the cabinet to carry all services, that's voice, video, data and whatever wholesale services they are carrying too. Whereas we'll only use copper for voice, use the superior coax for TV and broadband. A huge broadband advantage over competing technologies to speed, quality, reliability and cost. With our existing network and analog switch off, and it is an advantage, we will maintain for many years to come.

So moving onto TV. We had another great quarter driven by VOD and attractive bundling. TV net ads remain strong will go slightly down sequentially due to seasonal factors. Mix remains good with around 50% of digital subs on our top... extra large top tier.

Remember, this is our top basic tier, less than 20% of our TV subscribers subscribe to premium Sky channels. We are seeing increased usage of our video on demand service demonstrating the steady transformation of the way people watch and interact with their TVs is continuing on our data.

Usage has been boosted further by our launch of BBC iPlayer which was added to our electronic programming guide in June. We are the only TV platform in the UK to carry the service. iPlayer carries BBC programming from the previous seven days and is very, very user friendly. That is around 350 hours of content.

Developments like this give VOD a new impetus and help establish on demand as a genuinely mainstream TV service. We had 10.5 million views of BBC iPlayer in June alone. And as you can see from the chart, average monthly VOD views in Q2 have grown to 38 million. This is a whopping 92% increase over a year ago. Services used regularly by 48% of our digital base and average views per user per month have grown to 24 compared to only 14 a year ago.

Our huge library of content and quality of service are not easy replicable. And we believe this is playing an important role in both consumer retention and acquisition. We also had another strong quarter of the V+ growth. We've doubled the number of subscribers in less than a year and our research shows that DDR customers churn less than other customers.

Even with such strong growth, we still only had a 13% penetration of our digital base. So we feel there is still a huge growth opportunity here. We see our DDR product has been complementary to VOS so customers can time shift in different ways. With that super fast fiber optic broadband service and our market leading video on demand service, we are base place to benefit from the consumers increasing consumption of on demand content.

After accessing driving VOD usage and improving TV mix gives us great confidence that we can do the same with broadband. We have only relatively recently started to improve the mix.

Now turning to mobile, starting with contract. As I've already said, our strategy here is to use our favorable economics to cross sell into the cable base. We had another successful quarter with 56,000 net ads, 95% of these styles we threw are on channels which helps to keep the acquisition cost down and our profitability up.

We're seeing particular success in SIM only contracts where we would gross ad market leader in the second-quarter. Contract is an important element of our proposition, allowing us to offer appealing bundles to our customers and a 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 in prepaid customers. This means that the lifetime value of a contract customer is significantly higher than a prepaid customer. Also this quarter, we've been able to negotiate our wholesaler network contract with T-Mobile for both voice and data rights. The voice and data rights are which are active to first of January and the first of April respectively.

Not only does this allow us to improve our mobile margins, but it means we can now be more competitive in mobile data. Consequently, we will be launching a mobile broadband product in the fourth quarter, which we see as being complementary to our fixed-line broadband service.

Moving to prepaid, where last quarter our base was affected by increased market competition. This is flowed through into the reported prepaid disconnects this quarter because we use a 90 day definition for subscribers. That means that some customers who actually stop using their phone in Q1 have only appeared as churn in Q2.

Last quarter, we also saw an overall decline in usage which negatively affected service revenue in overall mobile ARPU. And to the leadership of Mark Schweitzer, our Chief Commercial Officer and Graham Oxfe [ph], our mobile AMD, we put in place a range of initiatives to address prepaid churn and stimulate prepaid usage.

We've made some selective prepaid price increases and other tear-off adjustments to address market competitiveness and grow ARPU. We've also begun to identify acreage customers and approached inactive customers much earlier with offers such as our new daily bonus tariff to reengage and retain them. We know that cheap handsets prices also led to early inactivity. So we increased these upfront costs and affectively withdrew from the low end of the market.

Our focus on profitable acquisitions as a result of the more aggressive push behind similar offers and an increased channel mix shifted Virgin Media managed channels away from third-party distribution, where commissions are significantly higher. The combined impact of these initiatives as well as the T-Mobile renegotiation has helped us to significantly increase mobile OCF compared to the first quarter.

Turning now for business. As you can see revenues is a 157 million, which is slightly up year-on-year. System without strategy, we continue to see a mixed shift in retail revenue from voice to data. Retail data is up 10% year-on-year, leveraging up our superior network and a superior network economics. Retail and other revenues is lumpy in nature and the majority of the this revenues is from infrastructure projects which are nonrecurring in nature.

Our largest infrastructure project is the provision of telecoms network equipment in Heathrow's Airport terminal fire. This revenue is expected to decline in the third quarter as the contract comes to an end. However, this contract is in a very low margin, so we will did not foresee any material impact in OCF. Wholesale revenue was down mainly due to a reduction on our ISP subscriber base and contract decline in mobile account.

Turning to content, VMTV revenue was up 9% year-on-year due to an impressible 11% increase in advertising revenue. Despite weakness in the overall TV ad market, our strong channel performance meant that we grew our market share and outperformed the market.

Our commercial impacts are up 8% year-on-year. You can see on the right hand side, our viewing share has been strong. We are growing our viewing share from about 3.5% year-on-year while Sky Basics was down 1.4%, Viacom is flat and discovery are down 0.8%. Sit-up revenue was 7% compared to the same quarter last year, which is a strong performance in a weakening macroeconomic environment which clearly will impact this business.

UK TV has also delivered strong performance and we have received 10 million cash in the first half. Content OCF was a £1 million loss. This was down by ₤6 million sequentially due mainly to an increase in VMTV programming and marketing costs and seasonally lowest sit-up revenue. OCF was down by about 1 million on year-on-year. As in previous years, VMTV's programming costs are expected to seasonally increase in the third quarter.

Now, let me now hand you over to Charles, to run through the financials before I return to summarize. Charles.

Charles K. Gallagher - Senior Vice President of Finance

Thanks, Neil. On my first slide, you can see the revenue split between the segments. Consumer revenue is down 1% year-on-year as a result of the decline in ARPU. What is important, however, is that the revenue decline has slowed from previous quarter as the competitive environment has stabilized and we have become more effective of back book migration and improved our up sell and cross sell propositions.

As you heard from Neil a moment ago, business revenue is slightly up year-on-year with a small sequential declines as the lower voice, wholesale and other retail revenues partially offset by growth in retail data revenues. Mobile revenue is slightly down year-on-year, but is up sequentially due to our improved ARPU as a result of the prepaid enhancement initiatives that Neil outlined. As we have just heard VMTV revenues up year-on-year due to strong ad revenue growth.

On my next slide you can see some revenue trends over the last year. The year-on-year movement on our principle revenue metrics have improved although they remain negative year-on-year. This slide shows that percentage require in ARPU, our net consumer, business and total revenue have all improved in Q2.

In the consumer business, this is because we have seen an increase in customers over the last year and we have seen a more stable ARPU positions due to successful up sell and cross sell. In the business division, we have seen retail data growth offset weakness in other lower margins areas.

Let's now move to the summary income statement showing Q2 '08, versus Q1 in the same quarter of last year. I'll break up all the detail cost movements on the next couple of slides. I've already discussed the revenue movements... operating costs are flat from the same quarter of last year and down 5% on the previous quarter.

SG&A was down by 9% on the same quarter last year, but up 3% on the previous quarter. This results in OCF was 333 million, which is up 6% year-on-year and up 3% on the previous quarter. OCF margin has increased to 33.6%, up nearly two percentage points from last year.

Cash CapEx at 108 million was down in both the previous quarter and here, which is an increasing amount of fixed assets acquired on the finance leases, together with the timing of cash payments related to fixed asset purchases. During the quarter, we acquired 30 million of fixed assets under the finance lease.

Accrued CapEx of 156 million was flat year-on-year. It was up on the previous quarter due to increased scalable infrastructure costs related to the broadband speed upgrades, partially offset by reduced consumer premises equipment expenditure as a result of reduced volumes.

So, let's look at the cost in more detail where we can see that we have demonstrated good spending control. Cable operating costs were down, both sequential and year-on-year mainly due to lower volume related costs and lower network facilities costs. This sequential decline also included lower business costs, reflecting reductions in other retail volumes. As a result, cable gross margin has increased to 61.9%.

Mobile operating costs are down on the previous quarter, just the lower equipments costs and the renegotiated wholesale and voice rates. This change in rates was retroactive to January 1st for voice and April 1st for data. Consequently, the second quarter reflects six months of voice rate reductions, as a result mobile gross margin is up sequentially to 42.3% roughly flat year-on-year.

Content offering costs are up year-over-year due to the launch Virgin 1 on October 2007. The results of all of this is gross margin is relatively flat year-on-year at 56.1%.

Turning to SG&A, cable SG&A is down by 10% year-on-year due to the reduce headcounts and marketing cost. As we signaled last quarter, cable SG&A is up sequentially due to higher marketing costs driven by a Samuel L. Jackson TV campaign and also higher stock-based cost compensation expense.

Mobile SG&A is down 14% year-on-year due to lower employee expenses and content asset remain fairly flat. As a result, total SG&A is down 9% year-on-year but up sequentially 3% at 22.5% of revenue.

As Neil has already said, we will continue to target substantial cost reductions on a number of years going forward as we continue to reengineer the business. We currently have a number of ongoing work streams that help deliver this and when we are in a position to share more details with you, we will do so.

The result of all this is shown in my next slide. Cable OCF is up 5% year-on-year, but down slightly sequentially due to extra marketing costs. However, OCF margin is slightly up in the previous quarter at 38.9% and well up in the same quarter last year.

Mobile has made a significant improvement on the previous quarter as Neil has already outlined. And in content continues to hover around breakeven. The net result of the total OCF margin has increased from 33.6% from 31.7%.

In the third quarter, we expect OCF to be lower than Q2 for four main reasons. Firstly as usual we'll see VMTV's programming cost seasonally increase. Secondly, we will be increasing our sales and marketing other volume related costs to support improvement in ARPUs and gross ads that Neil discussed.

Thirdly, mobile OCF will be marginally lower as Q2 benefited from the retrolife have changed the voice wholesale rates. And finally there will be a small increase in employee related cost resulting from our annual salary review.

On my final slide, I have set our debt position as of the end of the quarter as compared to a year ago. As you know, in April we issue $1 billion convertible bond and use the proceeds to preface some of our outstanding bank debt. As a result, we do not have any material bank repayments due until March 2010.

We had a strong working capital performance in the quarter and we have had good cash generations in the quarter. You can see that our cash balances increased to ₤427 million and as a result, net debt was reduced to $5.6 billion, which is about 200 million lower than a year ago. Our key leverage ratio has also fallen to 4.2 times confirming our deleverage and profile.

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

Neil Berkett - Chief Executive Officer

Sure Charles. So let me summarize with this final slide. You can see from the results from the last few quarters that our discipline focus on execution is bearing results and driving improved fundamentals, which has resulted in our best ever underlying OCF performance.

In particular, we focus on driving down churns for a range of operation improvements. We've been effectively managing our back book pricing issues through improved cross sale and up sell. As a result, we've seen ARPU begin to stabilized in a narrow range and revenue trends improve.

We've seen the benefits of cost savings come through and start to drive improvements in our bottom-line. We remain convinced that we can target further efficiencies. We have an amazing asset in our network which we are focused on and exploiting. We have a clear technical advantage in the broadband and on demand space alongside the economic advantage of owning and running our own network, both now and in the future. Growing consumer demand the bandwidth quality and on demand consumption is freely playing to our strengths.

Competitive environment is more stable that has been for sometime as the market pricing changes have now been in the market for one to two years. If you are comfortable enough with the competitive environment of the strength of our brand and our products, that we've raised prices for the second half of the year and we're also starting to see some of that competitors raise their on own pricing.

The wider macroeconomic outlook is clearly weakening and we have felt some impact of this, particularly in gross ad. Nevertheless, we feel we are well positioned to address these conditions that are outlined. We feel we have a significant opportunity to take further cost out of the business next year and we have various work streams running to scud them out.

So, we are pleased to have the first half of the year has gone and about our prospects for the future. And with that, we'd be happy take your questions. Operator?

Question And Answer


Thank you. [Operator Instructions]. The first question comes from the line of Wilton Fry from Merrill Lynch. Go ahead please.

Wilton Fry - Merrill Lynch

Yes. Hi there. I have two questions if I may. First, please can you outline the magnitude of additional cost savings you mentioned when you likely to be able to give us more details on that? Secondly, what advice does your legal team given you regarding BT's and for Sky's Quest towards the network? Thanks.

Neil Berkett - Chief Executive Officer

Cheers Wilton. Let me pick up both of those. We... as you've seen in terms of our current cost profile, SG&A is down some 9% quarter-on-quarter, you've seen us continue to deliver against the £100 million OpEx reduction that we announced in the second-quarter of 2007. And we continue to work on our overall OpEx. I've gone on record in terms of my views about OpEx growth that itself it's not a positive thing.

When we are in a position to work about what this through child is leading a whole bunch of work in this area, we'll come to the market in the next couple of months. In terms of our position in respect to our network, I completely understand then respect why our competitors would want us to open up by a superior network.

However, there is no legal position as to why we would do so. We've invested billions of pounds in developing this asset and for any opening after the network; we would need to prove that in fact there was a new market for high speed broadband. We haven't even got there yet and we haven't even launched 50 megabits. So I think we are somewhere away from that.

Wilton Fry - Merrill Lynch

Thanks very much.


The next question comes from the line of Jerry Dellis from J.P. Morgan. Go ahead please.

Jerry Dellis - J.P. Morgan

Yes, good afternoon. Three questions please. Firstly on mobile, I think over the last year you have added expanded the contract base about 60%. you were saying that the phone only base down 30%. Unless and yet revenues continued to shrink and I think the trends are not really improving. I just want to whether you could comment on when that revenue base will start to expand and whether you can twin that together with the maintenance of our OCF margin around 25%?

The second point is just on cable ARPU, I wonder whether you could quantify the uplift to the Q3 cable ARPU trend of the 1st January price increases. And where that sort of sets you at the Q3 stages, you got the full quarter impact. And then finally just in terms of customer growth, I guess you're still not really seeing growth in the actual cable customer base. I just wondered at what point we can start to see push into customers who are new to the Virgin Media Network. Thank you.

Neil Berkett - Chief Executive Officer

Sure Jerry. Thank you for your questions. Yes, you have seen the reduction in prepaid mobile revenue each way what I think a pretty solid performance in terms of contract mobile. You would have seen a recovery in the second quarter in terms of what we've done with prepay. And I would expect to see growth going into the back end of the year and into 2009 in our overall mobile business.

Critically, we see it as an adjunct to the overall consumer home proposition. In respect to ARPU, unfortunately we are not giving specific guidance around Q3 ARPU. We continue to say that it will operate at a narrow range and had said the bottom of that range is probably Q3 2007. You only got one month impact of the price increase in June in our Q2 ARPUs number. So, I'm sure you will be able to model that through.

I've seen right through the back end of last year and an each... first and second quarter year, 2008 is not about assuming that consumer, customer subscriber growth. It's about consolidating the base. And that's occurring in two ways a) we are taking current subscribers and up selling or cross selling to them. We are been bringing on board new subscribers that are a higher values than we have done in say Q2 of 2007 VMTV of the average subscriber is materially higher than it was a year ago.

And we are losing lower tier single telephony, for example, subscribers 132,000 of single product telephony own only subscribers lists in Q2 '08 versus Q2 '07. So you can see quite a substantial shift, not just in the quality of incumbent customers but in the new customers we are acquiring versus the customer we are losing.

So, we've also said that the second half of the year that our gross ads will be stronger than the first half of the year. I mean strategically as we moved from number one priority being churn, substantially improving the portfolio in terms of that product and proposition that you are on demand contract mobile, higher speed and higher quality broadband and the applications and features that go with it that we can move into a position of looking for a stronger gross ads position in 2009.

Thank you. Operator?


The next question comes from the line of Steve Malkin from Aright Research [ph]. Go ahead please.

Unidentified Analyst

Yeah. It's Steve Malkin, Marasay Research. I'll go for three questions well please. First of all just on your sort of overall network speed side, I completely take the point on DOCSIS 3 upgrades and what you can with your spectrum. Can you just give us some reassurance on your kind of core capacity and what you can do in terms of note splitting adding more core back whole to make sure that you can support... the young dated improvement you can make an access, it's over the next couple of years at a very low capital costs?

Secondly, you talked about BT NGA plans, can you also just sort of update us in your thinking on outcomes and consultation document and copper price you think that might do to your arrivals access costs and pricing in the market whether that might be at another end of price increases later in the year? And finally just on the point you made on the analog and digital base, can you give us an idea when you think the analog signally will actually be switched off for you whether it was still looking to that's in top whether you can do earlier from what you are saying given the migration you are seeing in the network already? And thanks.

Neil Berkett - Chief Executive Officer

Sure. Let me pick those up safe, clearly there was a huge, huge investment made in the NTO core, two or three years ago. We've effectively switched over on to the NTO core, obviously complemented by Telewest. I am not concerned at all in the next two or three years in terms of substantial additional capital in the core. We continue to see that in the excess in terms of the DOCSIS 3 upgrade. And I am as comfortable as I have ever been. I positively saw in the guidance we give around capital.

That's enhanced somewhat, if I just move to your third question, to answer that second. I would see us moving to analogs as digital customers certainly back end of next year, beginning of 2010. And then we will move through 2010 to turn analog off completely. And you've seen the benefit of that in terms of the slides that we've --

The BT review in terms Ofcom pricing, various people have made projections in that respect and we're obviously aware that BT open reach may not be making the returns anticipated at the time it was set up. It appears that Ofcom may be considering [indiscernible] about open reach in general, places to which it can make better returns. Probably be better directing equations to Ofcom really. If there was any such review, it would obviously involve extensive consultation with all parts of the industry. General consensus is that there might be an increase coming through but as I say, you're better asking Ofcom that question.

Unidentified Analyst

Okay. Thanks a lot.

Neil Berkett - Chief Executive Officer

But the one think is that there is no down side from our point of view.

Unidentified Analyst

Can I just ask one quick follow up question. Not really a follow up, a separate question, just on the gross ads guidance for the second half, which you were down 13% in the first half. You are obviously guiding off in a better customer additions off lower churn in the second half. I mean do you think this sort year-on-year performance on gross ad stakes. Can you do better than that? Just a bit on color on where the extras gross ads come from?

Neil Berkett - Chief Executive Officer

Yes, now I won't take it much further than I have said Steve. We just said that we think second half gross ads will be stronger than the first half. I'm trying to provide some comfort in terms of the strength of the businesses as we go forward into a tighter economic environment which is why I sort of stepped out as you would aware of my normal discomfort in giving any guidance in the uptake. That's why I said that, it's also why I said that RGUs for the third quarter will be roughly in line without you using he third quarter of 2007. Quite transparently its there to be able to provide comfort of our performance in the current climate.

Unidentified Analyst

Okay. Thanks


The next question comes from the line of David Gober from Morgan Stanley. Go ahead please.

David Gober - Morgan Stanley

Thanks guys, just two for me. First you talked a lot about the impact of the overall economy on gross additions, but I'm just wondering if you could give some color around what impact it's having on ARPU, or whether or not you're seeing any impact in terms of acceleration of backlog re-pricing or potential spin down. I know that's probably not as much of an issue for you guys giving your mix and also you guys mention a little bit about the mobile broadband offering that you're planning for launch in 4Q. I'm just wondering if you give a little bit more color on that. What type of product you're planning on offering and whether or not that would be integrated, or any sort of hybrid model that might be a being looked at there?

Neil Berkett - Chief Executive Officer

David, I will pick those...I will pick those both up. In terms of ARPU impacts from the economy, we are not seeing any material impact in terms of the change or measurable impact in terms of the change of spin down versus up sell. You quite right of the highlighted this significant opportunity we have got for up sell particularly in broadband and the strengthening we are getting in mid tier, what is to be 10 meg gives us confidence that we will continue with that. As I said no evidence to support any shift in that at the moment.

Similarly on the back book, I think its moving at roughly what we though it would be. As I said in my little speeches... I'm very pleased with the way on which we are managing ARPU and do not see any significant acceleration of the back book, as the result of the last two to three months of tightening in the UK economy. In respect to the mobile question, yes you will see some bundling in terms of the mobile dongles as part of our overall offering. We would be foolish not do that, it's our real strength and in fact that is where, and so in the same way as I'm really looking to market a contract mobile into the media base. We will be looking to market mobile broadband into the media base in a complimentary way. We see it very much as complementary product and not a supplementary product, particularly for higher quality broadband.

David Gober - Morgan Stanley

Along these lines of, have you guys seen any increase in the mobile substitution trends in last quarter or so both internally and externally in terms of sales moving from cable telephony over to mobile telephony?

Neil Berkett - Chief Executive Officer

I don't think that there has been any shift in the continual decline of low single digit usage in six line telephony. I mean that will continue going forward. We're not seeing any shift in those trends across the mobile. Similarly I'll ask the question, I thought you're asking which is nor have we seen any material impact of mobile broadband on our fixed line broadband product. I think it is hurting some of the lowest speed DSL operators where potentially could be supplementary, but I see it very much complementary to a superior of Virgin Media broadband product.

David Gober - Morgan Stanley

Great. Thanks guys.

Neil Berkett - Chief Executive Officer

Cheers David.


Your next question comes from the line of J. Bolman [ph] from New Street Research. Go ahead please.

Unidentified Analyst

Thank you. I have got just two please. I know that you think it going to building in the value of [Indiscernible] of your customer base, but as kind of things turned off in Warner broadband [ph] share of net ads of 15% or above. Is that something we should continue or look at? And secondly just on the deal in term of T-Mobile. Could give us a little bit more background specifically on the old deal, the concern was as mobile submission came down, so your revenue would also come down. Your out payments to T-Mobile went off, so that was kind of build in margin squeeze, Could you address that in the mid year?

Neil Berkett - Chief Executive Officer

Okay, let me pick me those up. We are very interested acutely interested in economic profit share of the broadband pool. It's currently sitting in an RGU same-store circle of 15% that I suggest we are taking significantly higher share than that in terms of the economic profit pool. This is about growing the premium in the broadband, I doubt that it will flow much below that 15%, but to be honest that really depends on growth to segmentation, the attractiveness if you like of next generation broadband.

As you know Joe I'm obsessed with MPV, I am obsessed with economic profit share. So, yes and clearly at the moment you just look at the second quarter's performance with the only operator that's actually go Q2 '08 over Q2 '07 improvement. So you know I'm pretty pleased as we move that forward. On T- Mobile the details of are obviously between T- Mobile and ourselves. We have...I think we have addressed some of the issues around voice that you highlighted to and that more importantly I think we have some pretty strong data position going forward, and don't read too much in to the Q2 number. Charles you might just comment briefly on the impact of Q2 in terms of our over all position for Virgin mobile that's retrospectives up?

Charles K. Gallagher - Senior Vice President of Finance

Yes obviously the given the confidentiality we can't give you the specifics but as I indicated in my comments there was a marginal benefit in Q2 given the retroactive nature of the price change, but that's clearly a low single digit type of number, I assume the benefit it's going to have... the ongoing benefit will recur in future quarters.

Unidentified Analyst

Okay. Thank you Charles.

Neil Berkett - Chief Executive Officer

Thanks Jeff.


The next question comers from line of Stuart Gordon [ph] with Merrill Lynch go ahead please.

Unidentified Analyst

Hi guys, just a couple of things first of all, could you remind us the number of customers who have experience a price increase just to get the flavor for the potential impact in the third quarter, just from that price increase and secondly, in OCF, I'm just...really I know that you've not given full year guidance I know that you won't, its just... I notice consensus seems be to be suggesting a fair 2 million increase year-on-year. You're doing that in the first half, but I'm conscious in the second half you've that OCF would be down in 3Q and 2Q.

And also last year I think you had the benefit in the second half from the fact that the share from the share option program was curtailed in the second half of last year. I really just wanted the flavor, are you quite comfortable with that sort of liable of EBITDA and sort of just over to 1.3 billion mark and as we move in the second half, given your comments on what you expect in the third quarter?

Neil Berkett - Chief Executive Officer

I'll answer in reverse; we don't give guidance in terms of OCF. We try and give Stuart [ph] as sure much granularity as we can around the operating metrics to allow you to work through in terms of our overall guidance. I think we better not sit [ph] talking about the strategic value of the asset what we are doing operationally than giving short term OCF guidance. And Charles took you through some of the things that where we say Q3 coming off Q2 ... do your sums and you will get in there.

On price increase impact again, what we said is we charged 1.50 pounds for all of our top tier TV subs, which are roughly half of their TV subs and we charged ₤1 for all of our front book bundled customers. We've given no further guidance then that, that obviously you walked its way through in terms of just the month of June in the second quarter and that will flow through to in full obviously to the third quarter.

Unidentified Analyst

So there's for all the cust..., yes, that's what I had, so 1 in 150 subsequent?

Charles K. Gallagher - Senior Vice President of Finance

Then obviously we didn't put a price increase to that back book bundle for customers.

Unidentified Analyst

Right. No problem. Okay, thank you.


The next question comes from the line of Ian Wichacuf [ph] from Libran [ph]. Go ahead please.

Unidentified Analyst

Thanks so much. I have two questions, just first one has to do with...and the question answered before on analog. I was just wondering given its actually so few analog customers and yet the benefit in term of analog seems to be so high why don't you actually just accelerate the switch over those analog customers rather than waiting for you 2010, and the fee of the network be.

The second thing is I know you are not going to say anything in terms of the regulation view that's going on with Ofcom but if hypothetically Ofcom was to come back and suggest that the Sky wholesale premium programming at wholesale prices to operate and feed them [ph] yourself. Would you see that as a very good opportunity in terms of being able to push TV subscriber through or increase the number of TV subscribers rather or the moment you kind a look in that as a fringe benefit, but wouldn't it really be core to any future strategy

Neil Berkett - Chief Executive Officer

On analog switch off... we can vary that subject to our economic needs. It's only a couple of hundred thousand subs, but they're very profitable subs. So at the moment the profile looks to basically rather than force migrate to allow that natural migration through the back end of 2009.

In terms of the need for the bandwidth, if that increased in terms of for whatever reasons, we would just do the sums and do the acceleration. That completely at our... under our management and our discretion. I think Dan you've hit it on the head in terms of the market investigation. Currently there is instinct of whatsoever for us to be selling Sky Premium. That is absolutely behind our arguments in the market investigation. In fact every Sky premium customer we sell, we don't make any money, in fact we lose money on the Sky Premium element. If we had a wholesale rate, we would aggressively sell Sky Premium into the market place and introduce Sky Premium at a better price for more customers in the UK market.

Unidentified Analyst

Okay. Just going back to the first thing in terms of analogs. So, basically it's a sorely a profit thing. You're not for example concerned of those that you try and push these customer's off on to digital, rather you are going to huge spike in share amongst them?

Neil Berkett - Chief Executive Officer

Look at things fairly, predictable and consistent. We manage in a... it's not reactive, but its not aggressively proactive way. I mean, clearly we mange the capital there, because we put new [Indiscernible]. I mean it is literally a, I watch it on a monthly basis and I just reiterated it's absolutely at our discretion and flexibility we can ...if we believe that it was appropriate to accelerate, then we will.

Unidentified Analyst

Okay that's great. Thanks very much.

Neil Berkett - Chief Executive Officer

It's all right.


The next question comes from the line Matthew Walker from Lehman Brothers. Go ahead please

Matthew Walker - Lehman Brothers

Thanks very much, it's just ... its just one small question which is on slide pattern, it's actually about the economy, the financial things. The broadband customers, 74% of broad-band customers on the MP3 player there.

You would kind of think that given the Virgin broadband is at the quality end of the spectrum. I fancy it will be the other way around and more people beyond the high speed, so I was wondering if you could just say something that fact and how it's moved over the couple of years?

Neil Berkett - Chief Executive Officer

Sure in fact there is a chart, Matthew in the pack that takes you through that. This is actually the core of our advantage. I guess one of the frustrations I've had is that the U.K. cable is never really exploited its advantage which is evidenced by that broadband TMS. Yet as soon as we started doing based despite and started to move broadband office we refer it to as our hero product.

You can see quite a dramatic shift by way of example 82% growth in our top tier of broadband. We never really had an incentive for the middle tier because that were 2 meg to 4 meg. Why in hell would you pay the €5 or €6 or €7 extra to move from two to four. Would you from two to ten? We believe that customers will. And we are already seeing in terms of that gross styles mix going through to July and improvements in the overall tier mix IE we are the number of customers taking middle and top tier is measurably greater than it was prior to 4 to 10 mega upgrade.

Matthew Walker - Lehman Brothers

Okay that's helpful. Thank you.

Neil Berkett - Chief Executive Officer

Pleasure, we have probably got time for one more question operator.


Okay the next question comes from David Hoag from MS Label [ph]. Go ahead please.

Unidentified Analyst

Hi there yes it's David Hogg, MS Label [ph] here just a couple of them points of detailed questions. You mentioned in your slides that the average bandwidth that your customers are using in Q2 remains what was still over 8 gig, I wondered if you could just be a bit more specific. I recall you said on the Q1 call that, Q1 usage was 8.1 gig per line, I just wondered if you could give us that sort of detail for the Q2 '08 number. And then also tell us what the Q2 '07 equivalent number was as well.

And then secondly I just wondered what the average proportion of your customer base is this being impacted by your subscriber traffic management policy you introduced in June. And given your comments earlier about the benefits of DOCSIS 3, is it fair to assume that you won't need to apply that policy once you got DOCSIS 3 fully up and running?

Neil Berkett - Chief Executive Officer

Okay, chill David, 8.5 gig Q2, 2008. Q1 2007 which is the number I have got over top of my head because 75% odd increase that we just over four so, this you seeing this sort of 50% CAGR growth of data consumption in the home continuing if not accelerating is the message there I think its our sweet spot as customers look for more data download, as they look at more video onto the video, and the lots of BBC iPlayer, more access at home which is one of the big drivers through wireless network that's where we see this increase continue.

It's interesting, I think I saw a quite from Steve Berk must have been from yesterday, I guess given the timing where he talked about DSL as being the current dial up. Yes, we really are starting to get a differential in the overall market between doctors and DSL. Point you make around ATNT clearly running 20 meg over a DOCSIS 1 network stretches our capability about 5% of their customers are impacted through SMT. As we move into DOCISS 3, we're modeling what that might look like.

But it will be less than that as we move out 15 meg sorry 20 main customers. And 20 meg customers on to the DOCSIS 3 environment that will loosen things up for the Doxis-1 environment for the 2 and 10. I mean clearly we are investing in the networks such that the average quality of service of our customers is... as close to double the quality of services we possibly can in terms of DSL so headline speech will be double and quality of service high, the percentage of those headlines speed at peak time we would aim to be double as well and this is a bad eye quality push.

Unidentified Analyst

Okay that's great thanks very much.

Richard Williams - Director of Investor Relations

All right thanks David. Look with that operator I think we will close the call down, apologies if some of you have not been able to ask your question clearly Charles, Richard and I will be available over the next sort of 24, 48 hours.

Please feel free to call in if your questions have not been answered. Thank you very much for your support and thanks for spending the time with us today. Thank you.

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