Sky Plc ADR (OTCQX:SKYAY) Q1 2017 Earnings Conference Call October 13, 2016 10:00 AM ET
Andrew Griffith - COO
Colin Jones - Group Finance Director
Constantin Wolf - J.P. Morgan
Scott Wipperman - Goldman Sachs
James Dix - Wedbush Securities
Thank you, and welcome to the Sky PLC Results Conference Call for the three months ended 30th, September 2016. Today's call is being recorded.
Hosting the call will be Andrew Griffith, Chief Operating Officer, and Colin Jones, Group Finance Director. This call is the property of Sky PLC it may not be recorded for broadcast without the written permission of Sky PLC.
This call may include certain forward-looking statements with the respect to the Group’s business and strategy. All forward-looking statements are subject to recent uncertainties and are qualified by the cautionary statements in Sky’s 2016 annual report.
I would now like to hand the call over to Mr. Andrew Griffith. Please go ahead, sir.
Thank you and good morning everyone. Thanks for joining us today. I am Andrew Griffith, and I am here with our Group Finance Director, Colin Jones.
So I hope you’ve had a chance to read our trading statement this morning. I thought I’d briefly take you through the highlights of the quarter, and then Colin and I will be happy to take some questions.
So, it's just only been a couple of months since our full results in July, and we’ve made a good start to the year. Including the benefit of a stronger euro, our revenues for the quarter were up 13% year-on-year to reach £3.1 billion. On a like-for-like basis, they grew to 5%, which we were pleased with. Trading wise, we had the customers at a good right, albeit, as expected the quarter gone off to a slower start due to the tail-end of the Euro 2016 and the Rio Olympics, both big free to air events in the UK. But since then we’ve seen demand build across the quarter and September was strong.
Financially, this is a year in which we had saw the full effect of a number of programming renewals, including the new Premier League contract in the UK. We once again done a good job on cost and we’ve been able to offset much of the effect this quarter with strong progress on operating costs, which we reduced by 2% in absolute terms. So three months in, we are on track to deliver our full year profit expectations.
So those are the headline. I thought I’d now just go through each market quickly before looking ahead to what's coming up in the current quarter and then taking questions. Starting with the UK and Ireland, compared with the same quarter last year where we invested to maintain our share of voice around the Champions League, we pulled back a bit our marketing spend against the backdrop of the Olympics and the end of the Euros. As a result, our growth was a bit lower but we still added 35,000 customers in the quarter.
We were pleased with revenue growth for the UK and Ireland at 5%, and that was driven by good customer demand for our expanded range of products. The June price rise, which is landing well and a small FX benefit from Ireland where we generate our revenues in euros. We did face a little headwind in the UK advertising market, which is weak and down by, we estimate, almost 4%. Our own advertising revenues were down by less than this despite free-to-air competition.
We drove a busy innovation agenda in the UK, including launching our Ultra HD service for the start of the new Premier League season. We’re now showing every match in Ultra HD, a strong benefit of the Sky Q platform. A second enhancement to our Q service with the launch split screen viewing. So customers can watch two football matches at the same time. Both of these are good examples of how having creative platforms we continue to innovate on them.
And the metrics on Sky Q are very positive. Around three quarters of Sky Q customers say they will recommend it to friends and customers are watching 70% more on-demand or recorded content than they did when they had Sky Plus. As a result and with the help of a bit of value engineering to bring down the upfront cost, we started this month using Sky Q for new customers. This saves us the cost of doing a hardware upgrade later, and means we’re putting our best equipment in more customers’ homes faster.
There is no change to our full-year profit or cash flow numbers as we’ll manage this in the rounds. The UK also had two big content initiatives to land this quarter. In August, we launched a brand new basic channel, Sky Sports Mix, available at no cost to every customer and our first channel launch since 2011. SKY Sports Mix showed nine different live sports in its first month alone, including Cricket, Rugby Union, Rugby League, Golf and Football, and it's already finding a regular audience with almost 3 million homes tuning in to-date.
Secondly, our completely re-launch movie service Sky Cinema has got off to a great start with consumption up 8%, the highest Q1 ever. As well as the premier every day, the service offers customers high definition of standard 20% more blockbusters and classic films and more pop-up channels such as the Tom Hanks themes channel currently running on the service. Finally our preparations for the launch of Sky Mobile in the UK are going well. We’ve hit a number of final stage milestones this quarter, including completing live text calls and provisioning our own SIMs. We’re excited about our plans and we look forward to being in the market this side of Christmas.
So now let me talk about Germany and Austria. We added almost 50,000 customers this quarter, the highest absolute customer growth of any of our territories. We saw our similar Olympic and Euro effect in Germany, and also here, the start of the Bundesliga football season, which delayed because of these events.
Revenues were up by 9%, driven by a larger customer base, up 300,000 on a year ago, as well as 25% growth in advertising revenues on the back of the increased reach of our channels. In Germany, we’re focused in putting in place the building blocks that are going to drive future growth. The key elements are broadening out to our content offering, launching the full suite of connected services that we have in the UK and getting new advanced set top boxes to market. And this was a good quarter of progress on all these fronts.
On screen, we continue to invest in our content proposition, expanding our collection of movies to over 1,000, and launching Sky Cinema Family, a brand new channel for movie fans. It has proved to be a very strong launch with viewing up full-fold in the first week. We’re also launching Germany’s first-ever live Ultra HD service tomorrow with the Dortmund Vs Hertha Berlin game followed by one live Bundesliga match at ultra high definition every week this season.
On the platform side, we deployed a host of small innovations, all of them created and proven first in our other markets. We launched our new OTT streaming service Sky Ticket, which offers customers flexible contract free access to our great entertainment. We've also recently launched a brand new next generation set top box, called the Sky+ Pro, which is based on our Sky Q platform. For the first time, customers in Germany will get an internal Hard Drive, Ultra High Definition, built-in Wi-Fi and 1 terabyte of storage, giving customers a much better viewing experience and an improved user interface.
Finally, let's turn to Italy where we had a really strong quarter. Trading was good. We generated the highest level of Q1 customer growth for four years, and continued the good momentum we've been building there. We've seen good results from the changes we're brining, enhancing our customer offering, and making it available across the larger number of platforms. And this was the fourth quarter of customer growth in a row.
On the back of that, revenues were up 4% on a like-for-like basis, and at the highest rated Q1 revenue growth we've seen for the past seven years. On screen, our latest series of X-Factor has got off to a fantastic start with a record 4 million viewers tuning into the launch show. We've also seen a strong performance by our new free-to-air channel TV8, which was the fastest growing channel in the Italian free-to-air market during the period.
And we’ve continued to improve the customer experience in Italy with over half of our customers opting to connect their box to the Internet and access their market leading on-demand services. And yesterday, we launched an enhanced mobile TV service, Sky Go+, giving customers the same flexible service we have here in the UK.
So that’s Italy. Now before I hand over to questions, I just like to give you a bit of a feeling for Q2 where we've got a very strong set of plans. In UK, we’ll be in market with Sky Mobile, to seize the opportunity in our largest adjacent sector worth an estimated £15 billion. In Italy, we’ll make the customer experience even better with the launch of Sky Kids applications, a new top box home page, and HD in full on-demand. And finally, Germany, we’ll broaden out our channel business by taking Sky Sports News free-to-air and by launching Sky 1 with MasterChef as we look to replicate the success of that channel seen in Italy and the UK.
As part of a strong line-up on screen as we head toward Christmas. In entertainment, customers will be able to join 22 returning U.S. series, including Westworld from HBO. In addition, we’ll be brining 32 Sky Original productions to our customer screens, including the Young Pope.
Sports will be stronger than ever, featuring top football, such as Dortmund against Bayern, Chelsea Vs Man U, and the Midlands Derby, together with key local market sports such handball English Cricket and Moto GP. And finally Christmas wouldn’t be Christmas without a strong slate of films across all our territories, including the Jungle Book, The Resonance and Captain America, to name a few.
So, in summary, it's been a good first quarter. We’re into Q2 in good shape with a strong set of plans and 13 weeks into the year we're on track to deliver our full-year profit expectations. So now we've got time to take a few questions. Operator, over to you please.
Thank you [Operator Instructions]. And we’ll go first to Constantin Wolf of J.P. Morgan.
I just have really one question for Colin, I think. In your annual report your reference had said, a 74% and net add exposure to euro. And so just given the sterling volatility recently, do you mind talking a little bit how you think about hedging policies? And why you wouldn’t think about taking that percentage down somewhat, maybe in favour of selling? Thank you.
Hi Constantin. So well 70% of our debt is in euros, it's a non-cash movement when you look at the trends and the ForEx effects on our debt. So it's non-cash. We’ve got excellent liquidity so cash of between 1.5 billion and 2 billion and an undrawn revolving credit facility of about £1 billion. And that euro debt that is actually cheaper than sterling, and such that our interest costs were well hedged naturally, and they’re only about 60% of our interest costs are actually in euros. So we’re well hedged on the P&L. And from a debt perspective, we’re in pretty good shape with none of that euro debt falling due for at least four years, so it's not an immediate concern for us.
And I may just add, the hedge is working I mean the economic hedge, our euro interest costs are more than covered by the pre-tax profit we generate in euros. One of the reasons for that is that our Irish business, which we’re going for a long time generate these cash flows in euros as well. So in addition to Italy and Germany, these cash flows are building strongly. We’ve already got a stable and growing line of cash flow coming out of Ireland.
I guess just coming from perspective of sterling weakness persists then you’ll have a significantly higher level over the long term, so I guess…
No, we would but in practice we would refinance the euro debt when it forced you, because euros are a functional currency for us. And the portfolio is very long dated, so that euro debt did fall in due and becoming a current liability, or a cash liability any time soon.
And our next question comes from Scott Wipperman of Goldman Sachs.
Thanks for taking the question. Maybe I’ll focus on the cost side since we just talked about the balance sheet. But the operating cost down 2% in absolute terms. Can you just remind us though, what are the, as we think about the rest of the year, what are the main levers you have to manage the cost and margins in light of some of the initiatives that you have, including Premier League, you mentioned the Mobile launch, in the Sky Q deployment?
Our SG&A costs for the Group were down 2% in the first quarter. And while we’re still investing somewhat in marketing, especially in Germany behind some of the newer innovations, like Sky Ticket that Andrew mentioned. We’ve got a lot of the opportunity, in both cost to serve, so the cost it takes to serve our customers and we’ve saw some good productivity in Italy, especially in Q1. But we have that across the board in the UK as well with our digital first program where we’re making more customers -- taking down customer contacts to its call center and turning them digitally. And then also in G&, we have good productivity in G&A as well from the UK. And we believe that we’ve still got took hold, so we’ve got plenty more opportunity to pull and we’d expect to be able to keep with these cost to serve, with G&A costs, with SG&A costs in general in good shape for the year.
And maybe just to circle back on the balance sheet, just because is a -- just a question that we’ve been getting. Just in light of S&Ps negative outlook change and just following up on the discussion around the percentage of euro debt and the capital structure. Is there other levers you have to pull on managing the leverage, I recognize that the interest costs are hedged, but clearly the leverage is going to continue to move around here based off the sterling-euro exchange rate. How should we think about from a credit side, just your ability to manage the leverage over the next one to two years in a given that simply how it change? Thank you.
I think for my part of, if Colin wants to check in. But the key thing that will help manage the leverage is ob building our base of EBITDA that will help. We’re confident of coming through. You’ve seen today that we have reported profit that you see good levels of revenue growth coming through from both Germany and Italy. Italy, in particular, is very operational, but in both businesses we have excellent visibility of rights costs. They’re locked in for many years forward. So you’re going to see a high drop through the incremental revenue.
You see these rates of revenue growth, a high proportion of those are going to drop through to EBITDA and that’s going to build a growing base of euro denominated EBITDA to play against that euro denominated debt. That’s the biggest single lever that we’ve got. Because as Colin said, we’re actually, from a cash perspective, we’ve got excellent liquidity and the debt is term debt, but that doesn’t hold for a long time. And if you’ve got anything to add Colin?
The other thing first to add to that would be in terms of our actually debt covenants that based on an average ForEx rate rather than the reported rate. So, if you think from a covenant headroom perspective, we still see plenty of headroom in that, and it’s not in fact so much in the short term while that translate effects.
[Operator Instructions] And we’ll go next to James Dix of Wedbush Securities.
I’ll actually focus away from a balance sheet for the moment. Three questions, any commentary you have on just the underlying demand outlook you’re seeing across your three major markets, both at the consumer level for subscriptions services and at the corporate level for advertising, I’d be interested in that. And then second on Ad Smart. What average CPM differential you’re seeing now for Ad Smarts, ad sales relative to your other ad sales. And at this stage of a lifecycle of a product, what are the key drivers of the demand from the advertiser side, whether it's in terms of particular verticals or perhaps if you’ve got strategies, which I think you may have called out like local targeting? And I had one follow-up, but I’ll just leave it there for a moment.
I think the consumer demand remains healthy in all our markets, because viewers have a lot of choices, and they’re very careful with the choicest they make. They’re making smart choices. But you can see from our growth, in what was a pretty quiet quarter, particularly at the start because of the shadow from the Euro 2016 football event and then the Olympics that was a big free-to-air shadow. We’re still seeing good growth. And I wouldn’t particularly differentiate any of our markets, sometimes the challenges are little bit different. In Italy, the economic is relatively subdued the consumer in real terms haven’t got as much purchasing power as they have a few years ago. But yes that was our fastest growing market.
In Germany, we saw good absolute growth, and a lot that was just about getting our preposition right. We're putting new value in that preposition every day. There are new bricks in the wall, as we seek to build out a fully rounded Pay TV preposition of the sort that you see in the UK. And then the UK consumer is still buying, albeit with the level of maturity in the UK market more of that growth is coming from new services, like Now TV pay-as-you-go service. But I would say healthy. And it's up to us to make the most of those opportunities and to post great numbers that we have.
And also just because there is a big focus for us, and you've seen we've moved to this trading statement format that actually we’ve got a lot more ways of growing, so our revenue growth exceeds the volume growth in each of our markets. And we've seen great take up of things like our transactional services. We think we’re now either toe-to-toe, well sometimes bigger as a retailer of movies to buy to own than an iTunes or in Amazon. So, we’re growing in the new categories as well. And there because we’re taking share, we’re not finding any inability to grow, whatsoever, because we were just switching from a different platform potentially.
But the UK ad market was tough. We saw -- the other markets are less about the market growth and more about share. We have an abundance of headroom in the German and Italian advertising markets. So, we don’t need those markets to grow. For us to grow our revenues, we’re up 25% in Germany. And I didn’t even know what happened to the German ad market, so it certainly can grow anything like that percentage that was coming from other incumbent.
The UK was a bit weaker, and we've got a big market share in the UK ad markets. Only a very small proportion of our business is ad revenue or ad dependent, but we estimate the UK ad market was down by between 3% and 4%. And right now that would be my outlook for the current quarter, albeit we typically see -- or if there is late money in the market. We have a forward and a spot market in the UK advertising. If there is late money in the spot market, we wouldn’t necessarily get cited that yet, so there is not perfect visibility.
And then let me finally finish up on Ad Smart. We get typically a two or three times yields CPM yields on targeted advertising that we would for a normal linear spot asset. And the reason is typically because the next best alternative of that advertiser is comparing with is not linear TV but is a direct mail campaign, its local press, or its digital. And those tend to be the higher priced, if you want quality, they tend to be higher priced and less efficient media. So that's what's driving the pricing. There has to be a spread versus spot, or it wouldn’t be efficient for us to use the inventory in that way. But we would manage to hold on to that pretty constant since we launched Ad Smart.
In any bigger advertisers or verticals or strategies which have really driven the traction of the Ad Smart product at this stage?
It's pretty diverse. We've had over 1,000 different campaigns now run within Ad Smart. So, almost every sector and almost every attribute that we sell, but there is a demographic attribute or post code, which still remains the most popular. Targeting ads based on postcode, whether that's drive-time or regional franchise, or a product that's only appeals to a certain part of the UK. So lot of it is targeted by postcode. And big users, I would highlight, would be autos. The auto sector is naturally -- they understand the segment well, their products appeal to different diverse parts of the base. And there is often a geographic nature to the places that they want to reach audiences. We see quite a lot of financial services; again, because it can be used to target a premium affluent audience, or an audience that has, for example, how ownership criteria. So, those are just two front in line categories, but it really is very diverse.
And then my last one is just on the state of competition that you’re seeing with the SOVD services in the market. What would you say the impact is in terms of your core subscriber growth? And then also in terms of competition that you may see from them in terms of why to take content and rates that you have to pay?
I don’t think we’re seeing a big impact on our growth. It's another choice for customers. Very typically, the two services don’t sit directly toe-to-toe. People will often look an escort service, either they want me to take pay at all, they were just going to stick with free and it's a supplement, and which get to really in the market to offer them that product. Or more-more commonly they have already go a Pay TV subscription with a Sky or a Virgin, and they would look at one or more escorts as a top-up, as supplement on top. And that much has -- the customers have always, maybe gone and bought DVDs in addition to taking a Pay TV service.
Similarly, in terms of competition for rights, there is always competition for rights. That’s come from -- multiple areas, different sources, including through the L-3 to our broadcasters are probably our biggest single competitor in each territory. What we deserve is haven't seen any difference in that trend over the last few years. For example, in the UK -- in all our markets, we typically have all of the first pay rights. So, unlike I think some of these escort services in the U.S. where they participate against MSOs to buy the first-pay window that is not feature of the services in Europe. They trade a little bit more on their original content, the same original content from the U.S., but they don’t have, for example, a big strength in movies. The only movies they have on their services in Europe are non-exclusive, live re-movies, where as I do understand some of those services in the U.S., part of their appeal is front list movies. All of which in the case of the UK would be on Sky.
Thank you. There are no further questions at this time. I would now like to hand the call back over to Mr. Andrew Griffith for any closing remarks. Please go ahead sir.
Thank you very much for joining us this morning. I hope you all have a good day. From our perspective, we’ve had a good start to the year. The business is in good shape. And we’re on track to deliver our full-year profit expectations. And for those of you that either will travel or would like to listen-in, I wanted to remind you, we’re holding an Investor Day here at Sky next Thursday. And I look forward to seeing or hearing from many of you then. Good-bye. Thank you.
That does conclude today's conference. We appreciate everyone's participation. You may now disconnect.
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