Andrew Griffith

Andrew Griffith

Chief Financial Officer

Review of the year

We have had another strong year of growth in which more customers took more products than ever before. High Definition (HD) was a standout performance reaching 30% penetration of the customer base, and we've continued to grow our share in home communications with one in five customers now choosing to take all three of TV, broadband and telephony. Our operational performance is translating into strong financial results with double digit growth in each of revenue, operating profit, cash flow and record earnings per share.

Operational review

The business performed well in what continues to be a tough consumer environment, with strong demand for our products across the board. Net customer additions for the 12 months to 30 June 2010 (the year) were 418,000, bringing the total base to 9.860 million. Within this, gross additions and churn were in line with last year at 1.4 million and 10.3%, respectively.

We continue to see good success in our multi-product strategy where, in recent years, we have driven a step change in the way we grow our business. While we have continued to attract new customers, we have also added a second leg of growth by selling more products to each of those customers. Over the last three years, we have grown from a base of 2.9 million additional subscription products to 11.7 million today, with another strong performance in the current year.

HD has gone from strength to strength with net additions more than doubling year on year. At the same time customers are choosing broader bundles of services, with one in five now taking all three of TV, broadband and telephony - from a standing start four years ago. As customers rewarded us with more of their business, ARPU reached a new high of £508, up 9% year on year.

Content

Customers continue to respond strongly to the breadth and depth of our TV offering. Sky1 continued its track record of bringing more cut-through content to customers, achieving strong audiences for talked about programmes such as Pineapple Dance Studios, Modern Family, Strike Back and Going Postal. As a measure of success, the number of Sky1 shows achieving audiences in excess of one million almost doubled during the year.

Sky News HD, Europe's first HD news channel, launched on 6 May 2010 to coincide with the General Election. A total of 20 million viewers across the UK tuned in to watch Sky News during the fourth quarter, up 15% year on year. The Sky News Leaders' Debate, broadcast live from Bristol on 22 April, attracted Sky News' highest ever audience, reaching 6.5 million viewers across all channels where the programme was shown.

Sky Arts continued to demonstrate how we can offer distinctive content to underserved segments of the audience. Average monthly reach across the Sky Arts portfolio increased to 1.7 million in the fourth quarter, up 16% year on year, with high-quality, original content including In Confidence, Songbook, Playhouse: Live and The Book Show presented by Mariella Frostrup.

Sky Sports benefited from a strong close to the Premier League season and drew its highest ever audience for cricket, with 2.3 million viewers to the World Twenty20 final. Following the launch of Sky Sports News HD in August, the only place to enjoy the breadth and depth of all five Sky Sports channels in HD will be on Sky. At the same time, Sky Sports News will become a pay-exclusive channel.

High definition

We have continued to see strong demand for Sky+HD from both new and existing customers. At the year end, 30% of our customers are choosing to pay for our best viewing experience, the top end of our original range of expectations. We added over 1.6 million net HD customers in the year, more than double the rate of growth in the prior year, bringing the total customer base to just under three million.

Ownership of HD TV sets continued to rise and this calendar year will see the number of HD-Ready households exceed standard definition homes in the UK. We identified the opportunity in HD early and have seen a strong response to our decision to lower the upfront cost of the box in January 2009 and again in January 2010. The second of these reductions was fully funded through supply chain efficiencies, with no impact on per customer economics. In 18 months, the percentage of customers choosing HD has more than tripled and is now generating a significant, high-margin revenue stream.

Broadband and telephony

We continue to see strong demand for our home communications products. During the year we added 421,000 broadband customers taking the base to 2.6 million, 517,000 telephony customers taking the base to 2.4 million, and 769,000 line rental customers taking the base to 1.7 million. In addition, we now have 883,000 customers on our fully unbundled network following completion of its roll-out.

This year, we significantly improved the returns in our broadband and telephony business, which moved into profitability for the first time in the fourth quarter. This performance reflected a number of initiatives over the last 18 months, including an improved take-up of bundled products and a continued focus on cost efficiency. As a result, we have improved the economics of growth going forward, with every customer now making a positive financial contribution.

Financial summary

For the year, we delivered double-digit growth in each of revenue, operating profit, cash flow and earnings on an adjusted basis. Reported operating profit was £1,096 million (2009: £813 million) and included a net exceptional gain of £241 million (2009: £33 million gain) leading to adjusted operating profit of £855 million (2009: £780 million). Reported profit after tax of £878 million (2009: £259 million) included a net exceptional gain of £336 million (2009: £192 million loss) leading to adjusted profit after tax of £542 million (2009: £451 million). For more information on adjusting items please refer to 'Exceptional items'.

Adjusted revenue increased by 11% to £5,912 million, reflecting a growing customer base and success in our multi-product strategy. Adjusted operating profit was 10% higher at £855 million, generating margin of 15.5% in the fourth quarter, the second successive quarter of increase and the highest quarterly margin for two years. Adjusted basic earnings per share (EPS) increased by 20% to reach a record 31.1 pence, with reported basic EPS increasing to 50.4 pence reflecting both the EDS litigation settlement and the partial divestment of our investment in ITV plc. Adjusted free cash flow, excluding one-off items, increased by 23% to £626 million as we continue to efficiently convert profit to cash.

Reported revenue of £5,912 million includes £619 million related to Sky Broadband and Talk and £203 million related to Easynet. Reported operating profit of £1,096 million includes operating losses of £38 million attributable to Sky Broadband and Talk and an operating loss of £18 million from Easynet.

Revenue

Group revenue, excluding exceptional items, increased to £5,912 million (2009: £5,323 million), up 11% year on year (up 10% on a reported basis).

There was a particularly strong performance in retail subscription revenue, which increased by 15%, excluding exceptional items, to £4,761 million (2009: £4,141 million), reflecting a 4% increase in customers and a £44 year on year increase in ARPU.

Wholesale subscription revenue increased by £32 million to £238 million (2009: £206 million) benefiting from a higher number of subscribers to our premium channels and the return of Sky's basic channels to the cable platform.

In advertising, we increased our estimated share of the advertising sector by around two percentage points to 15.8%. Revenue for the year was 4% higher at £319 million (2009: £308 million), which was in line with the sector for the 12 months. While we remain cautious on the outlook for advertising, our agreement with Viacom positions us well.

Easynet revenue was level year on year at £203 million (2009: £202 million). On 21 July 2010, the Group announced that it entered an agreement with Lloyds TSB Development Capital (LDC), over the sale of its business-to-business telecommunications operation, Easynet Global Services.

Installation, hardware and service revenue was £174 million (2009: £235 million), with the doubling of HD customer additions more than offset by the lower retail price of a Sky+HD box.

Other revenue of £217 million (2009: £231 million) was 6% lower year on year, with the loss of conditional access fees from Setanta and the absence of third party set-top box sales associated with the former Amstrad business. This was partially offset by higher Sky Bet revenues.

Direct costs

Direct costs increased as the result of continued investment in content and the strong growth in our broadband and telephony business. Within this, programming costs were 9% higher year on year at £1,902 million (2009: £1,750 million) with increased investment across most categories, partially offset by rate savings in movies.

Sports costs accounted for two-thirds of the year on year increase, reflecting additional UEFA Champions League rights, new deals for events such as US PGA Tour golf and renewals for the Football League and rugby's Super League. Third-party channel costs were also higher, reflecting the new retail relationship with ESPN, as well as the launch of a further nine HD channels during the year and the full year impact of launches in the prior period. Entertainment and News spend increased slightly on the comparative period, with increased investment in more original commissions. Increases were partially offset by lower movie costs which benefited from improved terms on recent renewals from some of the major studios.

Direct network costs increased to £518 million (2009: £373 million) as a result of the 19% increase in broadband customers, the 28% increase in telephony customers and the 84% increase in line rental customers. In addition, we completed the migration of eligible customers to our fully unbundled network in the year, with all related charges fully expensed upfront. On an ongoing basis, migrating customers directly lowers the regulated monthly cost per customer by £2.43.

Other operating costs

Marketing costs increased by £211 million to £1,118 million (2009: £907 million), primarily reflecting the volumes of HD additions doubling year on year and our policy of expensing customer acquisition costs upfront. The proportion of new customers subscribing to HD directly on joining increased year on year, with almost half of gross additions in the fourth quarter choosing to pay an additional £10 a month for our HD channel pack. Above-the-line spend was also higher in the year as we continued to focus on HD in our marketing.

Subscriber management and supply chain costs (excluding exceptional items) were reduced by £24 million to £638 million (2009: £662 million), reflecting continued focus on operational efficiencies. In particular, we have achieved lower set-top box costs through greater in-sourcing of box design and manufacture, helping to offset the 21% year on year increase in net additional subscription product sales.

The cost to acquire a new subscriber increased by £31 to £339. This increase reflects strong demand for HD from customers joining Sky for the first time, offset by continued efficiencies in our supply chain and routes to market.

Transmission, technology and fixed network costs increased by £21 million to £374 million (2009: £353 million) reflecting higher IT costs and a stronger euro impacting transponder costs.

We have maintained tight control of 'back office' costs. Administration costs (excluding exceptional costs) were 2% higher at £507 million (2009: £498 million), reducing as a percentage of sales by a further 80 basis points. Over the last two years we have held administration costs broadly flat, achieving 150 basis points of improvement in operating margin.

Earnings

Net interest was £132 million (2009: £161 million) excluding income relating to the EDS litigation settlement, gains and losses relating to the remeasurement of derivative financial instruments not qualifying for hedge accounting and gains and losses arising from designated fair value hedge accounting relationships. Reported net interest payable was £70 million (2009: £185 million).

Profit before tax in the period of £1,173 million (2009: £456 million) includes the Group's share of results of joint ventures and associates of £32 million (2009: £19 million), a net interest charge of £70 million (2009: £185 million) and a profit on disposal of ITV shares of £115 million (2009: impairment charge of £191 million).

Taxation for the period was £295 million (2009: £197 million). The full year adjusted effective tax rate was 28%, as a result of new rules exempting foreign dividends from UK tax and the impact of the movement in share price on the tax accounting for share options.

Adjusted profit for the period was £542 million (2009: £451 million), translating into 20% growth in adjusted basic earnings per share of 31.1 pence (2009: 25.9 pence). Including all exceptional items, profit for the period was £878 million (2009: £259 million), generating reported earnings per share of 50.4 pence (2009: 14.9 pence).

Distributions to shareholders

Dividend per share: 2010 19.40p, 2009 17.60p, 2008 16.80p, 2007 15.50p

The Directors propose an increase of 10% in the full year dividend to 19.40 pence, continuing our track record of dividend growth.

Cash flow and financial position

Adjusted free cash flow increased by 23% to £626 million reflecting 11% growth in adjusted EBITDA, improved working capital and lower interest payments. This excludes £229 million cash received from the EDS litigation settlement after tax and £1 million of associated costs (2009: £3 million), as well as a £3 million receipt on closure of a joint venture, and £57 million for the purchase of freehold land (2009: £24 million). Adjusted free cash flow for the prior year excluded £7 million relating to a restructuring exercise. Free cash flow including these items was £800 million (2009: £474 million), up 69%.

During the year we completed the purchase of freehold land and buildings adjacent to our Osterley site for £57 million and let the site back to the current occupant in the short term. The comparative period included £24 million relating to the purchase of the freehold of part of our existing site. Both of these allow us to consolidate operations into a single, sustainable campus and make the most efficient use of our existing Osterley site. Excluding these amounts, capital expenditure was 3% higher at £387 million.

Strong cash flow generation during the year has contributed to the reduction in net debt of £660 million to £1,076 million (2009: £1,736 million). The combination of falling net debt and higher EBITDA over the past 12 months has reduced the Group's net debt to EBITDA ratio to 0.9x compared to 1.6x as at 30 June 2009.

The Group's liquidity and headroom are comfortable with no bond redemptions falling due until October 2015. As at the end of the year, cash and cash equivalents and shortterm deposits were £1,049 million and, in the fourth quarter, we extended our £750 million Revolving Credit Facility (RCF) by an additional year to 30 July 2013.

During the year, total assets increased by £235 million to £4,804 million at 30 June 2010. Non-current assets increased by £186 million to £2,818 million, primarily due to an increase of £180 million in non-current derivative financial assets resulting from mark-to-market movements on derivative instruments and an increase of £91 million in property, plant and equipment and intangible assets. This increase was offset by a decrease of £79 million in available-for-sale investments which was primarily due to the partial disposal of the Group's investment in ITV.

Current assets increased by £49 million to £1,986 million, predominately due to a £148 million increase in cash and cash equivalents and short-term deposits as a result of receipts on the settlement of litigation with EDS, the part disposal of the Group's investment in ITV and net cash generated from operating activities, offset by dividend payments and the repayment of the Group's current borrowings. This increase was offset by a £75 million decrease in trade and other receivables and a £43 million decrease in inventory.

Total liabilities decreased by £389 million to £4,244 million at 30 June 2010. Current liabilities decreased by £495 million to £1,699 million, primarily due to the repayment of current borrowings in July 2009. Non-current liabilities increased by £106 million to £2,545 million, principally due to a £179 million increase in the fair value of the Group's non-current borrowings mainly resulting from the weakening of pounds sterling against the dollar. This increase was partially offset by a £65 million decrease in non-current derivative financial liabilities.

Exceptional items

Results for the year included a net exceptional gain of £336 million (2009: £192 million loss), of which £241 million is included within operating profit (2009: £33 million gain). The total amount has been excluded from adjusted profits and earnings to show the underlying performance of the business.

The exceptional gain of £336 million comprises six elements:

  • Full and final settlement gain for litigation between Sky and EDS of £318 million; other related items £4 million gain.
  • Restructuring charge of £32 million relating to reorganisation costs and asset impairments.
  • Profit on disposal of £115 million from the placement of 404 million ITV shares (2009: impairment of £191 million).
  • Mark-to-market gains of £13 million, relating to derivative financial instruments not qualifying for hedge accounting and gains and losses arising from designated fair value hedge accounting relationships, recorded within net interest (2009: £24 million loss).
  • A £3 million gain from joint ventures and associates, related to a one-off receipt on closure of one of our joint ventures.
  • The related tax effect of the above items resulted in an exceptional tax charge of £85 million (2009: £4 million).

In relation to the EDS litigation settlement, £269 million was recorded within Litigation settlement income (included within operating profit) and £49 million within Investment income on litigation settlement. In addition, a £5 million credit related to the cancellation of accounts payable and was recorded within Subscriber management and supply chain costs, and a legal expense of £1 million was recorded within Administration costs (2009: £3 million).

In relation to the restructuring charge of £32 million, £10 million was recorded within Administration costs and related to restructuring costs which comprise principally redundancy payments incurred as part of business-wide actions to improve operational efficiency. The remaining £22 million was recorded within Subscriber management and supply chain costs and relates to the impairment of Picnic - our proposed pay TV service over the DTT network. Picnic was proposed in February 2007 and in April 2007 Sky submitted its application to Ofcom for the necessary approvals. In September 2008, with Ofcom's consideration of Sky's proposals still ongoing, Sky announced its decision to suspend preparations and cease work on the project. The impairment reflects our decision not to proceed with a DTT pay service in the form originally envisaged.

Results in the prior year also included an adjustment to Retail subscription revenue of £36 million representing amounts invoiced in prior years, which did not meet revenue recognition criteria under IFRS until March 2009 and an adjustment of £6 million relating to a deferred tax write-off following a change in law in the period in respect of industrial building allowances.

21%

Customers taking all three of TV, broadband and telephony

£508

ARPU (average revenue per user)

+15%

Adjusted retail subscription revenue

+20%

Adjusted basic earnings per share

Our performance