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Edited Transcript of SKY.L earnings conference call or presentation 20-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 Sky PLC Earnings Call (US Analysts and Investors)

Isleworth Middlesex Jun 4, 2017 (Thomson StreetEvents) -- Edited Transcript of Sky PLC earnings conference call or presentation Thursday, April 20, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew John Griffith

Sky plc - CFO, Group COO and Executive Director

* Jeremy Darroch

Sky plc - Group CEO and Executive Director

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Conference Call Participants

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* Allan C. Nichols

Morningstar Inc., Research Division - Senior Equity Analyst

* Benjamin Daniel Swinburne

Morgan Stanley, Research Division - MD

* James Geoffrey Dix

Wedbush Securities Inc., Research Division - VP and Senior Research Analyst

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Presentation

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Operator [1]

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Thank you, and welcome to the Sky plc third quarter results conference call. Today's call is being recorded. Hosting the call will be Jeremy Darroch, Group Chief Executive Officer; and Andrew Griffith, Group Chief Operating Office and Chief Financial Officer.

This call is 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 respect to group financial conditions, business and strategy. All forward-looking statements are subject to risks and uncertainties. Further details of which are provided in Sky's 2016 annual report.

I would now like to turn the call over to Mr. Jeremy Darroch. Please go ahead, sir.

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Jeremy Darroch, Sky plc - Group CEO and Executive Director [2]

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Okay, thanks, and good morning, everybody. Thank you for joining us today. As you heard, I'm here with Andrew Griffith.

Now in terms of the agenda for the call this morning, what we'd like to do is first of all, I'll take you through some headlines. Andrew will then take you through the detail of our operating and financial performance, and then I will come back on a couple of areas before we take any questions.

It's been another strong quarter for Sky in what is our seasonally quietest period, and we continue to make good progress in implementing our strategy right across the group. We attracted more customers across our platforms and territories. We added over 0.75 million new customers in the last year, including 106,000 in the third quarter. Our total customer base now stands at 22.4 million households.

We've had a good financial performance. Group revenue grew by 11% and was up 5% on a constant-currency basis. This was in line with guidance, we delivered good growth across all territories in each of our categories. We achieved adjusted EBITDA of GBP 1.5 billion, and operating profit was in excess of GBP 1 billion, after absorbing the step-up in the new Premier League contract. This shows the strong underlying progress that we are making, and it includes, as part of that, strong growth in operating profit in Italy, Germany and Austria.

Looking forward, we entered the final quarter of our financial year in good shape. Whilst we expect the broader consumer environment to remain uncertain, we are on track for the full year.

I'll now hand you over to Andrew to talk through the detail of the operating and financial results.

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Andrew John Griffith, Sky plc - CFO, Group COO and Executive Director [3]

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Thanks, Jeremy. Good morning, everyone.

Let's start with the U.K. and Ireland, where we're making strong progress in a year of investment. We added 40,000 new customers, taking our total customer base to 12.7 million. Despite a weaker advertising market, our U.K. revenues were up 4%, with every part of our business growing, and our operating profit at GBP 918 million. In a big quarter for rights negotiations, we've secured long-term rights renewals with significant third-party providers, like NBCUniversal, UKTV, A+ E Networks and Discovery. And on Sky Mobile, we've most recently stepped up a gear with the launch of handsets at the end of March. We feature the latest devices at highly competitive prices, and give customers the option to upgrade their handset every 12 months, building on our unique offer to let customers save by rolling unused data every month.

In Germany and Austria, we've had another strong quarter, driving customer growth and market penetration. We added 73,000 new customers in the third quarter, taking our total customer base in Germany to 4.9 million, that's now over 1 million customers we've added, since our acquisition of Sky Deutschland. Revenues increased strongly by 10% in the period. EBITDA grew by 117%, and operating profit in Germany increased by GBP 43 million year-on-year.

[Find] Italy, where we've continue to deliver good revenue growth and strong operating leverage. Revenues on a like-for-like basis were up 4%, our fastest rate of growth in Italy for 8 years, and at GBP 91 million, our operating profit was over 3x higher than last year. Due to an ongoing contractual dispute with Telecom Italia, and more generally, the ongoing economic uncertainty in Italy, we gave back some of the year-on-year customer growth this quarter. However, our total customer base is still up 68,000 on the prior year and now stands at 4.8 million.

Turning to the financial results, and looking first at revenue, where we've delivered strong growth of 11% or 5% on a constant-currency basis. Within that, subscription revenue was up 4%. This is driven by strong customer growth over the last year as well as the June 2016 price change in the U.K. Weaker consumer markets in the U.K. and Italy have resulted in tougher advertising markets in calendar year 2017. Despite this backdrop, our advertising revenues across the group were up 4%, driven by a 30% increase in Germany to its highest ever level, and a 13% increase in Italy. Elsewhere, in some of our other new revenue streams, we're seeing faster rates of growth, with transactional revenue up by 10%, and program and channel sales increasing by 20%.

Moving on to cost. Total costs were up 8%, primarily reflecting the step-up in the new Premier League deal. We'll incur a further GBP 135 million in the final quarter, after which the cost will be flat for the next 2 years. Excluding the Premier League, costs only increased by 2%, which is well below the rate of revenue growth. Within that, operating costs were down 1%, as an absolute saving this period of GBP 36 million, reflecting the success of our efficiency programs across the group.

So bringing all this together, adjusted EBITDA was GBP 1.5 billion and operating profit was just over GBP 1 billion. Net debt was GBP 7.2 billion, that's over GBP 100 million lower than at the end of December, and with our net debt-to-EBITDA ratio at 3.1x.

So in summary, our financial results show strong execution and strategy, and we remain on track for the full year.

I'd now like to hand you back to Jeremy.

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Jeremy Darroch, Sky plc - Group CEO and Executive Director [4]

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Okay. Thanks, Andrew.

I wanted to conclude by rounding up the progress we've made on some of the growth plans that we laid out to the end of last calendar year. These are clear examples of how great content innovation and service are creating the best possible experience for our customers. Our content offering has never been stronger. Following a strong third quarter, customers can look forward to an exciting summer on-screen across our entire portfolio. Central to this is an outstanding standing slate of our own productions as well as a strong lineup of hit U.S. shows, and the seventh series of Game of Thrones. Movies will be providing access to the best premieres, with Hollywood blockbusters and popular local titles, including Jason Bourne, Captain America: Civil War and Puma, which is one of our own productions from Italy. As always, we have a strong summer of sport, with the climax of each of our domestic football leagues, in international rugby, the British and Irish Lions will take on the All Blacks, and in Formula 1, it looks like it could be the most wide-open championship for many years.

Finally, we're delighted to launch our third sport in Ultra HD, when we bring England versus South Africa in a test series to Sky Q customers, in July. We've also announced today some very exciting new partnerships that are a real validation of our Sky Original strategy. So we're joining forces with HBO to create a new global drama series powerhouse. This $250 million multiyear coproduction deal will bring together 2 of the world's leading direct consumer brands to commission and produce high-quality drama for a global audience. We expect to see our first commissions air in 2018, with initial product -- projects already in development. And in a big step forward for VR, we're teaming up with Sir David Attenborough and the National History Museum, with a ground breaking new interactive virtual reality experience, which customers will enjoy later this year.

Our innovation will continue a pace. We've recently launched a number of developments for Sky Q in the U.K., including a brilliant voice search and new personalization features, and we look forward to rolling out Sky Q to our other territories in due course. And we're making a major step change in our service delivery, once again, transforming the customer experience. So we launched our new Sky digital service in the U.K., and its heart is our new app, which has been downloaded by 1.2 million customers in the last 2 months since launch, and over the course of this year, we'll continue to enhance our digital service including our new messaging feature coming soon. All of this will have a dual benefit of improving the customer experience whilst also further transforming our cost base.

So in summary for the 9 months, each of our businesses are performing well. Despite the broader environment remaining uncertain, we continue to deliver on our strategy and remain on track for the full year.

Now as we move on to questions, I'd like to remind you that we're currently constrained by the Takeover Code as a result of the 21st Century Fox bid, and we're limited on what we can say about that topic, so we hope that you'll understand if we can't answer all of your questions.

But with that, I'll hand you back to the operator to take any questions that you have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from James Dix of Wedbush Securities.

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James Geoffrey Dix, Wedbush Securities Inc., Research Division - VP and Senior Research Analyst [2]

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Just first, how has your view of kind of consumer demand on the subscription side and kind of corporate's demand for advertising changed, since you last reported a couple of months ago? You made some references to the overall environment having some caution in it, but just wondering, how incrementally your view of that has changed based on what you're seeing in your business? And then, just more specifically in the U.K. market, how did your advertising come through in terms of growth in the first quarter versus your expectations? What's your outlook there for this -- for the final fiscal quarter? And then anything you had on just what you think the growth there is going to be for the calendar year versus your original expectations would be helpful. Then, I just -- one follow-up on AdSmart.

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Jeremy Darroch, Sky plc - Group CEO and Executive Director [3]

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Sure, James. Why don't I do the first question and then I'll get Andrew to do the second. I -- look, I think consumer demand feels like it's got a little bit tougher across probably all of our markets. The U.K., we've seen more inflation coming through in terms of household budgets, consumer confidence and retail figures have both been low. And we're just starting to see things like Brexit, now moving to -- into reality. Obviously, we've got election here. All these things I think just create a little bit less certainty in consumers' minds, and of course, we're a commitment, so they become a little bit more cautious. Italy, I think you saw, say, similar -- I mean different reasons, but similar sort of environment. Germany, I think less so, I think that it, that's pretty much stayed the same since we last spoke. So I describe that more as sort of slightly stronger headwinds more than anything else. I don't think it'll prevent us getting to our goals. We'll probably be a little bit different in terms of our trading strategy, and push harder behind the bigger initiatives we've got. Be careful not to overtrade the business too much. What we find in our markets is when things get a little bit harder, the market can get quite frothy in terms of promotions and you tend to see a proportion of customers spin a bit and we'll try and avoid getting involved in that. And so that would be my sense of where it is right now.

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Andrew John Griffith, Sky plc - CFO, Group COO and Executive Director [4]

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Yes, pretty similar on the ad market. We've definitely seen a slightly different tone from advertising clients since we've come into calendar 2017. For the quarter, in the U.K., this is I'm talking, James, we saw for the first calendar quarter, the market as a whole, down between 7% and 8%. Now we weren't down by anything like as much. We were only down 3%, underpinned by our growth in viewing and the quality of the audiences we deliver, but the market itself was poor. Now partly, that was due to the fact that Easter fell this year in April, versus in March a year ago. So Easter moved quarters. And so we'd expect the market to be up small single digits in April, and then May and June, slightly down on April and clearly the election isn't going to help corporate confidence in committing money to the market. But beyond that, we'll have to see. Now the only thing I'd say, just to give you overall context, is to a degree that was offset by a very strong performance in Germany, in particular, where advertising revenues were up by 30%, a big part of which was how our audiences are measured, deploying new panels, which have improved the ratings that we can then sell to advertisers in Germany. And in Italy, our advertising revenues were up 13%, in what was again a pretty flat market. So we're obviously playing on a broader European footprint now in advertising.

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James Geoffrey Dix, Wedbush Securities Inc., Research Division - VP and Senior Research Analyst [5]

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Great. So I guess, for the final quarter then, would you still expect the U.K. market to be a net-net down, and then obviously, Germany and Italy be up or are there any comp issues there that we need to think about?

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Andrew John Griffith, Sky plc - CFO, Group COO and Executive Director [6]

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We've got Euro 2016, which is a comp that would have seen some money in June last year. I think it's a little bit hard to call, but I'm not calling it up, let's put it like that. The risk is probably -- with the election now, the risk is slightly on the downside in the U.K. Same sort of trends in Germany and Italy as we've reported for the 9 months to date.

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James Geoffrey Dix, Wedbush Securities Inc., Research Division - VP and Senior Research Analyst [7]

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Great. And then just on AdSmart, I mean, how do you look at the competitive environment for AdSmart now as it's ramped up, as it's expanded its advertiser base? Do you have a clearer sense as to what are the most likely ad options which AdSmart is pulling from and competing with? And is that changing at all as the product scales?

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Andrew John Griffith, Sky plc - CFO, Group COO and Executive Director [8]

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It's also -- thanks, James. I mean, look, it's an evolution. The 2 categories that we saw best traction with early on were direct mail, which was always a product that was set up in a very segmented way, and people are purchasing direct mail found it easy to apply the same concepts and be able to segment and direct their advertising in TV for the very first time. And secondarily, press, because one of the key targeting features where you can target over 11,000 different categories now in AdSmart is a local, a regional play, the U.K. advertising market, this is true of most of the European advertising markets -- never really had a local TV ability. And so one of the most used segments or fields within AdSmart is the ability to target based on a particular catchment area or a drive time to a particular store, and so some of that money came out of local press. More laterally, and I don't want to overcall this, but more laterally, we've seen clients who have been spending big in digital look to AdSmart for the trust and transparency and the independent measurement that we offer. So I don't want to overstate that. There's a lot of money that goes into digital, and it was -- at the very least, take a long time for much of that to flow into AdSmart. But we would see it as an adjacent part and people like the digital tech giants as part of our competitor set when we're going to market with AdSmart.

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James Geoffrey Dix, Wedbush Securities Inc., Research Division - VP and Senior Research Analyst [9]

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Just 1 follow-up on that, I mean, any sense in talking to your people that there's an impact or a potential opportunity, which has increased because of the issues with the YouTube quality and brand safety maybe making more of those budgets available to you in the near term?

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Andrew John Griffith, Sky plc - CFO, Group COO and Executive Director [10]

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Opportunity, absolutely, James. I mean, we see that opportunity, we've always seen that. It is a very brand safe product. There's a world of difference between the quality of the context offered by some of the online players and the ability to pop your ad in the middle of a Premier League match on a Saturday afternoon or Game of Thrones or Big Little Lies. So there's a huge opportunity in terms of getting the quality and the context of our advertising to stick. I don't want to call that out yet though in terms of revenues. I would say, it was still at the anecdotal level, most of the stories we've seen reported extensively in the U.K., around the sort of content that some online advertising's been served up in is pretty new use and it's probably not yet fed through to media buying patterns.

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Operator [11]

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(Operator Instructions) We will take our next question from Ben Swinburne of Morgan Stanley.

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Benjamin Daniel Swinburne, Morgan Stanley, Research Division - MD [12]

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Two questions for you. Can you just a talk little bit, if you exclude sports rights fees, which obviously are rising at rapid rates and you have to deal with on a regular basis, and you look at entertainment spending, how do you think about the growth in content investment relative to your revenue growth? I was just wondering if you think there's leverage in the model because you obviously implemented a strategy to commission more of your own content, become more vertically integrated. I'm just wondering what that means to the financial model, longer term. And if that varies by market, I'd be curious. And then I have a second somewhat unrelated question which is, and I apologize if you guys have talked about this before, but is there any impact you can articulate to us from the Ofcom changes to wholesale rates, either in your strategy or your business model or your profitability that we could think about?

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Jeremy Darroch, Sky plc - Group CEO and Executive Director [13]

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Sure, I think -- well, I think in sports -- ex sports rights, I think there is leverage in the model, definitely. One of the things that we've done, a couple of things we've done is obviously broaden out our investment in content in those other areas, as you say, build more of our own commissions where we have greater direct control in terms of the level of investment we make, who we partner with, but also the back end, which is another source of efficiency, when we can hold on to more of the rights and sell them on into other market. So I think that's fair, definitely there. Whether we seek to take that or just keep investing in that area because we can see incremental growth on the back of it, I think there's just a fairly easy choice we can take on a sort of month by month, year by out-year basis. Probably, the priorities for us now having launched the entertainment channel in Germany is to keep going there and push hard to broaden out, and a little bit similar to that in Italy. I think the U.K. is where we are very well invested, and so probably, we've got more choices in the U.K. But we just seek the balance over the portfolio. But I think that option is definitely there for us. In terms of Ofcom rates, I mean, look, I don't think it particularly changes the strategy. Our assumption always has been that those rates would fall over time, and I think this is a good step that Ofcom have taken. There'll be further steps in the future. I think they'll be required, and so what it does is, it obviously -- just by reducing our own input cost over time, again, that gives us a chunk of capital that we can either choose to pass on to customers, deploy in more growth, perhaps advertise it a bit more or just let it flow through, depending upon how we're competing in the marketplace. So we haven't taken yet any decisions or firm thoughts on that, but again, we'll just do that as it comes through.

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Operator [14]

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We'll take our next question from Allan Nichols of Morningstar.

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Allan C. Nichols, Morningstar Inc., Research Division - Senior Equity Analyst [15]

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Can you talk a little bit more about the partnership with HBO? Will it be funded equally? Will you be doing just movies or will series be involved as well? And with revenue, once the productions have started, will that go back into the partnership to fund additional productions or will it be a split between the partnership, the 2 partners?

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Jeremy Darroch, Sky plc - Group CEO and Executive Director [16]

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So I think the -- basically, the way this all funding works is on a commission by commission basis. So we can decide there, according to what commission, and where -- how important is how we see what is the relativity of that, the relativity of that is and our focus is really on drama series rather than movies per se. But of course, as our relationship with HBO continues to deepen and we're always open to new ideas. Who knows where that might go to? And again, the sort of back stream revenues, depending on where it's sold, will effectively just flow back into the funding model in some shape or form. Our goal is to get to about 2 major drama series a year. We've got the first ideas that are being green lit now and we'll make some announcements on those fairly soon I think. And there's a group across both companies that will look at and green light these ideas, as and when they come through. So I think it's already -- I think we're really very excited about it. We think Discovery -- we think HBO are fantastic. They're a great organization to work with, brilliant creative leadership and commercial leadership as you know. And I think all of our experience with them has been positive, so I think we'll really be able to make a good fist of this.

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Operator [17]

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(Operator Instructions) And there are no further questions at this time. I would like to hand the call back to Jeremy Darroch for any closing remarks. Please go ahead, sir.

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Jeremy Darroch, Sky plc - Group CEO and Executive Director [18]

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Okay. Well, thank you, everybody, for joining the call today. Obviously, it's been another busy quarter here at Sky, but I think we'll exit the quarter with our business in good shape and more on track for the full year. So we look forward to talking to you all next time around, and have a good day. Thank you.