Operating reviewFinancial review
Total revenue for the year increased by 8% on the comparable period to £4,148 million. Total operating costs increased by £251 million to £3,271 million generating a Group operating profit of £877 million. This result includes an operating loss from the first time consolidation of Easynet of £11 million and the first phase of the Group's investment in the roll-out of its residential broadband business of £12 million.
Revenue
DTH revenues increased by 6% on the
comparable period to £3,154 million,
which was principally driven by 5% growth
in the average number of DTH subscribers.
Wholesale revenues continue to disappoint, growing by only 2% for the second consecutive year to £224 million. This largely reflects the decline in the absolute number of Pay-TV cable customers taking one or more premium channels, offset by changes to wholesale prices.
Advertising revenue for the full year continued to outperform, growing by 4% on the comparable period to £342 million against an estimated 0.2% decline in the UK television advertising sector. This principally reflects a further one percentage point increase in Sky's share of the UK television advertising sector during the year to 13.0%.
As announced on 25 April 2006, following recent changes in industry practice regarding the accounting for betting revenues and costs under International Financial Reporting Standards (“IFRS”), betting payouts have been netted against Sky Bet revenues. Accordingly, all financial results, including comparatives, have been prepared on this basis. There is no effect on operating profit.
Sky Bet revenue for the year was £37 million, an increase of 16% which reflects the strong growth in both Sky Vegas and sports betting. Gross Sky Bet revenue for the year was £341 million.
Sky Active revenues were £91 million for the year. Good rates of growth in both interactive advertising and enhanced TV service revenues were offset by the absence of SkyBuy revenue, following the closure of the business in the final quarter of the last financial year.
Other revenue grew strongly, increasing by 49% to £300 million. This reflects the first time consolidation of the Easynet corporate business (£76 million) and underlying growth of 11%, relating to the full year effect of Sky credit card revenues and the Sky News channel five contract.
Programming
Total programming costs continued to
reduce in absolute terms, falling by £36
million on the comparable period to under
£1.6 billion. This enabled the Group to
make significant progress in expanding
gross margin, which increased by a further
four percentage points during the year
to 61%.
Sports costs increased by £16 million to £766 million. The additional costs associated with the new ECB cricket contract, which started to be amortised in May 2006 and an additional cricket tour during the year were offset by the absence of the Ryder Cup, which is a biennial event. The Group expects sports costs for the 2007 financial year to increase by around £50 million behind an outstanding line-up of sporting events over the next twelve months, including live cricket from the new ECB contract and a number of non-annual events, such as the Ryder Cup in September 2006 and the 2007 Cricket World Cup and qualifying matches for UEFA Euro 2008.
Movie costs for the year were £310 million, a saving of £33 million on the comparable period and the lowest absolute cost for six years. This saving reflects contract renewals, the phasing of title delivery and a foreign exchange benefit of £8 million from a more favourable average exchange rate at which US dollars were purchased. The Group expects the recent contract renewals with three of the 'Major' Hollywood studios to deliver further cost savings on a per subscriber basis over the next two to three years.
News and Entertainment costs were £200 million, reflecting a combined increased investment of £20 million in Sky One commissioned programming and Sky News.
Third party channel costs fell by 11% on the comparable period to £323 million, a reduction of £39 million. A 5% increase in the average number of DTH subscribers was more than offset by a 15% reduction in the cost per subscriber to £3.37 per month.
Other operating costs
Total other operating costs increased by
£287 million to £1,672 million, including
£107 million of operating expenses from
Easynet and initial broadband expenses.
Excluding these items, other operating
expenses increased by £180 million on
the comparable period.
Marketing costs for the year were £622 million, an increase of £95 million on the comparable period. Marketing costs to new customers grew by £51 million to £359 million. This reflects an absolute increase in the number of new customers and a growing percentage of customers taking new products. During the year, 18% of new customers chose to take Sky+ from day one, as opposed to 13% last year. As a result of this activity, the total average subscriber acquisition cost increased by £24 on the comparable period to £261. During the year the rate at which existing customers upgraded to Sky+ and Multiroom also accelerated, which led to an increased investment of £23 million. Above the line marketing remained broadly flat at £75 million and retention and other marketing costs increased by £18 million on the comparable period to £110 million.
Subscriber management costs grew by £76 million to £468 million. This reflects the first time consolidation of Easynet and broadband expenses (£12 million), depreciation of the new customer management systems of £26 million and underlying growth of £38 million due to the expansion of the Group's customer management operation to further improve customer service levels and manage the increase in sales activity. During the year Sky expanded its existing customer service operations in Scotland, adding 1,500 new customer advisor positions and 600 new home installation engineers in preparation for the roll-out of broadband and providing the Group with one of the largest customer service and home installation workforces in the UK.
Transmission costs were £234 million, an increase of £63 million on the comparable period, which entirely related to the first time consolidation of Easynet and broadband costs of £63 million. Underlying transmission costs were flat on the comparable period.
Administration costs grew by £53 million on the comparable period to £348 million. This mainly reflects the inclusion of Easynet and broadband administration expenditure of £29 million and increased depreciation of £16 million as a result of the Group's infrastructure programme which commenced in August 2004.
Total operating profit grew by 7% on the comparable period (which benefited from a one-time £13 million receipt of ITV digital programming receivables) to £877 million. Group operating profit margin for the year was 21%.
Joint Ventures
The Group's share of net profits from its
joint ventures was £12 million, a reduction
of £2 million on the comparable period.
This reflects the disposal of the Group's
holding in Granada Sky Broadcasting and
Music Choice Europe and lower operating
results from the History Channel which has
been partially offset by improved results
from National Geographic and Attheraces.
Interest
The total net interest charge for the year
was £91 million, an increase of £33 million
on the comparable period. The higher
charge reflects an £18 million non-cash
movement in the mark-to-market valuation
of non-hedge accounted derivatives,
interest payable on the guaranteed notes
issued on 20 October 2005, which raised
net proceeds of around £1,014 million and
the net impact on interest following the
acquisition of Easynet.
Taxation
The total tax charge for the period of
£247 million includes a current tax
charge of £141 million and a deferred tax
charge of £106 million. The mainstream
corporation tax liability for the period was
£147 million and in accordance with the
quarterly payment regime, £95 million
was paid during the year in respect of
this liability.
As a result of the acquisition of Easynet, the Group recognised a deferred tax asset of £83 million during the year, representing timing differences on fixed assets. The current tax charge has benefited from a partial unwind of this asset in the current year of £59 million, reducing the cash tax liability due in respect of the current year profits accordingly. The balance is expected to unwind in future periods.
Earnings
The Group's adjusted profit for the year was
£561 million, generating adjusted earnings
per share of 30.7 pence, an increase of 9%
on the comparable period. Including a
mark-to-market movement, net of tax, of
£10 million, the Group's profit for the year
was £551 million generating basic earnings
per share of 30.2 pence.
Cash Flow
Sky's cash flow generation continued to
be very strong with operating cash inflows
exceeding £1 billion for the first time.
Earnings before interest, tax, depreciation
and amortisation (“EBITDA”) increased by
11% to £1,017 million. After a small net
working capital outflow of £13 million,
following the payment in the quarter of
the deposits for the recently secured FA
Premier League rights, the Group generated
a cash inflow from operations of £1,004
million. After taxation of £172 million,
net interest payable of £62 million, net
proceeds from joint ventures of £5 million
and capital expenditure of £212 million,
the Group generated £563 million of free
cash flow. A total of £599 million was
returned to shareholders through a
combination of the ordinary dividend and
share buyback programme and a net cash
outflow for acquisitions, primarily for the
acquisition of Easynet, was £209 million.
After the inclusion of share option
purchases and proceeds and the
revaluation of long-term borrowings and
borrowing-related financial derivatives, the
Group's net debt increased by £373 million
during the year to £761 million.
During the year the Group made further progress on its capital expenditure and infrastructure programme. The Group spent £38 million completing the final stages of the project to upgrade and implement new customer management systems, which went live for all DTH customers on 31 March 2006. A total of £37 million was spent unbundling exchanges and readying the business for the launch of Sky Broadband and £16 million was invested to progress the Group's property, business continuity and infrastructure projects. The Group invested £10 million to upgrade its production and broadcast facilities ahead of the launch of high definition services and capitalised £14 million of smartcard development costs. The remaining £97 million was spent on a number of projects, such as IS infrastructure, broadcast equipment and the development of new products and services.
Distributions to shareholders
The Board of Directors is proposing a final
dividend of 6.70 pence per ordinary share,
resulting in a total dividend for the year of
12.20 pence and consistent with the Board's
statement in February 2006 that it intended
to reduce target dividend cover from
approximately 3.0 times to approximately
2.5 times underlying earnings.
In light of the continued cash generative nature of the Group, it is the Board's aim to maintain a progressive dividend policy throughout the investment phase of the recently announced broadband strategy. It is therefore the Board's current intention to reflect the underlying growth in earnings when setting future dividends, resulting in continued real growth in dividend per share.
The ex-dividend date will be 25 October 2006 and, subject to shareholder approval at the Company's Annual General Meeting, the dividend will be paid on 17 November 2006 to shareholders on record on 27 October 2006.
During the year the Group repurchased for cancellation 76.4 million shares for a total consideration of £408 million, including stamp duty and commissions. This comprised 22.7 million shares which completed the authority granted on 12 November 2004 and 53.7 million under the current authority granted on 4 November 2005.
Corporate
On 18 July 2006, the Group launched
Sky Broadband, a compelling and exclusive
broadband product for Sky customers,
which offers great value and a range of
packages to suit different usage needs
within the home. The packages range from
a free service, “Base”, offering downloads
speeds of up to 2Mb to a fast 16Mb
connection, “Max”, for £10 per month.
All packages come with a free wireless
router, free 12 months McAfee Security
and the option of a professional home
installation. The launch of Sky Broadband
and Sky Talk, a telephony product for Sky
customers, enable the Group to enter the
highly valuable and growing markets of
broadband, telephony, and related services
for the first time. Whilst these markets
offer attractive opportunities on a
standalone basis, the Group believe that
these new products will have potentially
significant benefits to the Group's core pay
television business.
On 20 October 2005, the Group made a recommended cash offer for the entire share capital of Easynet Group plc. The offer became unconditional in all respects on 6 January 2006. Easynet was de-listed from the London Stock Exchange in February 2006 and the acquisition of Easynet was completed on 10 March 2006.
On 14 October 2005, the Group announced a private placement with institutional investors which raised net proceeds of approximately £1,014 million from the issuance of guaranteed notes by its wholly owned subsidiary, BSkyB Finance UK plc.
Balance sheet
Goodwill increased by £206 million,
from £417 million at 30 June 2005 to
£623 million at 30 June 2006, primarily
due to the purchase of Easynet.
Property, plant and equipment and intangible assets increased by £200 million, from £537 million at 30 June 2005 to £737 million at 30 June 2006, due to £232 million of additions in the year, including refurbishment of leasehold properties, investment in the broadband network, IT infrastructure and further investment in customer management systems, assets acquired on the purchase of Easynet of £108 million, partly offset by depreciation and amortisation of £140 million.
Current assets increased by £920 million from £1,363 million at 30 June 2005 to £2,283 million at 30 June 2006, predominantly due to an increase in short-term deposits of £453 million and cash and cash equivalents of £313 million principally due to the receipt of proceeds from the issuance of Guaranteed Notes on 20 October 2005.
Current liabilities increased by £383 million from £1,150 million at 30 June 2005 to £1,533 million at 30 June 2006. This increase was due to the reclassification of £162 million of borrowings from non-current to current liabilities (relating to a Guaranteed Note that is repayable in October 2006) and the timing of payments.
Non-current borrowings increased by £843 million, from £982 million at 30 June 2005 to £1,825 million at 30 June 2006, primarily due to the issuance of new Guaranteed Notes. The new Guaranteed Notes, which were issued on 20 October 2005, consist of (i) US $750 million aggregate principal amount of notes paying 5.625% interest and maturing on 15 October 2015, (ii) US $350 million aggregate principal amount of notes paying 6.500% interest and maturing on 15 October 2035 and (iii) £400 million aggregate principal amount of notes paying 5.750% interest and maturing on 20 October 2017.