11 November 2015

TalkTalk Telecom Group PLC

Interim results for the 6 months to 30^th September 2015

·      Strong acceleration in growth with Q2 revenues up 5.9% (H1: +4.7%)

·      176,000 Revenue Generating Units added in period: +12.2% year-on-year

·      Growing quad-play and fibre penetration in base: mobile 16%; TV 39%; fibre 16%

·      On track to deliver FY16 in line with current market expectations pre-cyber attack impact  

·      Interim dividend raised 15% to 5.29p (H1 FY15: 4.60p)

·      Material EBITDA growth in H2 and lower net debt;  expect to grow final dividend by 15%

Cyber Attack

·    Significantly fewer customers affected than initially feared

·    Customer facing online sales and service channels now back in operation

·    One-off financial impact estimated at £30m-£35m

·    Offering all customers the choice of a free upgrade

H1 Financial Highlights

·      Total revenue up 4.7% to £912m (H1 FY15: £871m); Q2 +5.9%

·      On-net revenue up 7.6% (Q2 +8.9%), Corporate revenue up 6.2% (Q2 +6.7%)

·      Headline EBITDA¹ £90m (H1 FY15: £110m)

·      Operating Free Cashflow £38m (H1 FY15: £44m)

¹ Excluding exceptional items and amortisation of acquisition intangibles

H1 Operating Highlights

·      On-net ARPU up 6.1% to £28.08 (H1 FY15: £26.45)

·      On-net churn 1.5% (H1 FY15: 1.4%)

·      On-net Broadband base down 80k after 72k disconnections for non-paying customers

·      Underlying on-net net adds -8k (positive in Q2)

·      Mobile net adds +132k, Fibre +99k, TV +25k

Dido Harding, Chief Executive of TalkTalk commented:

We have delivered H1 results in line with our plan and revenue growth accelerated strongly through the second quarter.  We have a robust plan to deliver a significant step-up in profits in H2, underpinned by the benefits of our transformation programme coming through strongly.

We have recently been able to confirm that far fewer people were impacted by the attack than originally feared. However, TalkTalk takes the security of customers' data extremely seriously and we are taking significant further steps to ensure our systems are protected, as well as writing to all our customers outlining what we are doing to keep their data safe. In recognition of the unavoidable uncertainty, and because we know that doing what is right for our customers will ensure the best possible outcome for the company over the longer term, we are today announcing the offer of a choice of free upgraded services to all our customers.

TalkTalk is well established as the value for money provider in the fast growing quad play market and, notwithstanding the recent attack, remains well positioned to deliver strong and sustainable long term growth.

Presentation and Q&A                

9.00am - 10.30am

Roundabout Room, M by Montcalm, 151-157 City Road, EC1V 1JH

Dial-in:                                                 

+44 (0) 20 3003 2666

Replay (available for 7 days)

UK & International                        

+44 (0) 20 8196 1998 PIN code 2737849

Webcast: http://www.talktalkgroup.com/investors/results-centre

Enquiries

Investor Relations   

Mal Patel                      +44 (0) 20 3417 1037

Media

Isobel Bradshaw        +44 (0) 75 8470 8351

OUTLOOK

We remain confident of delivering FY16 results in line with current market expectations (pre the cyber attack) from continued strong revenue growth, improving gross margin and lower operating costs. 

While it is too early at this stage to assess the wider impact of the cyber attack on the business, early data on churn and retention activity in the days since the attack is encouraging.  Based on the exceptional and one-off costs including the revenue impact from the loss of online sales and service capability associated with the attack, we currently expect a financial impact of £30m-£35m in FY16.

We remain confident in a material increase in profits in FY17 and beyond, driven in part by the contribution made by Making TalkTalk Simpler and the significant step up in profits as we exit the current financial year.

SUMMARY FINANCIALS

(1) Excluding exceptional charges and amortisation of acquisition intangibles

(2) Operating free cash flow is stated before exceptional costs

H1 FY16 BUSINESS REVIEW

SUMMARY - Results in line with plan

In line with our plan to deliver 5% growth for FY16, revenue accelerated through H1 with Q2 growth of 5.9% resulting in growth for the half of 4.7%.  On-net revenue growth accelerated from 6.2% in Q1 to 8.9% in Q2, with overall H1 growth of 7.6%. ARPU also grew strongly during the half (+6.1%) driven by a 12.5% growth in revenue generating units per customer and pricing.  Together with Corporate revenue growth in the half of 6.2%, this more than offset the year-on-year impact on Off-net revenues from the disposal at the end of last year, of our Consumer off-net broadband base.

H1 EBITDA of £90m (H1 FY15:  £110m) was impacted by a significant planned investment in our transformation programme Making TalkTalk Simpler ("MTTS").

We expect a significant step up in EBITDA in H2 and accordingly the Board has recommended an increase of 15% in the interim dividend to 5.29p (H1 FY15: 4.60p).

BROADBAND - Improvement in underlying net adds during Q2

The broadband base has traditionally included both on-net and off-net customers across both our retail and wholesale business.

On 31 March 2015 we announced the disposal of the off-net consumer broadband base to Fleur Telecom, and as a result of this transaction TalkTalk is no longer active in the off-net consumer market.  We retain a small number (c90k) of off-net customers through our wholesale relationships in TalkTalk Business, but for the purposes of external reporting, we will no longer report the off-net base. 

As part of the Making TalkTalk Simpler programme, we have made a number of changes to the credit terms offered to our customers, bringing them into line with the wider industry. As a result of making this change we have disconnected from the base, 72k customers with credit terms exceeding 90 days resulting in an annualised cost saving of c£6m.

This adjustment reduces our opening on-net position from 4.18m customers on 1 April 2015 to 4.11m, comprising 3.37m retail customers (residential consumers and small businesses) and 0.73m wholesale customers.

In total the on-net base fell by 80,000 during the half, after disconnecting 72,000 non-paying customers as a result of changing our late payment policy from 180 days to 90 days.  On an underlying basis, net adds fell by 8,000.

As indicated at the time of our Q1 trading update in July, UK broadband market volumes were softer than in previous years, with promotional activity more intense.  Against this background we focused our selling efforts on cost-effective customer acquisitions only, with a resultant softening of gross add volumes.  With churn remaining stable during the quarter this led to lower Q1 net adds than in previous quarters. 

Q2 saw a return to more normalised market volumes and as a result we chose to participate more actively in the market and net adds growth recovered, helped by the migration of the remaining Virgin customers and some Tesco customers.

CHURN - Modestly up year-on-year but trend improving

Against a background of more intensive promotional activity, on-net churn across the half was higher at 1.5% than in the same period a year ago (1.4%).  Within this, we continued to see materially lower churn amongst customers taking TV, mobile and fibre in addition to their phone and broadband connectivity. 

Whilst we expect some near term impact on churn from the cyber attack in October, we remain confident of the prospect of material improvements over the longer term, from two key drivers: growing take-up of additional products such as TV, mobile and fibre, and from the fundamental transformation of customers' experience that Making TalkTalk Simpler is delivering.

MOBILE - Fast growing quadplay penetration

The mobile base grew strongly in H1 with 132,000 net adds taking the total base to 596,000 customers, 16% of the base vs 10% a year ago. Our Unlimited SIM, launched during the summer with a market leading promotional price of £12 per month, was particularly successful and has provided valuable insights into the demand patterns and behavioural characteristics of the fast growing SIM only market.  This, together with continued take-up of their bundled SIMs by our Plus TV customers, and further growth across our other value for money SIMs, helped drive our share of the new acquisitions SIM only market to 14.4% in H1 (FY15 H2: 10.3%).

We expect the economics of our mobile proposition to improve materially when we migrate customers from Vodafone to Telefonica.  We began the build of our new billing system during H1. Testing on the migration process has begun and we currently expect live customer migrations to begin in Q1 FY17. At that time we shall be able to offer 4G and national roaming services, and extend our mobile proposition to business customers.

We remain confident about the longer term prospects for our mobile business.  During FY17 we will complete the build of our own core network systems for the Telefonica MVNO, which will give us greater control over customer propositions and traffic management, driving further improvement in the economics. 

Beyond FY17, we see opportunities to scale the base materially, beginning with the roll-out of femto cells to drive down traffic costs across an inside-out network, and potentially building a larger macro-cell network depending on the regulatory remedies that might become available from consolidation in the sector.

FIBRE - Continuing strong growth with 99,000 net adds

We added 99,000 net new fibre customers during the half, taking the base to 578,000, 16% of customers vs 8% a year ago.  Demand has been helped by the introduction of our self-install option, with over 90% of H1 connections being self-install. 

We have made good progress with Ultrafast, our fibre to the premise trial in York with 262 triallists signed up from the 3,328 homes in the first phase of the build and registrations from the wider build area covering 6,000 homes, running at 50 per week.

TV - Integration of Blinkbox driving expanded capabilities

We added 25,000 new TV customers during the half, taking the total base of triple-play customers to 1.4m - 39% of the base vs 33% a year ago.  The lower volume of net adds reflects our disciplined trading approach during the half, in which we focused on driving lower CPA Mobile and Fibre customers against the backdrop of a more intensely promotional market in broadband and TV.

TALKTALK BUSINESS - Delivering profitable growth

TalkTalk Business generated over £550m of revenues in FY15 (over 30% of group revenues), at a gross margin of just under 40%. As such it is a significant, profitable and fast growing part of the group. TalkTalk Business ("TTB") offers a wide range of voice and data connectivity products to customers ranging from SoHo and SME businesses to multi-site national enterprises.  In addition through its partner channel, TTB is one of only two network providers in the UK to offer wholesale phone and broadband services across 95% of the UK to independent ISPs such as the Post Office and Utility Warehouse.

TTB is organised around products and channels to market. Through its Direct channel, TTB offers Business Broadband and high value Ethernet circuits, Legacy Voice, and Next Generation Voice services.  Through its Partner and Managed Wholesale Services channels, TTB generates wholesale data and voice revenues through long term relationships, several of which are multi-year contracts, primarily for the supply of consumer and small business phone and broadband services.  Carrier revenues are generated from the trading of voice-interconnect minutes. 

For external reporting purposes we include TalkTalk Business's revenues in the Group's reporting framework of On-net, Off-net and Corporate. This reflects our view of the key value drivers of our core phone and broadband connectivity business: customers that are on our network irrespective of whether they are directly acquired retail customers, or the customers of other ISPs with whom we have wholesale relationships, and therefore allow us to leverage our scale and efficiency.

Corporate

Corporate comprises data, carrier, legacy and next generation voice products, sold directly and via wholesale relationships, to systems integrators, enterprise customers and voice network operators. 

Our suite of data products, which are typically subject to multi-year contracts comprising Ethernet and Ethernet First Mile products offer competitively priced high speed connectivity that exploits our significant network capability and reach.  Data revenues generate returns significantly in excess of the group average and with 15% growth in H1 FY16, are the fastest growing product set in Corporate.  We have a significant and accelerating pipeline of data connections although conversion is dependent on BT Openreach performance, which to date has driven a substantial increase in the backlog of connections.

Carrier generated revenues of £55m in the half (+34% year-on-year).  While carrier revenues tend to be variable in nature, they are profitable, with gross margins of around a quarter of the group average but minimal costs below gross profit.

Voice comprises declining legacy revenues and our newly launched, next generation voice product powered by our recent tIPicall acquisition.  Voice revenues declined 11% year-on-year in H1.  We expect the rate of decline to moderate as the next generation services start to gain traction. tIPicall gives TTB class leading capability in the B2B VOIP (SIP) market and we expect to take a significant share of this growing market as it consolidates from 60+ players. 

On-net

The on-net base in TTB comprises directly acquired SoHo and SME phone and broadband customers, and the wholesale customers of other ISPs such as the Post Office and Utility Warehouse. The wholesale base of 770k customers accounts for c19% of the group's total on-net base and offers strong fibre and mobile cross-sell growth opportunities for the group.

Wholesale is a profitable channel for the group.  While ARPU and gross margin are below the group average, EBITDA margins are comparable to that of the Consumer business because of minimal costs to sell, costs to serve and SAC expense.  In addition, these customers provide stable long term revenues through our contractual relationships with their ISPs.

Off-net

As part of our comprehensive service to wholesale customers we provide a range of off-net products to those customers in TTB who are outside our network. 

MAKING TALKTALK SIMPLER

Making TalkTalk Simpler ("MTTS") is our wide ranging transformation programme that will deliver material improvements to our customers' experience, drive significant operating cost savings, reduce SAC through lower churn and CPA and ultimately, create a simpler business which in turn will enable sustainable revenue growth through a transformed brand reputation.

MTTS consists of five key work streams focused on driving simplification of our network model, improving our fault management and order provisioning journeys, enhancing omni-channel service and improving credit and billing processes. The programme is expected to take until the end of FY17 to complete and we expect it to deliver annualised cost savings in excess of £90m across our cost of sales, operating cost and SAC lines through FY16 and FY17.

We made significant progress on all five work streams in H1, achieving £6m of cost savings and exited the period having completed most of the work required to deliver the full year benefits for this year. We plan to complete c70% of the work required to achieve next year's benefit by the time we exit this financial year and to achieve financial benefits of £25m-£30m in H2.

The recent cyber attack, highlights the need to put customers first and to build simplified, resilient processes. MTTS remains at the heart of this process and whilst we may need to reprioritise some of our technology work streams over the coming months, we do not expect the scale of financial benefits available to change.

CYBER ATTACK

On 23^rd October we informed customers that we had been the subject of a criminal cyber-attack that may have led to the theft of data including customer names and email addresses, credit and debit card details, and bank account information.  On the basis of the information we had at the time, we informed all our customers of the attack and the potential risk to their data. We took this decision so we could warn all our customers and help protect them, in advance of being able to identify who was directly affected.

Following forensic analysis of the attack, we were able to confirm that 4% of TalkTalk customers have any personal data at risk:

·     The total number of customers whose personal details were accessed was 156,959;

·     Of these customers, 15,656 bank account numbers and sort codes were accessed;

·     28,000 obscured credit and debit card numbers were accessed but cannot be used for financial transactions, and were 'orphaned', meaning that customers cannot be identified by the stolen data.

The Metropolitan Police have launched a criminal investigation into the attack, and the Board has launched an independent review led by James Powell, an independent non-executive director.

We are confident that putting our customers first by ensuring the security of their data and rewarding their loyalty is the right thing to do for the business and our shareholders, and will in time, more than mitigate any lasting impact of the attack.  We have already contacted all directly affected customers, and we are writing to all our customers regardless of whether they were directly affected or not to explain what we are doing to protect their data going forward, and offering them the choice of a free upgrade from 1^st December.

Based on the exceptional and one-off costs including the revenue impact from the loss of online sales and service capability associated with the attack, we currently expect a financial impact of £30m-£35m in FY16.

H1 FY16 FINANCE REVIEW

REVENUE

Revenue for the period increased by 4.7% year-on-year to £912m (H1 FY15: £871m), with strong growth in On-net revenues (7.6%) and Corporate revenues (6.2%) offsetting a 41.3% decline in Off-net revenues.  Growth accelerated through the half with Q2 revenues up 5.9% (On-net +8.9%, Corporate +6.7%).

On-net revenue growth was driven by ARPU growth in H1 of 6.1% from pricing and proposition, and an increased penetration of Revenue Generating Units per customer (from 1.46 in H1 FY15 to 1.64), offset by declining voice usage and mix.

Corporate revenue growth benefited from continuing growth in Data revenues (+15% year-on-year) and Carrier (+34% year-on-year), offset by a reduction in Legacy Voice revenues of 11% year-on-year.

The decline in Off-net revenues reflects the impact of the sale of our off-net Consumer broadband base to Fleur Telecom on 31 March 2015.

OPERATING COSTS

Operating costs increased by £28m in the period to £245m.  We incurred costs related to MTTS, continued to invest in expanding our network capacity, and invested further in innovation.

Infrastructure costs including IT and network costs increased £13m in the period reflecting our ongoing investment in security, capacity and customer usage; with our other innovation projects, principally ultrafast fibre and mobile, seeing a £5m increase in operating costs from systems development.

In order to achieve planned savings from MTTS we incurred a combination of restructuring costs which were treated as exceptional charges, and also incremental operating costs. A total of £15m of one-off costs were incurred in the period, related to double running elements of our property and contact centre estate, adding new capabilities to our workforce and implementing changes to our credit and disconnection policy.  These costs are expected to reduce materially in H2.

The MTTS programme delivered £6m of savings in the period and remains on track to deliver an incremental c£21m of operating cost savings in H2, out of total forecast savings across the P&L for the full year of £31m-£36m.  

SAC

SAC and marketing costs, at £152m were flat period on period with lower broadband and TV connections offset by the growth in fibre and mobile.  The fibre base grew by 88% year on year in the period, with the successful deployment of self-installation driving in a net reduction in fibre SAC.  In total 94% of fibre customers (H1 FY15: 4%) are now using self-install.

Mobile also expanded significantly in the period with SAC costs up although at a lower Cost Per Add as a result of higher numbers of SIM-only customers in the mix.

We expect to see material savings in SAC during the second half from MTTS, Cost Per Add and volume benefits, and by changes in a number of our distribution channels.

EBITDA

EBITDA decreased 18% year-on-year to £90m (H1 FY15: £110m) with EBITDA margin decreasing to 9.9% (H1 FY15: 12.6%), as a result of increased operating costs in H1 offsetting the impact of revenue growth in the period.

Exceptional items and amortisation of intangibles

Exceptional Items

1. Making TalkTalk Simpler - We incurred £19m of exceptional costs in H1 related to delivering MTTS, and expect full year exceptional costs for the programme to be c£30m.

2. Acquisitions and disposal - at 31 March 2015, the group provided £10m in relation to the costs of migrating the Tesco and Virgin Media broadband customers onto the TalkTalk network. In total £7m of costs were incurred in the period, primarily in relation to the Tesco and Virgin Media migrations.

During the period we completed the Virgin Media broadband migration and in line with the contractual terms adjusted the purchase consideration to take account of the final number of customers which had been successfully migrated. A credit of £3m was recognised in exceptional income, which was partially offset by £1m of costs related to the sale of the off-net base to Fleur Telecom.

Amortisation of acquisition intangibles - The amortisation charge in respect of acquisition intangibles remained stable at £5m (H1 FY15: £5m).

PROFIT BEFORE TAX

Profit before tax reduced to (£8m) (H1 FY15: £20m) driven by the increase in operating costs and higher exceptional costs.

TAX

The effective tax rate applied the headline profits remains in line with statutory rates at 20% (H1 FY15: 20%) with the impact of exceptional costs resulting in a statutory tax credit of £1m (H1 FY15: (£5m)).  Consistent with the prior period, the utilisation of tax losses resulted in cash tax being £nil in H1 FY16.

EARNINGS PER SHARE

Headline basic and diluted earnings per share both reduced by 1.7p year-on-year to 1.2p (H1 FY15: 2.9p) and on a statutory basis to (0.7p).

DIVIDEND PER SHARE

The Board has recommended an interim dividend of 5.29p (H1 FY15: 4.60p), which will be paid on 11^th December to holders on the record at 20^th November , with the ex-dividend date at 19^th November.

Headline Cashflow and net debt

Operating free cash flow for H1 was £38m (H1 FY15: £44m) with the impact of lower operating profits offset by a stronger working capital position and the timing of provisions.

During the period we completed the acquisition of tiPicall and agreed the final purchase price for the Virgin Media base. These two transactions together with the on-going funding for the YouView and Ultrafast fibre joint ventures contributed £5m of net cash outflow. 

Capital expenditure increased to £84m (H1 FY15: £55m), of which £18m relates to MTTS, £15m to the development of our new mobile billing platform and the balance to the development of our core systems and network. For the full year we expect capital expenditure to be 7-8% of revenues, including the impact of the investment in the systems supporting mobile and ultrafast fibre.  Looking forward to FY17 we expect underlying capex to return to 6.0%-6.5% of revenues.

Financing activities resulted in a net positive cash-flow of £22m in the period (FY15: outflow of £7m), as the dividend (£85m) and interest charges on our debt (£11m) were offset by an inflow of £61m from the employee share ownership trust (ESOT), which reflects a decision taken by the trustees of the ESOT to reassess the number of shares required to satisfy the ESOT's obligations under the share plans. The ESOT continues to hold 10.2m shares (1.07% of total share capital). 

Net debt increased by £42m in the period to £631m as a result of the phasing of capex and the payment of the final FY15 dividend, which resulted in Net Debt/EBITDA rising from 2.4x at 31 March 2015 to 2.8x at 30 September 2015. Excluding the impact of the cyber attack we expect FY16 Net Debt/EBITDA at the year end to be lower than at the end of H1.