Results for the third quarter and nine months to 31 December 2014

BT Group plc (BT.L) today announced its results for the third quarter and nine months to 31 December 2014.

Gavin Patterson, Chief Executive, commenting on the results, said:

“This quarter we have delivered good growth in profit before tax and strong free cash flow.

“Openreach achieved the highest growth in the number of landlines on record. It was also our best ever quarter for fibre broadband net additions. All the major communications providers are responding to the strong market demand for fibre broadband, helping to drive take-up in what is already a very competitive market.

“Our superfast fibre broadband network now covers around three-quarters of the UK. BT has been at the forefront of fibre innovation and investment, from which all communications providers benefit. We aim to keep it that way. So today we’re announcing large-scale pilots this summer of ultrafast broadband with G.fast. We now think we can deploy this technology at scale which will enable us to deliver ultrafast speeds of up to 500Mbps to most of the UK within a decade.

“I am pleased that we have agreed the 2014 triennial funding valuation and recovery plan with the Trustee of the BT Pension Scheme. The funding deficit is £7.0bn at 30 June 2014, an increase from 2011 reflecting the low interest rate environment. Over the next three years we will pay £2.0bn, which is less than we paid over the previous three years. We have agreed a 16 year recovery plan reflecting the strength and sustainability of our future cash flow generation.

“Mobility is a key growth area for us. We are making good progress on our due diligence in relation to a possible acquisition of EE and will make further announcements in due course. In the meantime, our Consumer mobile launch plans remain on track.”

Financial highlights for the third quarter:

• Underlying revenue2 excluding transit down 1%
• Underlying operating costs4 excluding transit down 3% reflecting the benefit of our cost transformation activities
• EBITDA1 up 2% and earnings per share1 up 10%
• Normalised free cash flow3 of £908m, up 64%
• Outlook reaffirmed

1 Before specific items.Specific items are defined on page 3

2 Excludes specific items, foreign exchange movements and the effect of acquisitions and disposals

3 Before specific items, pension deficit payments and the cash tax benefit of pension deficit payments

4 Excludes specific items, foreign exchange movements and the effect of acquisitions and disposals, and is before depreciation and amortisation

GROUP RESULTS FOR THE THIRD QUARTER AND
NINE MONTHS TO 31 DECEMBER 2014

1 Before specific items

2 Before specific items, pension deficit payments and the cash tax benefit of pension deficit payments

3 Certain results have been restated.See Note 1 to the condensed consolidated financial statements

Notes:

1.The commentary focuses on the trading results on an adjusted basis, which is a non-GAAP measure, being before specific items.Unless otherwise stated, revenue, operating costs, earnings before interest, tax, depreciation and amortisation (EBITDA), operating profit, profit before tax, net finance expense, earnings per share (EPS) and normalised free cash flow are measured before specific items. This is consistent with the way that financial performance is measured by management and reported to the Board and the Operating Committee and assists in providing a meaningful analysis of the trading results of the group. The directors believe that presentation of the group’s results in this way is relevant to the understanding of the group’s financial performance as specific items are those that in management’s judgement need to be disclosed by virtue of their size, nature or incidence. In determining whether an event or transaction is specific, management considers quantitative as well as qualitative factors such as the frequency or predictability of occurrence. Specific items may not be comparable with similarly titled measures used by other companies. Reported revenue, reported operating costs, reported EBITDA, reported operating profit, reported profit before tax, reported net finance expense, reported EPS and reported free cash flow are the equivalent unadjusted or statutory measures.

2.Trends in underlying revenue, trends in underlying operating costs, and underlying EBITDA are non-GAAP measures which seek to reflect the underlying performance of the group that will contribute to long-term profitable growth and as such exclude the impact of acquisitions and disposals, foreign exchange movements and any specific items. We focus on the trends in underlying revenue and underlying operating costs excluding transit as transit traffic is low-margin and is significantly affected by reductions in mobile termination rates.

BT Group plc
GROUP RESULTS FOR THE THIRD QUARTER
TO 31 DECEMBER 2014

Overview
Our key measure of the group’s revenue trend, underlying revenue excluding transit, was down 1%. The decline mainly reflects the timing of contract milestones within BT Global Services which benefited our third quarter results last year. For the nine months, underlying revenue excluding transit was flat.

BT Consumer revenue increased 7%, primarily driven by growth in broadband and TV. BT Business revenue declined modestly, reflecting lower call and line volumes as customers move to data and VoIP services. BT Wholesale’s revenue performance improved compared with the second quarter but continued to be impacted by Ofcom’s Narrowband Market Review. In Openreach, regulatory price changes offset good growth in fibre broadband, leading to a small revenue decline overall.

Our cost transformation activities this quarter led to an improvement in our EBITDA growth, despite the decline in revenue. Together with working capital movements and lower tax payments, normalised free cash flow1 was up 64%.

We have passed almost 22m premises with our fibre broadband network, around three-quarters of the UK. Openreach achieved a record 375,000 fibre broadband net connections. Over 3.7m homes and businesses are now connected, 17% of those passed. We added 209,000 retail fibre broadband customers, taking our customer base to over 2.7m.

The UK broadband market2 grew by 258,000, of which our retail share was 119,000 or 46%. Openreach grew the physical line base by 111,000, the best performance on record.

We have today announced large-scale pilots this summer of ultrafast broadband with G.fast technology in Huntingdon, Cambridgeshire and Gosforth, Newcastle. We expect to deploy this technology at scale and it will help us make ultrafast broadband speeds of up to 500Mbps available to most of the UK within a decade.

Mobility
In the quarter we entered into an exclusivity agreement with Deutsche Telekom and Orange in relation to a possible acquisition of their UK mobile business, EE. The period of exclusivity is ongoing, during which we aim to complete our due diligence and to conclude negotiations on a definitive agreement.

The potential acquisition would enable us to accelerate our existing mobility strategy whereby customers will benefit from innovative, seamless services that combine the power of fibre broadband, wi-fi and 4G. We would own the UK's most advanced 4G network, giving us greater control in terms of future investment and product innovation.

While continuing these exclusive discussions, we are progressing our own plans for providing enhanced fixed-mobile converged services for businesses and consumers. We remain confident of delivering on these plans should a transaction not take place.

Income statement

Reported and adjusted revenue of £4,475m were both down 3%. The decline mainly reflects a £49m negative impact from foreign exchange movements, a £26m reduction in transit revenue and a £3m impact from disposals. Underlying revenue excluding transit was down 1%.

Operating costs3 decreased 5% to £2,908m. Underlying operating costs4 excluding transit were down 3% reflecting the benefit of our cost transformation programmes. Adjusted EBITDA of £1,567m was up 2%, an improvement on recent quarters and despite EBITDA last year benefiting from the timing of contract milestones.

Depreciation and amortisation of £618m was down 8%, reflecting the more efficient delivery of our capital expenditure programmes over the last few years and some of our assets becoming fully depreciated. Adjusted net finance expense was £134m, down 7% due to lower net debt.

1 Before specific items, pension deficit payments and the cash tax benefit of pension deficit payments

2 DSL and fibre

3 Before depreciation and amortisation

4 Excludes specific items, foreign exchange movements and the effect of acquisitions and disposals, and is before depreciation and amortisation

Adjusted profit before tax was £814m, up 13% mainly reflecting the decline in depreciation and amortisation. Reported profit before tax (which includes specific items) was £694m, up 12%. The effective tax rate on the profit before specific items was 19.9% (Q3 2013/14: 20.9%).

Adjusted EPS of 8.0p was up 10%. Reported EPS (which includes specific items) was 6.9p, also up 10%. Our EPS measures are based on a weighted average number of shares in issue of 8,122m (Q3 2013/14: 7,867m).
Specific items Specific items resulted in a net charge after tax of £94m (Q3 2013/14: £78m). Net interest expense on pensions was £72m (Q3 2013/14: £59m). Restructuring charges of £54m (Q3 2013/14: £46m) were incurred as part of our group-wide restructuring programme and relate primarily to leavers and property and network rationalisation. We recognised a net profit of £6m on investment disposals (Q3 2013/14: £nil). The tax credit on specific items was £26m (Q3 2013/14: £27m).

Capital expenditure

Capital expenditure of £599m was up 3% and was net of £94m grant funding (Q3 2013/14: £42m) relating to our activity on the Broadband Delivery UK (BDUK) programme. For the nine months, capital expenditure was £1,648m, down 7% largely reflecting phasing during the year.

Free cash flow

Normalised free cash flow was an inflow of £908m, up 64%. The increase mainly reflects movements in working capital and lower tax payments primarily as a result of tax-deductible all-employee share option plan maturities in the second quarter.

The net cash benefit of specific items was £4m (Q3 2013/14: £58m outflow). This comprised receipts of £57m relating to the ladder pricing judgment (see Regulation below) and £8m from investment disposals, offset by restructuring costs of £54m (Q3 2013/14: £43m) and property rationalisation costs of £7m (Q3 2013/14: £7m). After specific items and a £15m (Q3 2013/14: £19m) cash tax benefit from pension deficit payments, reported free cash flow was an inflow of £927m (Q3 2013/14: £515m).

Net debt and liquidityNet debt was £6,202m at 31 December 2014, a decrease of £861m since 30 September 2014 and £1,438m lower than at 31 December 2013. In the quarter, reported free cash flow of £927m was partly offset by £52m spent on our share buyback programme. So far this year we have spent £249m and we continue to expect to spend around £300m for the year as a whole.

At 31 December 2014 the group had cash and current investment balances of £2.8bn and a £1.5bn credit facility, providing us with a strong liquidity and funding position. Debt of £0.3bn is repayable during the fourth quarter of 2014/15.

Pensions
The IAS 19 net pension position at 31 December 2014 was a deficit of £6.3bn net of tax (£7.9bn gross of tax) compared with £5.9bn (£7.3bn gross of tax) at 30 September 2014. The higher deficit primarily reflects a fall in the real discount rate to 0.63%, its lowest ever quarter-end level, partly offset by higher asset values. The IAS 19 accounting position and key assumptions for the IAS 19 valuation are:

BT and the Trustee of the BT Pension Scheme (BTPS) have reached agreement on the 2014 triennial funding valuation and recovery plan. The funding deficit at 30 June 2014 is £7.0bn with the increase from the 2011 valuation reflecting the low interest rate environment at the valuation date.

A 16 year recovery plan has been agreed reflecting BT’s long-term and sustainable cash flow generation. Over the next three years payments will total £2.0bn. BT will pay £1.5bn by the end of April 2015 out of existing cash and current investment balances which totalled £2.8bn at 31 December 2014. This will be followed by £250m in each of the years to March 2016 and March 2017.

Further details are set out in a separate announcement.

Regulation
In July 2014 the Supreme Court overturned a Court of Appeal judgment, made in July 2012, which had disallowed our ladder pricing policy. We received the Supreme Court Order in December 2014 and have started the process of recovering the money that we refunded to the mobile operators as a result of the Court of Appeal ruling. We received £57m of cash in the quarter, which has been treated as a specific item. We have not recognised any benefit from ladder pricing in our trading results for the quarter.

In November 2014 we were successful in our application to the Competition Appeal Tribunal for interim relief in relation to the supply of Sky Sports 1 and 2 on our YouView platform. This follows our application to the Tribunal in April to update a 2010 court order that restricted the scope of Ofcom’s original Wholesale-Must-Offer remedy for the supply of Sky Sports 1 and 2, solely to digital terrestrial television. We launched Sky Sports 1 and 2 on YouView on 16 December 2014.

On 15 January 2015 Ofcom published a draft Statement on its methodology for assessing the margin BT makes on retail fibre broadband. The European Commission has a month to review the draft Statement, after which Ofcom is expected to publish a final version in February, taking into account comments received. The methodology aims to assess the retail unit margin of BT’s weighted average fibre broadband customer acquired over a six month period. The draft Statement provides detail on the way in which certain revenue and cost items will be treated and Ofcom has indicated that it believes BT currently passes this new test. We are reviewing the draft Statement in detail and considering our response, which may include an appeal.

Outlook
Our outlook remains unchanged. We continue to expect underlying revenue excluding transit in 2014/15 to be broadly level with 2013/14 with growth in 2015/16. We expect adjusted EBITDA of £6.2bn - £6.3bn in 2014/15 with further growth in 2015/16. Normalised free cash flow is expected to be more than £2.6bn this year and to grow in 2015/16.

We continue to target a BBB+/Baa1 credit rating over the medium term. We expect to grow our dividends per share by 10% - 15% in both 2014/15 and 2015/16. We also intend to maintain our share buyback of around £300m in each of these years, to help counteract the dilutive effect of all-employee share options plans maturing over this period.

OPERATING REVIEW

BT Global Services

Revenue declined 8% including a £43m negative impact from foreign exchange movements. Transit revenue increased £6m. Underlying revenue excluding transit decreased 7% partly reflecting the timing of contract milestones which benefited our third quarter results last year.

Revenue in the UK was down 18% reflecting lower public sector revenue, continuing the declines seen in recent quarters, and the effect of the prior year contract milestones. The decline in the UK was partially offset by an increase in underlying revenue excluding transit in the high-growth regions2 and also in Europe, which benefited from improved volumes and new customer installations. In the US and Canada, revenue declined reflecting the migration of some services off a large contract.

Total order intake was £2.1bn, up 36%. Order intake was £6.7bn on a rolling twelve-month basis, down 1% year on year but up 9% since the second quarter. We signed a new contract with the Welsh Government to operate their country-wide public sector broadband network supporting 80 public service organisations across 4,000 sites. We expanded our relationship with Royal Mail to provide 76,000 handheld devices to its UK delivery staff. We also renewed a contract with Procter & Gamble for managed network and security services in more than 80 countries.

We launched a new cloud-based customer relationship management service for companies to produce personalised videos that keep their customers individually engaged. We opened a new data centre in Colombia to address the growing demand for cloud-based services in Latin America.

Operating costs declined 8%. Underlying operating costs excluding transit declined 6% reflecting our continued focus on cost transformation and the effect of the prior year contract milestones.

EBITDA declined 10%. Excluding foreign exchange movements, underlying EBITDA declined 8% reflecting the effect of the contract milestones. Excluding these, underlying EBITDA for the nine months was broadly level. Depreciation and amortisation reduced 18% mainly due to lower capital expenditure in recent years and some of our assets becoming fully depreciated.

Capital expenditure declined 15% largely reflecting lower network expenditure and a property purchase in Latin America last year. Operating cash flow was an inflow of £52m. This was £59m below last year due to working capital movements and the reduction in EBITDA, partly offset by lower capital expenditure.

2 Asia Pacific, Latin America, Turkey and the Middle East and Africa

BT Business

Revenue was down 2% with underlying revenue excluding transit down 1%.

SME & Corporate voice revenue decreased 5% reflecting the continued decline in business call and line volumes, as customers move to data and VoIP services. SME & Corporate data and networking revenue increased 2% with continued growth in fibre broadband. Business fibre broadband net additions were up 45% year on year.

IT services revenue was flat as lower hardware sales were offset by growth in software sales and professional services. Foreign exchange movements had a £6m negative impact on BT Ireland revenue. Its underlying revenue excluding transit was also flat.

Order intake increased 3% to £515m and was up 8% to £2,117m on a rolling twelve-month basis. BT Ireland grew its order intake by more than 75% in the quarter, including contracts with NI Direct, Three Ireland and ICON.

We continued the rollout of BT Cloud Voice, our new business-grade IP voice service which we launched in the second quarter. Initial orders for the service have been encouraging.

Operating costs were down 5%. Underlying operating costs excluding transit were down 4%, mainly reflecting the impact of our cost transformation programmes, including a 9% reduction in total labour resource. The lower costs offset the decline in revenue and as a result EBITDA was up 4%.

Depreciation and amortisation was down 6% and operating profit grew 6%. Capital expenditure increased £10m. This was offset by growth in EBITDA and working capital movements which led to operating cash flow increasing 3%.

BT Consumer

Revenue was up 7%, with a 15% increase in broadband and TV revenue and continued growth in calls and lines revenue.

Consumer ARPU grew 7% to £410. Our consumer line losses improved from 85,000 in the second quarter to 60,000. BT added 119,000 retail broadband customers, representing 46% of the DSL and fibre broadband market net additions. Fibre take-up continued to grow with 209,000 retail fibre broadband net additions, taking our customer base to over 2.7m. Of our broadband customers, over 35% are now on fibre.

We added to the range of products that help our customers save money. In the quarter, customers started to benefit from Right Plan, which helps households find the best value calling plan for them. We offer BT Basic with broadband, the UK’s cheapest line and broadband bundle for low-income customers. In addition, our Home Phone Saver package, aimed at elderly or low-income customers, offers a discount to those who just want a standalone telephone package.

In the quarter we added 45,000 TV customers and further enhanced our TV proposition. We launched TV Everywhere, which means customers can watch TV channels on multiple devices, and we became the UK’s first TV platform to make buy-to-keep movies available on multiple devices in addition to the set-top box. We also launched Netflix and a range of new packages.

In December we launched Sky Sports 1 and 2 on YouView, adding to our existing offering of BT Sport, ESPN and Eurosport. We have continued to grow our BT Sport residential and commercial customer bases. In just over a year since our launch, 25,000 commercial premises have signed up to BT Sport, including 30% of all UK pubs. Our audience figures continue to grow, with Premier League viewing on BT Sport up 17% so far this season.

Operating costs decreased 1% with savings from our cost transformation programmes partly offset by higher costs associated with the growth in revenue. EBITDA was up 43% reflecting a continued strong performance across voice and broadband. Depreciation and amortisation reduced 9% and operating profit was up 68%.

Capital expenditure reduced 2%. Operating cash flow increased £175m driven by the growth in EBITDA and as last year included the £60m deposit that we paid for the UEFA broadcast rights.

BT Wholesale

Revenue decreased 10% or £57m, including a £30m decline in transit revenue.

Underlying revenue excluding transit decreased 5%, an improvement compared with the second quarter decline of 11%. The decline this quarter primarily reflects a continued reduction in our traditional calls, lines and circuits revenue, including the impact of lower fixed termination rates following Ofcom’s Narrowband Market Review.

Managed solutions revenue declined 1%. This was an improvement on the 16% decline in the second quarter partly reflecting a much lower impact from the Post Office contract termination and some one-off contract revenue. Broadband revenue declined 17% as lines continue to migrate to LLU.

We continued to see good growth in IP services with revenue up 45%. As part of our focus on customer service, this quarter we improved the way we prioritise and resolve issues with our Ethernet ordering system, which has more than doubled the proportion we resolve within 24 hours.

Order intake of £439m was down 6%, but was a significant improvement compared with the second quarter. On a rolling twelve-month basis, order intake was £1,477m, down 33% due to the timing of re-signs on some of our major managed solutions deals. During the quarter we signed a contract with Telefonica O2 UK to support the upgrade of their core voice network to IP by moving it to our IP Exchange service. IP Exchange now carries over 1bn minutes a month.

Operating costs decreased 11%. Underlying operating costs excluding transit were down 5%, including a 19% reduction in selling and general administration costs as we continue to focus on our cost transformation activities.

EBITDA decreased 7% reflecting the lower revenue. Depreciation and amortisation reduced 5% and operating profit was down 8%.

Capital expenditure declined 20% reflecting lower spend on the Wholesale Broadband Connect rollout programme. Operating cash flow increased £84m partly reflecting lower capital expenditure and the impact last year of the timing of customer receipts.

Openreach

Revenue was down 1% with regulatory price changes having a negative impact of around £45m, the equivalent of around 4%. The impact of regulation was partly offset by 36% growth in fibre broadband revenue.

The physical line base grew by 111,000, the best performance on record. It has increased by 144,000 over the past twelve months. The UK broadband market1 increased by 258,000 connections in the quarter compared with 252,000 in the prior year.

We are making progress with extending the reach of fibre beyond our commercial footprint and in the quarter we passed a further 630,000 premises in the BDUK areas. In total, we have passed almost 22m premises with our fibre broadband network, around three-quarters of the UK.

We achieved a record 375,000 fibre broadband net connections, an increase of 11%, bringing the number of homes and businesses connected to over 3.7m, 17% of those passed. Of the additions in the quarter, 44% were provided to our external communications provider customers, showing the market-wide demand for fibre.

Operating costs were down 2% driven by cost efficiencies. EBITDA decreased 1% reflecting a smaller benefit from the sale of redundant copper. With depreciation and amortisation down 4%, operating profit was up 1%.

Capital expenditure increased 20% and is net of £94m grant funding (Q3 2013/14: £42m) relating to the BDUK programme. The higher capital expenditure was driven by an increase in BDUK fibre rollout, the expansion of our network to new homes and higher volumes of Ethernet provision. Operating cash flow increased 4% despite the higher capital expenditure, primarily as a result of lower outstanding trade debtors.

1 DSL and fibre

A conference call for analysts and investors will be held at 9.00am today and a simultaneous webcast will be available at www.bt.com/results

We expect to announce the fourth quarter and full year results for 2014/15 on 7 May 2015.

The full financial statements are available to download as PDF documents Full results release
Group income statement
Group cash flow statement
Group balance sheet
Notes to the condensed consolidated financial statements
Forward-looking statements – caution advised