Review of the year

The business continues to perform well in what remains a challenging consumer environment. We delivered good growth across our portfolio of products, achieving total product growth of 3.8 million for the 12 months to 30 June 2011 ('the year') and reaching a total product base of 25.4 million, an increase of 17% year on year.

At the same time, we continue to make progress in areas of long-term advantage, developing our on-screen offering and innovating to add value for customers. Our channel portfolio has been enhanced with the launch of Sky Atlantic HD and Sky Living HD and the quality of our content was recognised with six BAFTA nominations. Since its full launch in April, our video on demand service, Sky Anytime+, has made a strong start with over 800,000 enabled users and the launch of Sky Go in July 2011, giving all of our TV customers the opportunity to watch Sky content on multiple devices at no extra cost.

We have continued to deliver value for customers and, at a time when household budgets are under pressure, our success in home communications shows that customers are responding. In addition, we have recently announced a price freeze for existing customers across our television and home communications packages until at least September 2012. The actions taken on costs and our progress made in improving operational efficiency right across the business have given us the flexibility to do this for customers at the right time in the economic cycle.

Our approach to costs has allowed us to deploy more capital in areas where our customers see most benefit. For example, by making our online support environment more intuitive and accessible, we've driven a step change in online traffic, reducing telephone contacts and freeing time for contact centre advisors to deal with more complex customer issues. That focus has resulted in fewer customer calls despite a growing customer and product base while reducing cost and improving customer satisfaction. Savings from call reduction are being redeployed to grow our on-shore capability, enabling us to manage more customer service queries from new contact centres such as those recently opened in Stockport, Sheffield and the soon-to-open Newcastle hub.

Our single-minded customer focus is generating strong operational results. TV additions for the year were 327,000, bringing the total TV base to 10.187 million. Within this, loyalty remained stable with churn of 10.4% for the year and ARPU increased 6% to £539, benefiting from a higher penetration of additional products.

While product growth was broadly based, home communications performed particularly well as more customers saved money by switching their services to Sky. Net product additions across broadband, telephony and line rental increased to 2.4 million in the year, 43% higher than the prior year. Within that, our standalone home communications products have made good progress as we look to further leverage our fixed cost network and grow our addressable customer base. Given the scale and fixed cost nature of communications products, the contribution margin we make on the standalone service is in some cases higher than that on similar revenues derived from TV packages. We currently have 107,000 standalone home communications customers and, in total, we added over 420,000 new households in the year. In future, it is this measure – total customers – that we will focus on in our reporting.

Our strong performance in home communications means the number of customers choosing each of television, broadband and talk has grown by 37% on last year to 2.8 million customers, representing 27% penetration of the base.

We have continued to extend our broadband network coverage by unbundling 385 additional exchanges in the year, increasing our footprint to around 80% of households in the UK. At the same time, we are improving the economics of our home communications business by migrating more customers to our own network. We now have 1.7 million fully unbundled customers, 51% of our broadband base.

We closed the year with more than 3.8 million high definition (HD) customers, an increase of 30% on last year. In the context of exceptionally strong growth in the prior year following the reduction in the price of the HD box and the FIFA World Cup, net additions were lower than the prior year at 883,000. As penetration of HD-ready sets increases and our HD content offering continues to grow, we see a significant opportunity to continue adding HD customers.

Content

All of our channels have performed well in the year, and with our increased investment in UK drama and comedy now reaching the screen, we have a strong second half of calendar 2011 ahead.

Our new channel Sky Atlantic HD has performed strongly since launch in February with the standout show in the fourth quarter being Game of Thrones which reached 4.4 million viewers in its first season. Sky 1 delivered another good year with a strong performance in the fourth quarter from our UK-commissioned drama, The Runaway. We will build on this success with our forthcoming new slate of UK comedy, including Trollied starring Jane Horrocks and Stella from Ruth Jones. Alongside these shows, we will also be showing some of the best US content including the third season of the newly-acquired Glee in the autumn, and the new sci-fi action series Terra Nova from Steven Spielberg. Sky Living HD continues to perform well, with one in five Sky customers now rating the channel amongst their favourites. The former Sky 1 HD series, Bones has made a successful transition to the channel and other popular series such as Grey's Anatomy and Criminal Minds have also attracted significantly higher audiences compared to last year.

Sky Sports achieved record audiences for last season's Premier League, with an average audience of 1.4 million viewers per game, 11% higher than the previous year. Sky Sports also received record audiences for the US Open golf and we saw an excellent response to our coverage of The Masters. Sky subscribers with Sky Sports will also be able to watch live coverage online and on mobiles and tablets.

We continue to make good progress in 3D, with our Sky 3D channel winning a BAFTA award for Sir David Attenborough's Flying Monsters 3D, the first 3D programme ever to win a BAFTA award. Sky 3D also achieved another first when it screened Matthew Bourne's production of Swan Lake in conjunction with Sky Arts, the first full-length ballet to be shown in 3D.

Looking ahead, we will continue to invest in our content proposition, giving more people reasons to choose Sky. In line with this strategy, we have announced plans to increase our investment in UK-originated content and production, excluding sports rights, by more than 50% to £600 million in 2014. This will include weekly, original British comedy in 2011, a threefold increase in hours of original British drama and a tripling of our arts programming budget. In July 2011 we achieved a significant milestone with the opening of our new broadcast facility, Sky Studios. Sky Sports News HD has begun broadcasting from the state-of-the-art facility which houses space for eight studios as well as editing and post-production facilities.

Innovation

We continue to innovate to add value for customers.

Sky Go launched in July 2011 for all customers and means they can access Sky content on multiple devices at no extra cost. This will provide more flexibility and convenience for customers to watch live TV on the move via PCs, laptops, Macs, iPhones and iPads. Customers can register up to two devices for Sky Go and have access to a range of channels, including all five Sky Sports channels, in line with their TV subscription.

Our video on demand service, Sky Anytime+, has generated a strong response since full launch in April, with more than 800,000 customers enjoying the convenience and flexibility it offers. Sky Anytime+ gives customers access to TV box sets and over 600 movies, on-demand, at no extra cost. The service is supported by our state-of-the-art, high-capacity broadband network and its connectivity to the HD box. Customers with our unlimited broadband package also benefit from a truly unlimited service, with no fair use policies, data caps or traffic management.

We are progressing well with our technical integration of The Cloud, ahead of launching our customer proposition later this year. We have added to our existing high-quality Wi-Fi venues with the signing of over 1,200 new sites including Virgin Active and Pizza Express.

Financial summary

As we consistently execute our strategy, we have delivered strong double-digit growth in each of adjusted revenue, operating profit, earnings and cash flow.

Revenue for the year increased by 16% reflecting continued success in our multi-product strategy and strong growth in other business lines. Adjusted operating profit was 23% higher, exceeding £1 billion for the first time. Our continued focus on operational efficiency contributed to adjusted operating margin expanding to 16.3% and record adjusted basic earnings per share of 41.6 pence. Adjusted free cash flow increased by 51% as we once again efficiently converted profit to cash.

Unless otherwise stated, all figures and growth rates exclude exceptional items and are from continuing operations (including Living TV in the current year and excluding Easynet). The results for the year include the acquisition of Living TV, which completed on 12 July 2010, and contributed £107 million in revenue and £82 million of costs.

£1,073m

Adjusted operating profit from continuing operations

23 percent

Revenue

Group revenue increased to £6,597 million (2010: £5,709 million), up 16% year on year and benefiting from the broadly-based growth delivered this year.

Retail subscription revenue increased by 15%, to £5,455 million (2010: £4,761 million), reflecting the success in our multi-product strategy and a larger customer base.

Wholesale subscription revenue increased by £85 million to £323 million (2010: £238 million), following our acquisition of Living TV and a higher number of wholesale customers paying for our premium channels.

Our advertising business has performed particularly strongly, increasing our estimated share of the TV advertising sector by four percentage points to 20%. Revenue for the year was 35% higher at £458 million (2010: £340 million), as we benefited from the consolidation of the sale of airtime on Living TV. Advertising revenue now includes revenue related to our online properties and Sky Magazine; of which £19 million (2010: £21 million) was reclassified from other revenue.

Installation, hardware and service revenue was £112 million (2010: £174 million), reflecting our decision to lower the retail price of our Sky+HD box last year.

Other revenue of £249 million (2010: £196 million) was 27% higher year on year. This increase includes revenue from the sale of set-top boxes to Sky Italia in the fourth quarter, the cost associated with the boxes is included in subscriber management and supply chain costs.

Direct costs

Direct costs were higher compared to the prior year as we increased our on-screen investment and more customers chose our home communication services.

Programming costs were 15% higher at £2,188 million (2010: £1,902 million) reflecting our strategy to bring TV customers more highquality content. Entertainment costs increased as we launched Sky Atlantic HD in February and continued to invest in British drama and comedy on Sky 1 HD and Sky Living HD. We had a strong year of sport with additional content including the fifth pack of live Premier League matches, The Masters, the Ashes in Australia and the Ryder Cup. Third party channel costs were broadly level with additional costs relating to more third party HD channels on the platform offset by carriage fee savings upon consolidation of the Living TV channels.

Direct network costs increased to £584 million (2010: £440 million) as a result of our customers taking 9.1 million home communication products from us, 37% more than a year ago. Higher volumes have been partially offset by a higher proportion of fully unbundled customers leading to lower monthly payments.

Other operating costs

Marketing costs (excluding exceptional items) increased by £105 million to £1,220 million (2010: £1,115 million). The cost to acquire a new television subscriber ('SAC') was £376 as every customer joining received our Sky+HD set-top box, and the launch of the Sky Anytime+ service resulted in longer install visits.

Subscriber management and supply chain costs (excluding exceptional items) were £21 million lower at £596 million (2010: £617 million) as we benefited from our operational efficiency programmes to reduce costs in our supply chain and contact centres. This was partially offset by the cost of set-top boxes sold to Sky Italia in the fourth quarter, the revenue for which can be found in other revenue.

Transmission, technology and fixed network costs increased by £88 million to £395 million (2010: £307 million). The increase relates to higher network costs as we gain scale in our fixed line business and includes costs for network services previously accounted for within the Group by Easynet.

Administration costs (excluding exceptional items) were £541 million (2010: £456 million), reflecting a higher non-cash IFRS 2 'Share-based payment' charge and associated National Insurance costs, and the acquisition of Living TV. The IFRS 2 charge and related National Insurance costs were £86 million, up £41 million on the prior year as a result of the phasing of our share-incentive plans and a higher share price throughout the year.

Earnings

Adjusted profit before tax from continuing operations of £987 million (2010: £769 million) includes the Group's share of results of joint ventures and associates of £34 million (2010: £29 million), which is led by a strong portfolio of channel brands such as National Geographic, History and Nickelodeon. A net interest charge of £120 million (2010: £132 million) is also included.

Adjusted taxation from continuing operations for the period was £262 million (2010: £209 million). The full year adjusted effective tax rate on continuing operations was 27% (2010: 27%), with the reduced rate of corporation tax announced in the budget statement on 23 March 2011 having only a modest positive impact in the current year.

Adjusted profit for the period from continuing operations was £725 million (2010: £560 million), generating adjusted basic earnings per share of 41.6 pence (2010: 32.1 pence).

Reported profit for the period from continuing operations was £758 million (2010: £896 million), generating reported basic earnings per share from continuing operations of 43.5 pence (2010: 51.4 pence). Reported profit for the period including discontinued operations was £810 million (2010: £878 million) resulting in reported basic earnings per share of 46.5 pence (2010: 50.4 pence). A reconciliation between adjusted and reported profits can be found here.

41.6p

Adjusted basic earnings per share from continuing operations

30 percent

Cash Flow and Financial Position

Adjusted free cash flow increased by 51% to £869 million (2010: £577 million) reflecting 19% growth in adjusted EBITDA, flat capital expenditure, lower tax and interest payments than the prior year, and a strong working capital position. See Non-GAAP measures on page 60 for details of adjusting items.

Capital expenditure was £423 million (2010: £429 million), in line with our guidance of around 6.5% of revenue. Major items of expenditure in the period included the technical fit-out of our new broadcast facility and continued exchange rollout programme to increase the footprint of our fixed line communications network.

Strong cash generation during the year has contributed to the reduction in net debt of £326 million to £750 million (2010: £1,076 million).

The combination of falling net debt and higher EBITDA over the past 12 months has reduced the Group's net debt to adjusted EBITDA ratio. Rating agencies often make adjustments to EBITDA and net debt when assessing credit ratings and Standard & Poor's (S&P), for example, calculated an adjusted ratio of 1.4x as at 30 June 2010. The main adjustments that S&P make to our reported numbers are to add share based compensation back to EBITDA and to treat operating lease and transponder capacity commitments (approximately £650 million in total) as debt-like items. We estimate as at 30 June 2011 the S&P adjusted ratio of net debt to EBITDA would be 1.0x.

It remains the overall financial policy of the Board to maintain an efficient capital structure and a strong BBB+ credit rating, allowing sufficient financial flexibility to create additional value for shareholders via ongoing organic investment, disciplined and selective acquisitions, maintaining the Company's ordinary dividend and returns to shareholders.

The Group's liquidity and headroom are comfortable with no bond redemptions falling due until October 2015 when £428 million falls due. As at the end of the year, cash and cash equivalents and shortterm deposits were £1,351 million. However, this was ahead of substantial outflows (estimated at c.£330 million) associated with rights payments in July and August.

During the year, total assets increased by £550 million to £5,354 million at 30 June 2011. Non-current assets increased by £207 million to £3,025 million, primarily due to an increase of £218 million in goodwill and intangible assets following the acquisitions of Living TV and The Cloud, an increase of £33 million in available-for-sale investments due to the increase in the equity share price of ITV and an increase in deferred tax assets of £69 million. This increase was partially offset by the impact of the disposals of Easynet and Shine, together with a decrease of £107 million in non-current derivative financial assets resulting from mark-to-market movements on derivative instruments.

Current assets increased by £343 million to £2,329 million at 30 June 2011. This increase was predominately due to a £302 million net increase in cash and cash equivalents and short-term deposits, as a result of receipts from the sale of Easynet and net cash generated from operating activities, offset by the acquisitions of Living TV and The Cloud and dividend payments. Trade and other receivables and inventories also increased during the year.

Total liabilities increased by £75 million to £4,319 million at 30 June 2011. Current liabilities increased by £205 million to £1,912 million, primarily due to an increase in trade and other payables. Non-current liabilities decreased by £130 million to £2,407 million, principally due to a £125 million decrease in the fair value of the Group's non-current borrowings mainly resulting from the strengthening of pounds sterling against the dollar. This decrease was partially offset by a £30 million increase in non-current derivative financial liabilities.

 

Exceptional items

Reported operating profit from continuing operations of £1,073 million includes £26 million of restructuring costs from Living TV and costs of £15 million relating to the News Corporation proposal, both within administration costs. Within marketing costs there is an exceptional gain of £41 million relating to the recovery of duty arising on set-top boxes imported prior to this fiscal year.

In the prior year, reported operating profit from continuing operations of £1,113 million included litigation settlement income of £269 million relating to our claim against EDS, along with £5 million from the cancellation of accounts payable on settlement of the claim and legal costs of £1 million. Also included was £32 million relating to a restructuring exercise.

Reported profit after tax includes a £42 million exceptional gain (2010: £180 million gain), of which £18 million are mark-to-market gains relating to derivative financial instruments not qualifying for hedge accounting and gains and losses arising from designated fair value hedge accounting relationships (2010: £13 million gain), £9 million relating to the profit on sale of our stake in Shine and a £15 million tax credit following the settlement of a pre-acquisition tax issue relating to the Easynet networks business retained by Sky.

Exceptional items in the prior year also included investment income relating to our litigation settlement with EDS of £49 million, £115 million relating to the sale of ITV shares and the receipt of £3 million on closure of a joint venture.

The related tax effects on the above items results in a £9 million charge (2010: £85 million charge).

Distributions to shareholders

The Directors propose an increase of 20% in the full year dividend to 23.28 pence, continuing our track record of dividend growth. On this basis, the total cash amount of dividends paid in respect of this fiscal year will be £405 million; of which the final dividend accounts for £253 million.

The ex-dividend date will be 16 November 2011 and, subject to shareholder approval at the Annual General Meeting to be held on 29 November 2011, the final dividend of 14.54 pence will be paid on 9 December 2011 to shareholders appearing on the register at the close of business on 18 November 2011.

The Board has agreed to seek the necessary approvals and return £750 million of capital to shareholders via a share buy-back programme. Shareholder approvals will be sought at the Group's AGM on 29 November 2011. News Corporation has agreed to participate in the buy-back. The effect of that agreement is to provide that there will be no change in News Corporation's economic or voting interests in the Company as a result of the share buy-back programme.

The Board considers that an on-market share repurchase programme is a flexible, equitable and tax-efficient means by which to make distributions to shareholders which are incremental to the ordinary dividend.

positional

Dividend per share (p)

Andrew Griffith Andrew Griffith signature

Andrew Griffith

Chief Financial Officer

 
positional

More customers taking more products (million)

27%

Customers taking TV, broadband and telephony

25.4m

Total products

 
Mount Pleasant, Sky 1 HD

Mount Pleasant, Sky 1 HD

UEFA Champions League Final 2011, Sky Sports HD

UEFA Champions League Final 2011, Sky Sports HD

Boulton & Co, Sky News HD

Boulton & Co, Sky News HD

Matthew Bourne's Swan Lake, Sky Arts HD

Matthew Bourne's Swan Lake, Sky Arts HD

US Open, Sky Sports HD

US Open, Sky Sports HD