Directors’ Report – Business Review TalkTalk Group Financial Performance ▪ Revenue down 3% to £1,385m, reflecting a growing broadband base offset by declines in our narrowband and voice-only bases ▪ Headline EBITDA up 56% to £181m, driven by the increasing proportion of on-net customers ▪ Headline EBIT up 80% to £124m, reflecting EBITDA growth partially offset by higher depreciation and amortisation charges ▪ Capex of £106m, down 38% year-on-year after the substantial completion of our network build-out Operational Highlights ▪ Completed integration of AOL broadband business ▪ Continued migration of customers onto our own network, with 78% of all broadband customers now on-net ▪ 186,000 broadband net adds, before 93,000 AOL base TalkTalk clean-up, taking the total base to 2.8m ▪ Broadband monthly ARPU up 3% to £22.65 Group ▪ Major improvements in customer service, resulting in reduced churn and much more positive customer TalkTalk Group is our UK fixed line telecoms division, perception serving over 3.9m fixed line customers comprising 2.8m broadband and 1.1m voice-only and narrowband customers. It is currently the number 3 player in the UK broadband market, with by far the most extensive unbundled network in the UK, which supports a low-cost operating model that enables strong profitability even on market-leading tariffs. Its B2B operation, branded Opal, is a major player in the small business market. Over the last 12 months we have successfully completed the integration of the AOL broadband business and continued to grow the business organically. The bulk of our network investment is now complete and the business is set to be strongly cash generative going forward. 10 The Carphone Warehouse Group PLC Annual Report 2009 Key Performance Indicators Strategy Broadband customer base (m) The TalkTalk Group is clearly positioned and broadband, with no expensive as the best value provider in the UK extras. However, we have developed 2.8m residential broadband market. We do a range of “Boosts”, which allow 09 2.8 not believe that low cost should equate customers to sign up for higher speeds, 08 2.7 to low service, so we are absolutely greater download capacity and other focused on maintaining and improving features, whenever they like without 07 2.3 our network quality, developing being contractually committed to them. innovative products and delivering Headline EBITDA (£m) a positive experience to customers. Continuing to improve network performance and reliability £181m Maintaining and growing our As broadband becomes more ubiquitous 09 181 broadband market share and customers find more and more Our market share has been steady at things to do on the internet, usage 08 116 around the 16% mark for the last two is increasing significantly. We have 07 29 years. We believe that, as our service anticipated this trend and have been levels have improved, some of our direct developing our network to manage the competitors have weakened and as huge increases in demand expected over Headline EBIT (£m) consumers look for value, we are well the next three years. The investments we placed to grow our share. With strong have made will allow us to do this while £124m margins and low churn, each marginal protecting our margin structure. 09 124 new customer generates a very high net 08 69 present value for the division. In addition, Targeting strong cash generation increasing scale enables us to spread The Group has invested over £900m into (1) 07 fixed network costs across a wider base. the TalkTalk Group over the last six years. That period of investment is now over: % on-net Focusing on value and simplicity capex is declining sharply, and the Our customer research tells us that customer base we have built up is highly 78% people are fed up of paying over the cash generative. We have set a target of 09 78 odds for a bundle which includes over £100m operating free cash flow services they don’t want. Our proposition from the division in 2009-10. 08 67 is clear: we are the best value provider of 07 31 a combined package of calls, line rental Directors’ Report – Report Directors’ Review Business Marketplace Trends UK broadband market 20,000 1,200 Growth in the UK broadband market 16,000 960 slowed sharply during 2008, principally Net additions 000s as a result of the decline in housing 12,000 720 transactions. Penetration has reached over 65%, and despite the slowing 8,000 480 growth we expect the market to Subscribers 000s eventually reach 80% penetration in the 4,000 240 next 3-4 years. 0 0 Q205 Q305 Q405 Q106 Q206 Q306 Q406 Q107 Q207 Q307 Q407 Q108 Q208 Q308 Q408 BT Wholesale (L axis) Cable (L axis) LLU (L axis) Total market net additions (R axis) Source: Enders Analysis Broadband tariffs 50 Broadband and bundled pricing has been remarkably stable overall for the 40 last three years, since we came in and repriced the market in April 2006. 30 Competition is rational, with financially £ per month weaker players now marketing less 20 aggressively, and there have even been signs of price rises in recent months. 10 Over time we expect pricing changes to Sept 07 Jan 08 Jun 08 Feb 09 be driven by speed and metered access. Tiscali 8Mbps Broadband, line and calls Orange 8Mbps Broadband, line and calls Virgin Media 2Mbps Broadband, line and calls, TV Sky 2Mbps Broadband, line and calls, TV TalkTalk 8Mbps Broadband, line and calls BT 8Mbps Broadband, line and calls Source: Enders Analysis www.cpwplc.com 11 Directors’ Report – Business Review TalkTalk Group – continued Headline Financials 2009 2008 £m £m Revenue 1,385 1,424 Residential* 1,089 1,112 Business 296 312 EBITDA pre-SAC and marketing 307 280 SAC and marketing (126) (164) EBITDA 181 116 Depreciation and amortisation (57) (47) EBIT 124 69 EBIT % 9.0% 4.8% * Comprises residential customers and small business customers with similar profiles. Short-Term Risks TalkTalk Group delivered another good During the year underlying growth in the and Challenges performance last year, growing its broadband base was 186,000 customers, customer base, increasing the proportion but as part of the AOL integration of its customers on its unbundled process, we identified a discrepancy ▪ A weak consumer environment could affect network from 67% to 78% and achieving of 93,000 customers and reduced the market growth and increase a substantial reduction in its churn rate. base accordingly at the half year. the level of bad debts Despite the unexpected slow-down in This delivered a net increase of 93,000 the rate of growth in the broadband customers to 2.8m. ▪ We may not be able to pass market, TalkTalk Group still increased in on in full the copper price profitability, with Headline EBIT growing Our base of non-broadband customers, increases allowed by OFCOM by 80% to £124m and Headline EBIT encompassing customers taking our to our customers margins almost doubling from 4.8% to voice-only service or narrowband ▪ Struggling competitors may 9.0%. TalkTalk Group has also started package, continued to decline in line behave irrationally and to deliver strong cash flows, and has with our expectations, ending the year undercut the market significantly increased visibility of these at 1.1m customers. A large number of cash flows going forward. these customers are signing up to our own bundled broadband services. Residential revenues were down marginally in the last financial year, The TalkTalk broadband base made falling 2% to £1,089m (2008: £1,112m). further excellent progress during the year, increasing by 339,000 customers Blended broadband monthly ARPU or 27%. The customer service issues rose by 3% to £22.65. The increase of previous years are now behind us was driven by the greater proportion and our simple value proposition of higher ARPU TalkTalk customers continues to gain traction in the market. within the base. Non-broadband ARPU Growth picked up noticeably towards the rose 18% to £20.93, reflecting price end of the financial year, reflecting what Longer-Term Risks increases in line with BT’s voice price is seasonally our strongest quarter for and Challenges increases during the year. broadband growth but also underlining the brand’s value credentials as B2B revenues declined by 5% to £296m customers increasingly look to save ▪ Some of our competitors (2008: £312m). Opal continued to money in the current economic climate. have much greater financial improve its revenue mix, with an ongoing resources and may choose trend towards higher value services Trends in churn at TalkTalk were also very to use broadband as a offsetting falling premium rate traffic. encouraging, with annualised churn loss-leader for other products In the second half, the business falling materially year-on-year as ▪ Regulation may curb our launched its new suite of data products customers became increasingly satisfied access to fibre infrastructure for the small business market, which is with our service levels, and the housing at fair prices, thus preventing expected to drive moderate revenue market became more subdued. With our us from delivering higher growth in 2009-10. highly efficient, fully-unbundled network, speeds to customers ▪ Network or customer service may deteriorate, increasing our churn rate 12 The Carphone Warehouse Group PLC Annual Report 2009 we are able to generate strong cash At the year end we changed the way we margins while maintaining the most account for subscriber acquisition costs competitive telecoms bundles in the (“SAC”). Historically we have capitalised market. With customer lifetimes SAC and amortised it over a customer’s lengthening and acquisition costs stable, minimum contract term – typically we believe the net present value of the 18 months.