Business Overview

Business Overview
SKY’s mission is to be
SUBSCRIBER GROWTH
New Zealand’s most successful
A good indication of how well SKY is performing is whether
it is continuing to grow the size of its subscriber base.
If the base is growing then SKY is continuing to compete
effectively with other forms of entertainment. For the
fourteenth year in a row, SKY has increased its subscriber
base to a new record level of 576,602, a net gain of 33,711
for the year.
entertainment company.
This is a simple statement that incorporates three key themes:
1. SKY is based in New Zealand and is focused on
providing the entertainment experiences that Kiwis want.
2. SKY must be successful to survive in a competitive
entertainment market.
3. SKY is in the entertainment business, competing with
other products for the discretionary entertainment dollar
and leisure time.
SKY has been operating for 14 years and is a highly
recognised brand amongst New Zealanders. The essence of
the brand is providing high quality affordable entertainment
for the whole family. The slogan “What will you be doing if
you don’t have SKY?” is well recognised by our target
audience, providing a strong creative cue for our advertising
and emotionally connecting with our audience, both
subscribers and non-subscribers alike.
SKY’s consistently award-winning advertising, combined
with our ever-improving product and an aggressive sales and
marketing strategy, has been a winning formula for SKY with
our subscriber base growing consistently through our 14
year history.
Our research shows that interest in SKY continues to grow
amongst non-subscribers. People who, a few years ago,
dismissed the prospect of SKY in their home, are now
showing interest in subscribing.
SKY’s main objective is to continue to build on its current
position as the leading provider of multi-channel pay TV
services in New Zealand. At 30 June 2004 SKY was offering
84 channels and services, including 11 pay-per-view
channels, 14 music channels, 11 radio channels and
interactive services such as a weather channel, games
channels, email and access to TAB betting on certain
racing and sporting events.
s
10
SKY Network Television Limited Annual Report 2004
One of the features of this graph is the consistency of SKY’s
subscriber growth over time. Not only has there been a
number of watershed events for SKY over these years - for
example when we secured the SANZAR rugby contract in
1996 - but the underlying economic conditions in New
Zealand have also varied over the years. Despite a number
of significant events, there has been no spike or slow down
in subscriber acquisitions in any particular year. We expect
this steady consistent growth to continue into the future,
as we continue to expand our product offering and
gradually reach out and appeal to an increasing
percentage of the population.
The terminal penetration level is an important variable in any
valuation model for SKY. Management recognises this and is
committed to continuing to grow the subscriber base at a
consistent rate toward the penetration levels seen in more
mature markets.
IMPACT OF THE NEW ZEALAND DOLLAR
A factor that is beyond SKY’s control, but that can materially
impact the financial performance of the business, is the
exchange rate. SKY is an importer of television content and
capital goods (decoders), the majority of which are priced in
US dollars. In 2004 SKY spent over US$50 million on
operating expenses and US$7 million on capital items. One
of the biggest challenges faced by SKY is the volatility of the
US/NZ exchange rate. During 2004 the US/NZ spot rate
traded in a range from 0.56 to 0.71 and has ranged from
0.45 to 0.71 over the last two years.
Channel 20
Channel 10
SKY cannot eliminate this risk from its business as many of
our suppliers operate in the international market place where
programme rights and capital goods are traded in US
dollars. Transacting in NZ dollars is simply not an option.
What we can do in the short term is hedge our forecast
exposures in order to provide some certainty as to what the
exchange rate will be in the short term. The SKY board has
approved a hedging policy that results in 85% to 100% of
the forecast exposures being hedged on a rolling 12 month
basis and 25% to 45% of variable exposures being hedged
on a rolling 13 to 36 month basis. Fixed price US dollar or
Australian dollar contracts are at least 70% hedged for a
minimum of 36 months from the time they are entered into.
As the policy operates on a rolling monthly basis it does not
reduce SKY’s exposure to the volatility of the US/NZ
exchange rate but it does assist in providing greater certainty
as to what the exchange rate will be over the next 12 months.
Channel 52
Channel 11
•
acquiring transmission services from Broadcast
Communications Limited (“BCL”) for SKY’s UHF network;
•
accessing specialised outside broadcasting equipment
and services from On Site Broadcasting (NZ) Limited; and
•
providing 11 radio stations with access to a national
audience service via the SKY satellite platform.
SUCCESS FACTORS
If SKY is to be the most successful entertainment company
in New Zealand, it needs to be focused on five key areas of
its business:
1.
Strong Programmes: a subscription television business
must have strong programming content that people are
prepared to pay to see. To secure this content SKY must
build relationships with the global suppliers of sport,
movie and television content.
2.
Loyal Subscribers: SKY must attract and retain
subscribers so it can continue to build its business. This
means SKY must think about its subscribers, listen to
them and respond to their interests and needs.
3.
Robust Technology: technology is continually
impacting SKY’s business. Success is not about having
the latest technology; it’s about making the right
technology decisions at the right time, thereby ensuring
SKY can earn acceptable returns on these investments.
4.
Passionate People: SKY can only be the best
entertainment company in New Zealand if it has a great
culture and hires and keeps the best people.
5.
Increasing Profits: to retain the support of shareholders
SKY must increase its profits so as to provide acceptable
returns on the investment that has been made in
establishing its business.
IMPORTANCE OF LOCAL PARTNERSHIPS
One of the reasons for the success of the SKY business is the
strong partnerships we have developed with a number of
local industry players, including:
•
selling delayed rights to major sporting events to
free-to-air networks, including the rights to major rugby
and cricket games to TV3 (CanWest) and rugby league
games to Prime;
•
providing free access to SKY’s satellite digital platform
to national free-to-air broadcasters (TVNZ, TV3, C4
and Prime);
•
•
providing wholesale access to SKY’s programming
content to TelstraClear for distribution on its cable
network in Wellington and Christchurch and to Telecom
should it elect to distribute SKY over its network;
entering into a reselling agreement with Telecom
enabling it to resell SKY’s satellite pay TV services and
bundle these into one account;
•
purchasing complete channels from New Zealand
suppliers, for example, The Living Channel and Juice TV;
•
providing access to the SKY satellite platform for niche
channels such as Shine, Southland TV, Arts Channel,
Rialto, World TV and GoAuto;
SKY’s success in each of these areas is looked at in further
detail on the following pages.
s
SKY Network Television Limited Annual Report 2004
11
“Looking for 84
different windows
on the world?”
[Look No Further]
In a world awash with entertainment and leisure
options, hundreds of thousands of New Zealanders
look no further than SKY. With 84 channels and
services covering what we know is the full spectrum
of the world’s best listening and viewing, SKY
subscribers are consistently tuned into, and ‘turned
on’ by, our strong programme offering. We cover the
planet to deliver on our commitment to being the
country’s pre-eminent entertainment provider.
Strong Programmes
"If it’s worth knowing, or worth telling, you’ll catch
it on SKY."
Strong Programmes
Getting the programming wrong
is not an option. SKY’s business
has grown, and will continue to
1
grow, on the back of our skill,
determination and capability to
secure what people want at prices
that don’t cost the earth.
The continued growth of a subscription television
business is dependent on securing quality programming at
affordable prices.
2
At 30 June, SKY was offering the number of channels on its
digital platform illustrated in Chart 1.
SKY operates in a market of only 1.5 million homes so any
programming costs must be recouped from this small base.
Management continually monitors the performance of the
programmes it purchases to ensure that they generate the
viewing that is required to support ongoing investment.
3
During the year SKY introduced three new basic channels
that have had a big impact on viewing while also
broadening the appeal of SKY. Disney has been a big success
with families and younger viewers, while UKTV and
The History Channel have provided quality viewing for the
older demographic. To make room for these channels, CNBC
and Hallmark were dropped from the service on the basis
that their share of viewing had declined.
Chart 2 highlights the strength of SKY’s programming
relative to other broadcasters. It illustrates that SKY’s share
of all New Zealand television viewing has grown to 19% on
a 12 month moving average basis. This represents a 29%
increase in audience share over the 2004 year.
4
This is significant as almost 20% of television viewing in
New Zealand is spent watching a SKY programme even
though SKY is only in 37.8% of New Zealand homes.
Chart 3 illustrates how SKY’s share of viewing relative to the
other free-to-air channels has increased over the year.
Chart 4 highlights the percentage change in average
audience over the year.
Chart 5 illustrates how SKY has also experienced a 24%
increase in the average time spent viewing SKY digital
channels per subscribing home.
5
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14
SKY Network Television Limited Annual Report 2004
This is encouraging as the more time a subscriber spends
watching SKY, the greater the value they are getting from
their subscription.
Channel 10
Channel 20
Channel 21
Channel 13
It is also interesting to look at where this viewing
is occurring.
Chart 6 splits viewing on SKY’s digital platform among sport,
movie and pass-through (i.e. basic tier) channels.
Sports viewing stayed relatively flat over 2004 and the increase
in viewing has been on SKY pass-through and movie channels.
SKY subscribers pay a monthly fee to access a basic tier of
services and have the option of subscribing to additional
services including a sports tier, a movie tier, an Arts channel,
Rialto, digital music, rugby channel and a games channel.
Charts 7 and 8 provide information on the percentage of
subscribers purchasing different packages at 30 June.
The highest rating programme on SKY in the year to 30 June
2004 was the All Blacks vs England test match played on
12 June 2004. This game attracted 580,000 viewers, or 37%,
of the New Zealand market. These are the best viewing figures
that SKY has had on its digital platform and demonstrates that
live rugby is still very popular in New Zealand. On the basic
tier the highest rating programme was the Warriors vs Bulldogs
on SKY 1 on 16 April 2004, attracting 235,000 viewers. The
highest rating movie on the movie tier was Ice Age, watched
by 203,000 viewers.
On the UHF service there has been an increase in the
number of subscribers who purchased the sport-only tier
("super value package") from 28.7% to 34.7% of subscribers,
with 64.1% of UHF subscribers purchasing both the sport
and movie tiers, down from 68.9%. On the satellite service,
there has been a decline in the number of subscribers who
purchase the Basic+Sport+Movie package ("Full Monty") to
51.3% of subscribers, from 56.0% last year. While this
information on product penetration gives an indication of
trends, there is considerable movement between tiers during
the year as it is easy for subscribers to telephone SKY and
utilise the interactive voice response ("IVR") to upgrade or
downgrade their service.
Two highlights for the year have been the increased
penetration of Rialto and the Rugby Channel, with
Rialto having in excess of 80,000 subscribers and the
Rugby Channel having in excess of 50,000 subscribers.
6
7
8
Chart 9 illustrates that the number of pay-per-view ("PPV")
purchases has increased by 15.7% in the year to 30 June 2004.
The largest increase has been in Blockbuster movie purchases,
which are up 42.6% on last year. The most popular movie in
2004 was Austin Powers In Goldmember, which attracted
13,221 buys. None of the mega-hit titles that were available
on PPV in 2004 (for example Charlie’s Angels: Full Throttle)
rated in the top five buys, reflecting that these titles tend to
be viewed at the cinema, on aeroplanes or on DVD. The
average buy rate for the 2004 year, which reflects the
average number of subscribers who purchase a movie in a
month, has increased from 31.4% to 31.8%.
9
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SKY Network Television Limited Annual Report 2004
15
“Looking for an
adrenaline rush?”
[Look No Further]
At any one moment, many of our 576,602 viewers are
more than just visually connected to what is showing
on SKY. Loyalty is a two-way process – keep delivering
and people by nature will gladly return the favour.
The planet’s prime viewing, on standby for as little as
53 cents per hour, continually equates to many happy
returns. Moments that people witness, revisit, talk
about and share. SKY is their connection to, and
window on, the world.
Loyal Subscribers
"Full time one moment, kick-off the next. SKY’s always
on, it’s never over. Every end is just another beginning."
Loyal Subscribers
In the entertainment business,
people vote with their fingers,
feet…and their wallets. We never
There was an increase in churn in the period October to
February. To understand this it is necessary to break out
digital churn from UHF churn, which has been done in
the following graph:
lose sight of the reasons people
remain with us. In the eyes of
our beholders, our value is worth
the price.
To be successful SKY must continue to grow a base of loyal
subscribers who willingly pay for access to a television service.
Each month all 576,602 of our subscribers compare the
value offered by SKY with the other entertainment options
that are available and decide whether they will continue with
their subscription. To survive and grow as a business SKY
must continually provide value to its subscribers so that they
stay loyal and willingly part with the money for their
monthly subscription.
CHURN
It is very encouraging that the percentage of subscribers
who choose to disconnect SKY is continuing to fall, which
suggests that SKY is continuing to provide a valuable service.
Churn is a measure of the number of customers who
disconnect their service, either voluntarily or due to a failure
to pay their account. We evaluate churn on a gross basis, in
other words, the percentage of customers disconnecting
during a month compared to our total number of subscribers.
Other industry participants calculate a net churn figure,
where they subtract the number of subscribers who are
reconnecting from the number of disconnecting subscribers
during that month (that is, subscribers who have left but
have decided to return).
The following chart is of SKY’s gross churn on a rolling
annual basis:
This graph illustrates that the increase in churn occurred
on the UHF service and peaked in November 2003 before
returning to more normal levels by February 2004. The
reason for this is that SKY did not have access to one of
the more significant sporting events on the New Zealand
calendar, the Rugby World Cup, which played in
October/November 2003. These subscribers returned in
February 2004 for the start of the Super 12 competition.
Interestingly, digital churn stayed relatively flat over the whole
year, demonstrating the value digital subscribers see in the
greater range of channels that are available on this service.
VALUE
SKY is committed to providing a value-for-money pay TV
service. Subscribers pay a fixed monthly subscription for SKY
and as they continue to watch more and more SKY content,
the "value" they are getting for their subscription continues
to rise. A measure of value can be obtained by dividing the
average revenue earned per month per subscriber ("ARPU")
for the year by the average number of SKY viewing hours per
month, to obtain an average hourly cost per month for a
SKY subscription. The cost per hour has declined from 64
cents per hour last year to 53 cents per hour this year,
despite SKY imposing a 4.1% price increase in June 2003.
Our value proposition is based on the fact that there are very
few entertainment options available for the whole family for
as little as 53 cents per hour.
Churn is another good indication of whether subscribers
believe they are receiving value for money from their SKY
subscription and as this continues to fall we gain further
confidence that we are meeting our objective of providing
a value for money product.
s
18
SKY Network Television Limited Annual Report 2004
Channel 21
Channel 20
Channel 15
Channel 20
We also monitor the relative affordability of SKY. To do this
we construct a Big Mac Index for pay TV services. This index
calculates the number of Big Mac hamburgers it would take
to purchase a full package of pay TV services in a particular
country. As can be seen from the table below, SKY continues
to represent excellent value for money relative to Australia,
the US and UK.
The reliability of SKY’s distribution network is reflected
in the number of trouble calls received each year. This has
continued to decline in 2004 with the number of trouble
calls as a percentage of the subscriber base falling from
1.61% to 1.56%, as follows:
In interpreting this table we recognise that with
New Zealand’s relatively low level of disposable income,
SKY needs to be offering a more affordable product to
subscribers. SKY’s full package of pay TV services is a
much smaller offering than is available from these other
companies. Again the size of the New Zealand market is
such that it cannot support an offering of up to around
200 channels, as is available from DIRECTV in the US.
CUSTOMER SERVICE
The main point of interface between SKY and its subscribers is
the Customer Services department. This is the heart of SKY’s
operations and is where all existing and new subscribers call
when they require assistance. SKY received over 2.2 million
calls in the 2004 financial year, up 3.5% on 2003.
SKY is continuing to increase the level of staff it has in its
call centre in response to this increasing call volume and the
increased complexity of calls. As SKY continues to offer more
and more services to subscribers, it increases the likelihood
that a subscriber will require assistance in accessing these
services. The following graph summarises the number of
full-time equivalent staff (“FTE”) in the call centre relative to
subscriber numbers and highlights how we are continuing
to reduce the number of subscribers per FTE.
s
SKY Network Television Limited Annual Report 2004
19
“Looking for an
uninterrupted view
of entertainment
and events?”
[Look No Further]
Twenty-four hours a day, seven days a week, our focus
is on delivering the images you expect to see. Along
with the human face of this undertaking, robust
technology – versus constant cutting-edge innovation –
plays a pivotal role in our technical and overall service
delivery. When there’s a market advantage to do so,
we will adopt new approaches. In the meantime, our
priority is maintaining the technology that does the
business for us.
Robust Technology
"SKY technology keeps the windows of the world
open all hours. When the screen lights up, the
possibilities are without boundaries or limits."
Robust Technology
Technology for SKY is like the
highway. People pay more
attention to what they’re driving
than what they’re travelling on.
Our aim is to invest what is
required to receive and send the
product people are most focused
on – our programming.
The UHF infrastructure has a net book value of $20.3 million
in SKY’s accounts. Our current plan is to continue to operate
this network until the end of the current licence period in
2010. We would consider extending beyond this if our UHF
licences could be renewed on a cost-effective basis.
SKY’s satellite platform continues to perform strongly with
478,080 residential subscribers now receiving this service.
A total of 677,931 homes have been installed with a satellite
receiver, which represents 44.9% of New Zealand homes.
The average age of a SKY digital decoder is now 3.3 years
and we have some decoders that are 5.5 years old and still
in service.
The following table provides an age profile of satellite
decoders owned by SKY:
Year Purchased
SKY must have access to a reliable technology platform
to produce and deliver its pay TV services to subscribers.
However, to be successful, it must ensure that it can
generate economic returns from its technology decisions.
This can be a difficult balancing act. In a fast-changing
digital world there is continual pressure to adopt the latest
technological development to ensure that SKY retains its
competitive advantage. However, there is also a temptation
to sit back and see how a technology performs in another
market to obtain confidence that appropriate returns will be
earned from the investment. Management recognises the
importance of getting the timing of these technology
decisions right and is committed to monitoring international
developments to ensure SKY is positioned to take full
advantage of future developments.
SKY currently operates two distinct broadcast transmission
systems: a terrestrial analogue UHF network and a digital
satellite network. The UHF network was launched in 1990 as
a three-channel service and enabled SKY to launch the first
pay TV service in New Zealand. Developments in the
competitive landscape meant however that SKY could not
be limited by a technology that offered only a five-channel
service. In April 1997 SKY launched a satellite distribution
network and from December 1998 offered a digital service
with 100% coverage of New Zealand and a greatly increased
number of channels. This system utilised a different decoder
and required the installation of a satellite-receiving dish, as
opposed to a UHF aerial.
The UHF network was not abandoned by SKY and continues
to be used to provide an entry-level pay TV service for
residential subscribers. These subscribers paid a total of
$50.8 million in subscription revenue to SKY in the 2004
year, 14.6% of SKY’s total residential subscription revenue.
The UHF decoders are now up to 14 years old.
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22
SKY Network Television Limited Annual Report 2004
Age
Percentage
1999
5 to 6 years
16.1%
2000
4 to 5 years
19.8%
2001
3 to 4 years
27.6%
2002
2 to 3 years
12.6%
2003
1 to 2 years
14.2%
2004
0 to 1 year
9.7%
100.0%
SKY continues to depreciate its digital decoders over
five years. The net book value of digital decoders at
30 June 2004 was $69.1 million and capitalised satellite
installation costs were $88.6 million.
DECLINING INSTALLATION COSTS
Perhaps one of the most encouraging aspects of SKY’s
satellite pay TV business is the continued decline in the cost
of adding new subscribers to our network. As the following
chart highlights, the total installation cost for a new
subscriber has fallen from $719 in 2003 to $512 in 2004,
a reduction of $207 or 28.8%. This is a result of a further
reduction in the US dollar cost of the decoders and a
reduction in the cost of satellite dishes. We are forecasting
that this decline will continue in the 2005 year, with
installation costs forecast to fall to $452, a further reduction
Channel 10
Channel 20
of $60 or 11.7% (based on a US/NZ exchange rate of 0.65).
This forecast reduction is due to a lower US dollar cost of
the decoders, together with a more favourable forecasted
exchange rate. This is a significant benefit to SKY as less
capital is required to continue to grow the subscriber base
and provides a buffer should installation charges need to
be reduced to maintain subscriber growth momentum.
SATELLITE TRANSPONDERS
A key component of SKY’s satellite distribution network is
its lease of four transponders on the Optus B1 satellite.
This satellite was launched in 1992 and is projected to
have sufficient fuel to be able to maintain its geostationary
location at 160 degrees east until December 2006. SKY has
contracted to lease five transponders for up to 15 years on a
new satellite that is to be launched by Optus to replace B1,
known as D1. The D1 satellite is currently being constructed
by Orbital Sciences of the US and is on schedule to be
launched by December 2005.
By signing a long-term lease of five transponders on the D1
satellite, SKY is committing to retaining its satellite distribution
network into the future. We recognise that there are
alternative distribution technologies that have the potential
to offer multi-channel broadcast television, such as internet
protocol (“IP”) based television, which utilises existing
copper telephone wires to broadcast television and
technologies that utilise existing power-line infrastructure
to distribute television content. If these technologies
develop to the point where they are commercially viable
in New Zealand, then SKY will also look to utilise them in
its business. The arrangements we have with Telecom
and TelstraClear include a basis upon which SKY
content will be made available to subscribers who
choose to utilise alternative distribution technologies
owned by these parties. In fact, SKY is already
distributed over TelstraClear’s cable network in
Wellington and Christchurch.
Channel 11
Channel 21
SKY’s total capital expenditure on fixed and intangible
assets over the last five years, on an accruals basis, has
been as follows:
($millions)
Satellite transponder lease
2004
2003
2002
2001
2000
-
19.7
17.5
-
33.7
Subscriber equipment:
Decoders, smart cards and
associated equipment
14.5
31.1
38.5
75.6
44.2
Installation costs
38.2
43.3
47.2
55.1
49.4
Digital expansion
2.2
1.5
2.0
11.4
6.8
Interactive applications
0.2
0.7
3.0
2.0
0.4
Renewal rights
-
7.6
10.7
4.8
0.8
2.3
1.9
4.5
4.4
1.7
Total capital expenditure $57.4
$105.8
$123.4
$153.3
$137.0
Other
The satellite lease amounts included in the table above are
non-cash amounts that reflect the capitalisation of satellite
lease payments as commitments are made by SKY to lease
additional transponders. An offsetting finance lease liability
was also recognised in the accounts. The entry in 2003 was
to reflect the increased life expectancy of the satellite from
December 2005 to December 2006.
“Looking for people
who always travel that
extra mile?”
[Look No Further]
Many say SKY people are like magicians. With the turn
of a switch, or the connection of wire, we consistently
light up people’s lives. The magic starts with
passionate people who connect your world with ours.
Each installation is different – some are straight
forward, some are challenging – but each expectation
is the same. People have chosen us to bring the world
to their home and provide them with a rainbow of
entertainment options. SKY’s team watch over the
business of consistently delivering award-winning, and
high-quality programmes to people like you.
Passionate People
"For a moment their hearts sank. The screen seemed
blank – nothing was on. Then it lit up, along with
their faces. The show was on."
Passionate People
We know people sacrifice other
pleasures for the joy of watching
SKY. Getting it right to continually
make sure we’re on is the nature
of our operation. Having any
team member who is anything
less than passionate just wouldn’t
The most significant increase in staff turnover is in Customer
Services and Advertising Sales, areas where it is not
uncommon to experience a higher level of staff turnover.
SKY is reviewing the recruitment strategies in its call centre
to ensure they remain competitive and has increased the
level of staffing in the Advertising Sales department to
reduce some of the pressures that have been experienced
in this rapidly growing area.
SKY has a policy of internally advertising all vacancies first
and is proactive in encouraging staff to expand their skill
base by moving to new roles in the organisation. The
number of vacancies filled by internal candidates over
the last four years has been as follows:
make sense.
The success of SKY is dependent on the energy and
enthusiasm of its people. SKY is a 24 by 7 operation. It never
stops and neither do the demands that are placed on staff to
continue to provide a compelling and entertaining product.
The SKY culture is a young can-do attitude where everyone
gets involved and has fun delivering a great product. SKY
has retained the entrepreneurial flair that was needed to
develop a $2 billion business from scratch, and the business
continues to feel like it is being run by a hard-working owner
operator who carefully scrutinises every dollar that is spent.
As SKY’s subscriber base continues to grow, so do the
number of employees in the business. At 30 June 2004,
SKY employed 560 full-time equivalent employees, up
from 512 employed at 30 June 2003. The growth has been
spread around the business including in Customer Service,
Advertising Sales, Broadcast Operations, Sports Production
and Administration.
The level of staff turnover has increased in 2004 as is
illustrated below:
s
26
SKY Network Television Limited Annual Report 2004
SKY will continue to harness the passion of its people to
deliver an entertainment experience that is second to none.
©
Disney/Pixar
s
SKY Network Television Limited Annual Report 2004
27
“Looking for many
happy returns - and
a 2004 net profit of
$35.3 million?”
[Look No Further]
The combination of all the other pillars of SKY’s
business eventually turns into what any business is
all about – the numbers. In itself, people connecting
people to a world-class product and service is an
admirable pursuit. But in a financial context there
must also be a clear perspective on the bottom-line
mandate of delivering a quality return on investment.
We believe the improvement in profit from last year
($0.7 million) to this year ($35.3 million) is just what
investors like you are looking for.
Increasing Profits
"The aim is to continue to reward those who choose
SKY not just for its entertainment value – but who see
in us a quality investment opportunity and option."
Increasing Profits
Hundreds of thousands of
New Zealanders choosing to
have SKY as a critical part of their
world will continue to fuel our
financial performance. Increases
in revenue, profit, subscribers,
coverage and entertainment
options should keep the financials
travelling in the right direction.
SKY has been able to significantly improve on last year’s
net profit of $0.7 million by reporting a net profit of
$35.3 million for the 2004 year. This is a solid achievement
that means that SKY has been able to further reduce the
accumulated losses it has incurred in establishing its business
to a total of $200.4 million. Further growth in profits is
required if SKY is to reward its shareholders for their patience
in continuing to retain an investment in SKY.
REVENUE ANALYSIS
SKY revenue has increased by 12.6% to $440.6 million,
as follows:
2004
2003
($millions)
($millions)
% Inc
346.7
309.1
25.4
22.3
13.9
8.1
6.8
19.1
380.2
338.2
12.4
Advertising
26.6
19.6
35.7
Installation, programme
sales and other
33.8
33.5
0.9
60.4
53.1
13.7
$440.6
$391.3
12.6%
Subscription revenue:
Residential
Commercial
SkyWatch
Total subscription revenue
12.2
Other revenue:
Total other revenue
Total revenue
Subscription revenue increased by 12.4%, reflecting a 6.2%
increase in subscribers, an average 4.1% price increase
implemented in June 2003 and the net impact of a change
in the mix of services purchased by subscribers.
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SKY Network Television Limited Annual Report 2004
Residential subscription revenue: several analysts look at
revenue in terms of ARPU. This approach can be misleading,
especially at a macro level, because it does not recognise the
differing costs that attach to different types of subscribers.
For example, SKY earns less revenue (ARPU) from TelstraClear
under its retransmission agreement, simply because
TelstraClear provides the capital to install these customers,
operates its own network and manages all aspects of
customer service. However, this does not mean these
customers are less "profitable", as clearly the costs to SKY
of installing and servicing these customers are also lower.
In other words, the mix of customers determines the level
of ARPU. ARPU itself may not reflect the level of profitability
of these customers.
The following table outlines SKY’s ARPU over the last four
years, calculated on a rolling monthly basis:
Channel 13
Channel 20
SKY’s total ARPU increased by 5.2% from $51.83 to $54.55
in 2004. Satellite ARPU increased by 3.3% from $59.35 to
$61.33, reflecting the effect of the price increase, partially
offset by a reduction in the number of subscribers
purchasing both the sport and movie packages. Wholesale
ARPU has increased by 13.3% from $36.94 to $41.86
reflecting the impact of a full year of the new reseller
agreement with Telecom, which incorporates a lower discount.
UHF ARPU increased by 0.8% to $40.68. This is the first
time for several years that we have increased SKY’s UHF
ARPU and reflects that a greater proportion of subscribers
are purchasing the sport and movie channels on this service.
Commercial subscription revenue: the commercial business
continues to perform strongly with revenue up by 13.9%.
An increasing number of commercial subscribers are
switching from UHF to SKY’s satellite service and as a result,
are purchasing more of the services that are available on
this platform.
SkyWatch is SKY’s monthly programme guide. There were
322,473 subscriptions to the guide at 30 June 2004, an
increase of 11.9% for the year. The cover price of this guide
was increased from $2.00 to $2.25 in June 2003. The
penetration of the guide has increased from 58.1% to 60.6%.
Advertising sales exceeded even our own expectations in
2004, up 35.7% on the 2003 result. We are continuing to
benefit from increased viewership on SKY channels and
advertisers recognising the value of being able to market
to specific audiences on SKY. While two additional channels
were offered to advertisers with the launch of UKTV and
The History Channel, most of the increase in revenue has
been as a result of increased yields. SKY is now inserting
advertisements on a total of 18 channels.
Installation revenue is the revenue received from subscribers
who are charged an initial installation fee for subscribing
to the UHF or satellite service. Installation revenue is also
received from Telecom under the reseller agreement. SKY’s
accounting policy is to recognise this revenue as income,
when it is charged. The current listed installation rate for
new UHF subscribers is $50 (including GST), while the rate
for new satellite subscribers is $149 (including GST). From
time to time, the satellite and UHF installation rates are
reduced to attract new subscribers.
Channel 52
Channel 21
Programme sales revenue is the revenue received from
selling the replay rights of certain sporting events to the
free-to-air networks. Currently, TV3 has purchased the right
to replay certain rugby and cricket games and Prime has
purchased the rights to replay certain rugby league games
from the NRL league.
Other revenue is revenue received from satellite dish
sales, rental to third parties of transponder capacity and
production revenue for programmes sold to third parties.
As our subscriber base increases, it is possible that the quality
of customers could decline. To avoid this, SKY maintains an
active approach to managing debtors. Bad and doubtful
debts as a percentage of revenue have declined from 0.6%
to 0.4%. This rate is low compared to international peers.
A policy of billing customers in advance for their services,
maintaining a credit limit of $60 on PPV purchases, establishing
an up-front cost to subscription through the installation fee and
encouraging customers to utilise direct debit as a form of
payment, all assist in minimising bad debt levels.
Increasing Profits (continued)
In 2004, SKY’s total rights costs of NZ$137.4 million
included US$56.0 million of rights costs.
EXPENSE ANALYSIS
A further breakdown of SKY’s expenses is provided below:
Programming
Subscriber management
Transmission
2004
2004
2003
2003
($millions)
% of
revenue
($millions)
% of
revenue
175.8
39.9
168.1
43.0
4.6
17.6
4.0
13.7
3.5
28.5
7.0
1.6
7.0
1.8
-
%
Inc
Selling, general and
administrative:
Realised and unrealised
2.2
0.5
0.8
0.2
175.0
Other selling, general
and administrative expenses 52.5
foreign exchange
11.9
48.9
12.5
7.4
Selling, general and
administrative - total
54.7
12.4
49.7
12.7
10.1
128.1
29.1
124.1
31.7
3.2
$383.2
87.0%
$362.6
92.7%
5.7%
Depreciation and
amortisation
Total operating
expenses
Programming expenses have reduced to 39.9% of revenue,
from 43.0% the previous year.
Programming costs are made up of the following:
2004
2003
137.4
134.4
Production
20.9
16.3
Other
17.5
17.4
Total
$175.8
$168.1
($millions)
Rights
The bulk of programming costs relate to purchasing
programme rights, including the cost of sports content,
pass-through channels, movies (including PPV) and music
rights. Production costs include the costs of producing live
sporting events, in-house shows (such as Reunion and
Try Time) and taping, formatting, editing and adding other
features to programmes. Other costs include administration
and satellite linking costs for bringing in live events.
A significant proportion of SKY’s programme rights costs is in
US dollars. That means the NZ dollar cost included in SKY’s
accounts is partly determined by the strength of the NZ
dollar during a particular year and by SKY’s hedging policy.
The board’s policy is to hedge a minimum of 85% of the
forecast exposures on a rolling 12 month basis and 25% to
45% of variable exposures on a rolling 13 to 36 month basis.
Fixed-price contracts denominated in US or Australian dollars
are at least 70% hedged for a minimum of 36 months from
the time they are entered into.
In 2004 SKY made US dollar operating payments at an
average exchange rate of 50.4 cents. Based on 2004 results,
each 1 cent movement in the US/NZ rate would have
affected operating costs by around NZ$2.0 million. At the
same time, capital costs would have changed by around
NZ$0.3 million.
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SKY Network Television Limited Annual Report 2004
Subscriber management costs include the cost of servicing
and monitoring equipment installed at subscribers’ homes,
a portion of the overhead costs of SKY’s customer service
department and general administrative costs associated with
SKY’s eleven regional offices. They do not include installation
costs as these are capitalised and amortised on a straightline basis over a five-year period. Subscriber management
costs increased by $3.9 million to $17.6 million (a 28.5%
increase) primarily as a result of the reduction in the
percentage of overhead costs that are capitalised.
Transmission costs consist of transmission and linking paid
to BCL for transmitting SKY’s UHF signals from its studios in
Auckland to other locations, using a digital microwave
and optical fibre distribution network. They also include
broadcasting the signals from BCL’s television towers
throughout New Zealand. Payments to BCL for transmission
services are based on revenue generated from SKY’s UHF
network, subject to minimum and maximum annual payments,
whereas payments for linking are predominantly fixed.
Selling, general and administrative expenses consist
of marketing costs, including overheads and the costs of
producing advertisements promoting SKY products, selling
advertising and sponsorship on SKY and production of the
SkyWatch programming guide. General and administrative
costs include such overheads as corporate management,
the finance department, the information technology
department, the costs of collecting bills from subscribers
including bad debts and the write-off of damaged and
unreturned decoders. Also grouped here are realised foreign
exchange gains and losses not attributed to programming
expenditure and all unrealised foreign exchange gains and
losses. These costs increased by $5.0 million in 2004 to
$54.7 million (a 10.1% increase). This was primarily as a
result of increases in marketing expenditure and increases in
advertising costs (agency commission and employee costs,
commensurate with increased advertising revenue).
Depreciation and amortisation include depreciation charges
for subscriber equipment, including aerials, satellite dishes
and decoders, all owned by SKY, as well as installation costs.
Depreciation also includes depreciation of the transponders
leased on the Optus satellite and fixed assets such as the
studios, facilities and UHF transmission equipment.
Channel 52
Channel 10
Interest and financing charges include interest on the bank
loan, interest on the capital notes (both inclusive of interest
received or paid on swaps) and also the amortisation of
capital notes issue costs, bank commitment and facility fees.
The weighted average interest rates for the relevant years
have been calculated to be as follows:
2004
2003
Bank loans
6.9%
6.4%
Capital notes
8.8%
9.1%
Combined weighted average
7.9%
7.5%
Finance lease interest relating to the four Optus transponders
is also included in interest expense and is being ‘expensed’
over the remaining estimated life of the satellite lease.
The significant reduction in interest costs reflects the decline in
bank debt from $148 million to $46 million during the year.
Taxation expense: a small tax charge was incurred for the
year ended 30 June 2004, due to SKY DMX Music Limited .
SKY estimates that at 30 June 2004 it had deferred tax assets
of approximately $42.6 million calculated at the current
corporate tax rate of 33%. These deferred tax assets include
$1.8 million attributable to tax losses carried forward,
$7.2 million due to timing differences and $33.6 million
that is receivable from Independent News Limited (“INL”)
under the tax loss agreement (refer below).
These deferred tax assets have not been recognised, as
they are currently unable to meet the virtual certainty test
required under New Zealand generally accepted accounting
practice (“GAAP”). Under New Zealand law, a minimum
49% continuity of shareholding is required for
accumulated tax losses to be carried
forward. SKY continued to satisfy
this test at 30 June 2004.
Channel 20
Channel 11
TAX LOSS AGREEMENT WITH INL
SKY and its 78% shareholder, INL, have agreed that INL will
utilise certain income tax losses incurred by SKY from 1 July
2001. INL will pay SKY the "value" of the losses that have
been offset. The amount payable will be calculated by
multiplying the losses utilised by the corporate tax rate
applicable in the year of offset and will be paid when SKY
becomes liable to pay income tax. This is anticipated to be
received by SKY during the 2005 year.
As at 30 June 2004, losses totalling $101.8 million had been
offset by way of notification to Inland Revenue. As SKY will
utilise the cash received from INL to pay income tax, it will
receive imputation credits from these payments. These
imputation credits would not have been available had SKY
retained the losses and offset them against its profits in
future years.
If at any time INL and SKY cease to be members of the same
group for tax purposes (that is, if INL ownership of SKY falls
below 66%) the compensation for any losses utilised by INL
would be immediately repayable to SKY.
SKY has not recognised the INL tax receivable of
$33.6 million in its accounts as it cannot satisfy the virtual
certainty test specified under New Zealand GAAP.
Increasing Profits (continued)
INTERNATIONAL FINANCIAL REPORTING STANDARDS
SKY anticipates being an early adopter of International
Financial Reporting Standards ("IFRS"). If this occurs, then
the first set of accounts published under IFRS will be SKY’s
interim results for the six months to 31 December 2005.
SKY has reviewed the IFRS and believes that the only
standard that could have a material impact on SKY’s balance
sheet will be IAS 39, Accounting for Financial Instruments:
Recognition and Measurement. This standard requires all
derivatives to be recognised on balance sheet and any gains
or losses on these contracts must be recognised in the profit
and loss account, unless “hedge accounting” criteria can be
met. SKY believes it will satisfy this criterion and therefore
unrealised gains and losses on these hedges will be
recognised in reserves and only taken to the profit and loss
account when the underlying transaction is recognised in
the profit and loss account. SKY currently discloses the fair
value of its off-balance-sheet derivatives by way of a note to
its accounts.
There will also be a number of other less significant changes
to SKY's accounting policies in order for these to comply
with IFRS, including accounting for deferred tax. None of
these changes is expected to have a material impact on
SKY's financial results.