27565 SKY edit 01 35 · SKY’s mission is to be New Zealand’s most successful entertainment...

10 SKY Network Television Limited Annual Report 2004

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Business Overview

SKY’s mission is to be

New Zealand’s most successful

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.

SUBSCRIBER GROWTH

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.

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.

11SKY Network Television Limited Annual Report 2004

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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.

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;

• 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.

SKY’s success in each of these areas is looked at in further

detail on the following pages.

Channel 20 Channel 10 Channel 52 Channel 11

Strong Programmes

“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.

"If it’s worth knowing, or worth telling, you’ll catch it on SKY."


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Getting the programming wrong

is not an option. SKY’s business

has grown, and will continue to

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 ataffordable prices.

At 30 June, SKY was offering the number of channels on itsdigital platform illustrated in Chart 1.

SKY operates in a market of only 1.5 million homes so anyprogramming costs must be recouped from this small base.Management continually monitors the performance of theprogrammes it purchases to ensure that they generate theviewing that is required to support ongoing investment.

During the year SKY introduced three new basic channelsthat have had a big impact on viewing while alsobroadening the appeal of SKY. Disney has been a big successwith families and younger viewers, while UKTV and The History Channel have provided quality viewing for theolder demographic. To make room for these channels, CNBCand Hallmark were dropped from the service on the basisthat their share of viewing had declined.

Chart 2 highlights the strength of SKY’s programmingrelative to other broadcasters. It illustrates that SKY’s share of all New Zealand television viewing has grown to 19% ona 12 month moving average basis. This represents a 29%increase in audience share over the 2004 year.

This is significant as almost 20% of television viewing in New Zealand is spent watching a SKY programme eventhough SKY is only in 37.8% of New Zealand homes.

Chart 3 illustrates how SKY’s share of viewing relative to theother free-to-air channels has increased over the year.

Chart 4 highlights the percentage change in averageaudience over the year.

Chart 5 illustrates how SKY has also experienced a 24%increase in the average time spent viewing SKY digitalchannels per subscribing home.

This is encouraging as the more time a subscriber spendswatching SKY, the greater the value they are getting fromtheir subscription.

Strong Programmes

1

2

3

4

5


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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 increasein viewing has been on SKY pass-through and movie channels.

SKY subscribers pay a monthly fee to access a basic tier ofservices and have the option of subscribing to additionalservices 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 ofsubscribers purchasing different packages at 30 June.

The highest rating programme on SKY in the year to 30 June2004 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 figuresthat SKY has had on its digital platform and demonstrates thatlive rugby is still very popular in New Zealand. On the basictier the highest rating programme was the Warriors vs Bulldogson SKY 1 on 16 April 2004, attracting 235,000 viewers. Thehighest rating movie on the movie tier was Ice Age, watchedby 203,000 viewers.

On the UHF service there has been an increase in thenumber 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 sportand movie tiers, down from 68.9%. On the satellite service,there has been a decline in the number of subscribers whopurchase the Basic+Sport+Movie package ("Full Monty") to51.3% of subscribers, from 56.0% last year. While thisinformation on product penetration gives an indication oftrends, there is considerable movement between tiers duringthe year as it is easy for subscribers to telephone SKY andutilise the interactive voice response ("IVR") to upgrade ordowngrade their service.

Two highlights for the year have been the increasedpenetration 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.

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 in2004 was Austin Powers In Goldmember, which attracted13,221 buys. None of the mega-hit titles that were availableon PPV in 2004 (for example Charlie’s Angels: Full Throttle)rated in the top five buys, reflecting that these titles tend tobe viewed at the cinema, on aeroplanes or on DVD. Theaverage buy rate for the 2004 year, which reflects theaverage number of subscribers who purchase a movie in amonth, has increased from 31.4% to 31.8%.

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Loyal Subscribers

“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.

"Full time one moment, kick-off the next. SKY’s alwayson, it’s never over. Every end is just another beginning."


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In the entertainment business,

people vote with their fingers,

feet…and their wallets. We never

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 loyalsubscribers who willingly pay for access to a television service.

Each month all 576,602 of our subscribers compare thevalue offered by SKY with the other entertainment optionsthat are available and decide whether they will continue withtheir subscription. To survive and grow as a business SKYmust continually provide value to its subscribers so that theystay loyal and willingly part with the money for theirmonthly subscription.

CHURN

It is very encouraging that the percentage of subscribers who choose to disconnect SKY is continuing to fall, whichsuggests that SKY is continuing to provide a valuable service.

Churn is a measure of the number of customers whodisconnect their service, either voluntarily or due to a failureto pay their account. We evaluate churn on a gross basis, inother words, the percentage of customers disconnectingduring 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 arereconnecting from the number of disconnecting subscribersduring that month (that is, subscribers who have left buthave decided to return).

The following chart is of SKY’s gross churn on a rollingannual basis:

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:

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.

Loyal Subscribers


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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.

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.

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:


Robust Technology

“Looking for anuninterrupted 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.

"SKY technology keeps the windows of the worldopen all hours. When the screen lights up, thepossibilities are without boundaries or limits."


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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.

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.

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:

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

Year Purchased 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%

Robust Technology

($millions) 2004 2003 2002 2001 2000

Satellite transponder lease - 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

Other 2.3 1.9 4.5 4.4 1.7

Total capital expenditure $57.4 $105.8 $123.4 $153.3 $137.0

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.

SKY’s total capital expenditure on fixed and intangible

assets over the last five years, on an accruals basis, has

been as follows:

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.


Passionate People

“Looking for people who always travel thatextra 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.

"For a moment their hearts sank. The screen seemedblank – nothing was on. Then it lit up, along withtheir faces. The show was on."


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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

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:

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:

SKY will continue to harness the passion of its people to

deliver an entertainment experience that is second to none.

Passionate People

Increasing Profits

“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.

"The aim is to continue to reward those who chooseSKY not just for its entertainment value – but who seein us a quality investment opportunity and option."


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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:

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.

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:

2004 2003 % Inc($millions) ($millions)

Subscription revenue:

Residential 346.7 309.1 12.2

Commercial 25.4 22.3 13.9

SkyWatch 8.1 6.8 19.1

Total subscription revenue 380.2 338.2 12.4

Other revenue:

Advertising 26.6 19.6 35.7

Installation, programme sales and other 33.8 33.5 0.9

Total other revenue 60.4 53.1 13.7

Total revenue $440.6 $391.3 12.6%

Increasing Profits

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.

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.



s

Increasing Profits (continued)

EXPENSE ANALYSIS

A further breakdown of SKY’s expenses is provided below:

Programming expenses have reduced to 39.9% of revenue,

from 43.0% the previous year.

Programming costs are made up of the following:

The bulk of programming costs relate to purchasingprogramme rights, including the cost of sports content,pass-through channels, movies (including PPV) and musicrights. Production costs include the costs of producing livesporting events, in-house shows (such as Reunion and Try Time) and taping, formatting, editing and adding otherfeatures to programmes. Other costs include administrationand satellite linking costs for bringing in live events.

A significant proportion of SKY’s programme rights costs is inUS dollars. That means the NZ dollar cost included in SKY’saccounts is partly determined by the strength of the NZdollar during a particular year and by SKY’s hedging policy.

The board’s policy is to hedge a minimum of 85% of theforecast exposures on a rolling 12 month basis and 25% to45% of variable exposures on a rolling 13 to 36 month basis.Fixed-price contracts denominated in US or Australian dollarsare at least 70% hedged for a minimum of 36 months fromthe time they are entered into.

In 2004 SKY made US dollar operating payments at anaverage exchange rate of 50.4 cents. Based on 2004 results,each 1 cent movement in the US/NZ rate would haveaffected operating costs by around NZ$2.0 million. At thesame time, capital costs would have changed by aroundNZ$0.3 million.

In 2004, SKY’s total rights costs of NZ$137.4 million

included US$56.0 million of rights costs.

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 straight-

line 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.

($millions) 2004 2003

Rights 137.4 134.4

Production 20.9 16.3

Other 17.5 17.4

Total $175.8 $168.1

2004 2004 2003 2003($millions) % of ($millions) % of %

revenue revenue Inc

Programming 175.8 39.9 168.1 43.0 4.6

Subscriber management 17.6 4.0 13.7 3.5 28.5

Transmission 7.0 1.6 7.0 1.8 -

Selling, general andadministrative:

Realised and unrealised

foreign exchange 2.2 0.5 0.8 0.2 175.0

Other selling, general and administrative expenses 52.5 11.9 48.9 12.5 7.4

Selling, general and administrative - total 54.7 12.4 49.7 12.7 10.1

Depreciation and amortisation 128.1 29.1 124.1 31.7 3.2

Total operatingexpenses $383.2 87.0% $362.6 92.7% 5.7%

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:

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.

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.

2004 2003

Bank loans 6.9% 6.4%

Capital notes 8.8% 9.1%

Combined weighted average 7.9% 7.5%


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.

27565 SKY edit 01 35 · SKY’s mission is to be New Zealand’s most successful entertainment...

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