Operating results
Group operating costs before specific items and leaver costs increased by 3 per cent to £4,525 million, partly due to exchange rate movements. Staff costs before leaver costs increased by 5 per cent to £1,370 million, largely due to acquisitions made in the past year, with the impact of pay inflation being largely offset by efficiency savings. Leaver costs before specific items were £73 million in the quarter (£8 million last year), mainly due to the earlier timing of leaver programmes this year. Payments to other telecommunication operators decreased by 2 per cent to £1,037 million, with the growth in BT Global Services being more than offset by the decline in transit volumes and prices. Other operating costs before specific items of £1,585 million increased by 6 per cent, reflecting increased costs of sales due to growth in the networked IT services business, as well as the impact of acquisitions and higher energy and fuel costs, and have been partially offset by cost efficiency savings. Efficiency savings were £145 million in the quarter and we have increased our full year target by £100 million to achieve total savings of about £800 million in the year. Depreciation and amortisation decreased by 3 per cent year on year to £691 million, largely as the result of some legacy assets becoming fully depreciated. Other operating income before specific items increased by £23 million to £90 million in the quarter, which included some up front benefits from the transformation of our operational cost base through global sourcing and process improvement, together with income from the sale of scrap materials and cable recoveries.Group operating profit before specific items and leaver costs increased by 4 per cent to £742 million. Group operating profit margin before specific items and leaver costs increased to 14.3 per cent compared with 14.2 per cent last year, the sixth consecutive quarter of year on year margin expansion.
Earnings
Net finance expense before specific items was £130 million, an increase of £75 million against last year. The increase in net finance expense primarily reflects the higher average net debt, due mainly to the share buyback programme, together with a reduction in finance income associated with our defined benefit pension scheme to £78 million (£105 million last year).
The effective tax rate on the profit before specific items was 22.8 per cent (24.8 per cent last year) compared with the UK statutory rate of 28 per cent (30 per cent last year), reflecting the continued focus on tax efficiency within the group.
Profit before taxation, specific items and leaver costs of £613 million decreased by 7 per cent.
Earnings per share before specific items and leaver costs increased by 2 per cent to 6.1 pence. This is based on average shares in issue of 7,731 million (8,216 million last year) with the reduction due to the shares repurchased under the buyback programme.
Specific items
Specific items are defined in note 4 on pages 26 to 27 of the attachments. Specific items were a net charge before tax of £27 million (£50 million last year) and a net charge after tax of £19 million (£119 million credit last year). Specific items before tax wholly relate to restructuring costs (£49 million last year) incurred on our transformation and reorganisation activities in the quarter which mainly comprised manager leaver costs and transformation programme costs. Last year specific tax items included a £154 million tax credit relating to the re-measurement of deferred tax balances for the change in the UK statutory corporation tax rate to 28 per cent.
Earnings per share after specific items was 5.1 pence in the quarter (7.4 pence last year).
Cash flow and net debt
Net cash inflow from our operating activities in the first quarter decreased to £387 million compared with £848 million last year. This was reflected in free cash flow which was an outflow of £734 million compared with an outflow of £152 million last year. The higher free cash outflow is primarily the result of a higher working capital outflow of £962 million (£691 million last year), which is expected to largely reverse in the second half of the year. In addition there was a higher net cash outflow in respect of net interest paid of £285 million (£182 million last year) as a result of the timing of interest coupon dates on new debt raised in the last year and a one off interest receipt from HMRC last year. In addition, last year free cash flow benefited from the receipt of £504 million from the settlement of open tax years up to and including 2004/5 agreed with HMRC, offset by pension deficiency contributions of £320 million, both of which are non recurring in the current financial year.
Net cash outflow for the purchase of property, plant and equipment and software was marginally up at £836 million (£819 million last year). The net cash outflow on acquisition of subsidiaries in the quarter was £94 million (£164 million last year) and related principally to the acquisition of Wire One Holdings Inc, a video conferencing company based in the US. During the quarter we raised new long term borrowings of £794 million at an average annualised interest rate of 7.7 per cent. We repurchased 118 million shares (113 million last year) for a total consideration of £257 million (£365 million last year), resulting in a net cash outflow of £271 million (£382 million last year). As announced earlier this month, the share buyback programme is being suspended with effect from July 31, 2008 as a result of our strategic investment in fibre deployment.
Net debt was £10,581 million at June 30, 2008 compared with £8,631 million at June 30, 2007 and £9,460 million at March 31, 2008. Free cash flow and net debt are defined and reconciled in notes 7 and 8 on pages 28 to 30 of the attachments.
Pensions
The BT Pension Scheme IAS 19 valuation deficit at June 30, 2008 was £0.6 billion, net of tax (£0.8 billion gross of tax), compared with a surplus of £1.4 billion at June 30, 2007 (£2.0 billion gross of tax). The BT Pension Scheme had assets of £36.8 billion at June 30, 2008 (£39.5 billion at June 30, 2007).
