Amidst a challenging operating environment marked by high inflation and cost pressures, Spark (SPKKY) has reported modest revenue growth in its half-year results ending December 31, 2023. The telecommunications company saw its adjusted revenue increase by 1.3% to $1.98 billion, with notable performance in mobile services and data centers.
Still, higher interest rates and payments led to a 4.8% decrease in adjusted net profit after tax (NPAT) to $157 million. Spark's focus on expanding its digital infrastructure, including investments in IoT, digital health, and high-tech solutions, aligns with its strategy to support New Zealand's economic transformation and sustainability objectives.
Key Takeaways
- Adjusted revenue grew by 1.3% to $1.98 billion, with mobile and data center segments driving growth.
- Adjusted EBITDAI increased by 3.9% to $530 million.
- Adjusted NPAT decreased by 4.8% to $157 million due to higher interest rates and payments.
- Capital expenditure increased as the company accelerated investments in line with its new strategy.
- The company is focusing on IoT, digital health, and high-tech solutions to support New Zealand's economic goals.
Company Outlook
- Spark reaffirmed its full-year guidance and expects improved performance in the second half.
- The company aims to develop three large-scale data centers targeting returns of 9% to 10% over time.
- Spark is considering a $250 million offer of unsubordinated, unsecured fixed-rate bonds.
- The outlook includes growing momentum, optimization of margins in broadband, and growth opportunities in hybrid cloud and data centers.
Bearish Highlights
- Free cash flow for the period was down 60% to $46 million.
- Net debt increased by $759 million, although expected to stabilize.
- Broadband revenue declined by 1.3%.
- IT services faced challenges with service management revenues down $8 million.
Bullish Highlights
- Mobile service revenues grew by 6.3%.
- Cloud revenue and data center revenue increased by 3.8% and 38.5%, respectively.
- High-tech revenues grew by 13% due to IoT connection growth and the new Takanini data center.
- The company is on track to exceed its gross cost reduction target of $40 million to $60 million in FY '24.
Misses
- Adjusted NPAT fell by 4.8% due to increased interest rates and payments.
- Other product revenue decreased due to the closure of Spark Sport.
Q&A Highlights
- Executives discussed the company's target for a return base of 9% to 10% above the cost of capital.
- They addressed the financial impact of Connexa, with a combined share of losses around $5 million.
- Questions regarding the revenue decline in digital health and the impact of 5G investments were addressed.
- The competitive landscape in mobile and broadband markets remains intense but stable.
Spark's half-year results reflect a company that is adapting to economic challenges while strategically investing in growth areas. With a focus on digital infrastructure and technology capabilities, Spark is positioning itself as a key player in New Zealand's economic development, despite facing headwinds in the broader market.
InvestingPro Insights
In light of Spark's recent half-year results, InvestingPro data and tips provide a deeper understanding of the company's financial health and market position. Spark's market capitalization stands at approximately $5.58 billion, indicating its substantial size within the telecommunications sector.
Despite a challenging economic environment, Spark has maintained a dividend yield of 5.11%, showcasing its commitment to returning value to shareholders, a practice it has upheld for 33 consecutive years according to an InvestingPro Tip.
The company's price-to-earnings (P/E) ratio, a measure of its current share price relative to its per-share earnings, is 21.87, with a slight adjustment to 21.26 for the last twelve months as of Q2 2024. This figure suggests that investors are willing to pay above the industry average for Spark's earnings, possibly due to its stable dividend payments and anticipated profitability this year.
Moreover, Spark's price to book (P/B) ratio of 5.48 signifies that the market values the company at over five times its book value, potentially reflecting the company's robust intangible assets and market position.
Still, analysts anticipate a sales decline in the current year, with revenue growth down by 9.88% in the last twelve months as of Q2 2024. This aligns with the reported revenue challenges in the article, particularly in the broadband and IT services segments. Despite this, Spark remains profitable over the last twelve months and continues to trade with low price volatility, as highlighted by an InvestingPro Tip.
For investors seeking a more comprehensive analysis and additional insights, there are nine more InvestingPro Tips available for Spark, which can be accessed through InvestingPro's platform. These tips could further guide investment decisions, especially in the context of Spark's strategic focus on digital infrastructure and technology capabilities in New Zealand.
To explore these additional insights and make informed investment decisions, readers may use the coupon code PRONEWS24 to get an additional 10% off a yearly or biyearly Pro and Pro+ subscription at InvestingPro.
Full transcript - Spark New Zealand Limited (SPKKY) Q2 2024:
Jolie Hodson: [Foreign Language] and good morning. Thank you for joining us today as we share Spark's half year results for the period ending 31 December 2023. This morning, I'm going to provide an overview of our results and an update on our strategy. I'm then going to hand over to Stefan Knight, our CFO, to speak to our financial performance in more detail before we move to Q&A. So as was the case for most businesses, we experienced a challenging operating environment during the half with a high inflation, cost of living pressures and uncertainty resulting in lower levels of consumer and business confidence. Our core telco products are resilient during economic downturns, but not immune and uncertainly did dampen demand in some parts of the public and private sectors. Despite these challenges, we continue to deliver top line growth and made solid progress in implementing our new 3-year strategy. I'm going to speak to the adjusted numbers for the purposes of providing a like-for-like comparison, which strips out the impact of the TowerCo transaction and the exit of Spark Sport in FY '23. So if we move to that, we delivered adjusted growth of 1.3% to $1.98 billion, driven by a standout mobile performance and momentum in data centers and high-tech. When combined with strong cost control, holding operating expenses broadly flat, the adjusted EBITDAI grew 3.9% to $530 million. Adjusted NPAT decreased 4.8% to $157 million, due to higher average interest rates on debt and higher interest payments on Connexa leases. We expect to see a second half improvement in line with stronger H2 EBITDAI and Stefan's going to talk through that a bit more shortly. Capital expenditure was higher in the first half as we accelerated investments to gain a fast start on our new strategy. And as we implemented upgrade programs like ERP and this in turn impacted free cash flow. We remain committed to delivering our overall CapEx envelope within guidance and achieving our free cash flow ambition. Finally, we declared in HY FY '24 dividend of $0.135 per share, 100% imputed. I'm now going to move to Slide 4 and our telco market performance. Mobile remains central to our growth with mobile service revenues up 6.3% to $510 million as the benefits of annual price review flowed through and we captured 47% of total connection growth. Broadband revenue held broadly flat, so that's 1.3% decline to $309 million despite high levels of competition in an inflationary environment. Margins were maintained as fiber input cost increases passed through and wireless broadband grew to 31% of our base. So moving now to our digital services market performance outlined on Slide 5. So pleased to have cloud back in growth with revenue up 3.8% through increased private and public cloud workloads and the launch of our new hybrid cloud service. Cloud gross margins grew 7.6% as the cost base was reset, with benefits continuing to flow through the second half. Overall, IT revenues held flat at $345 million. That was impacted by a 10% decline in service management, primarily due to lower public sector demand. Our investment in the high-growth data center market is progressing to plan with a 10-megawatt expansion of our Takanini data center completed in August '23 and revenue streams coming online during the half. This drove a revenue increase of 38.5% to $18 million, and I will provide more detail on our data center investment shortly. High-tech revenues grew 12.9% to $35 million. That was driven by strong IoT connectivity growth with Spark's IoT networks now supporting around 1.8 million connections. With several converged technology proof-of-concepts underway with customers to identify future commercialization opportunities. Digital health revenues were down 8.7% to $42 million and also impacted by public sector slowdown. We were focused on growing new revenue streams through further expansion to supporting the private sector. So looking at our indicators of success on Slide 6, in high tech, the slowdown of public sector activity did impact growth in our data business, Qrious, which we expect to improve in the second half. More broadly, we're on track or making solid progress towards all of our measures. So H1 marked the first 6 months of our new strategy. And we've been operationalizing our new ambitions across the business. On Slide 8, we overview our Operate Program which is focused on accelerating growth investment in digital infrastructure and redesigning our operating model to align to our FY '26 goals. To do this, we are directing labor investments to new growth areas and are reducing investment in areas where EBITDAI profiles are changing, such as cloud. When we combine this work with our ongoing focus on AI and automation, simplification, digitizing our customer journeys and growing wireless broadband, we are on track to exceed our gross cost-out target of $40 million to $60 million in FY '24. The dual focus of growth and resilience is a key feature of our strategy. The strategic digital infrastructure investments we are making build on the strengths of our core connectivity assets. And when combined with the lowest-cost operating model creates the flywheel that underpins ongoing strength in our core business and new high-tech commercialization opportunities that will build out our future growth engines. On Slide 10, we provide a road map for these high-tech opportunities. In the near term, our ambition is to continue scaling our presence in IoT and digital health, leveraging what are now more mature technologies in mature markets, we'll continue to expand into new sectors while moving up the value chain into high-tech or converged solutions. Our investments into emerging technologies, including 5G stand-alone and converged technology will open up new commercialization opportunities in these markets. We are making progress with our satellite trials as capability matures. We sent our first satellite text message on our network in November last year, and we have a Starlink business-grade satellite broadband solution in market for our business customers. Finally, we have MATTR, which is focused on building entirely new markets with new digital identity technology. Here, our ambition is to support the establishment of the market locally and globally and to secure high-growth SaaS-based annuity revenues, building scale over time. So just turning now to our data center strategy on Slides 11 and 12. We continue to experience positive tailwinds with the ongoing growth in data, business digitization and the rapid uptake of generative AI accelerating demand for data center capacity. We're well positioned to capture our share of this growing market and our strategic ambition is to create 3 large-scale data centers in Auckland at Takanini, our Aotea campus and on the North Shore. The completion of our 10-megawatt expansion at Takanini brings our total built capacity to 22 megawatts with 88% contracted utilization. We then have a further 1-megawatt expansion due to complete at our Aotea campus by the end of the calendar year. Our potential development pipeline beyond this is significant, now totaling up to 70 megawatts. Of this, we have 5 megawatts in design at Takanini which is expected to be under construction during the first half of FY '25, and we have a conditional agreement to purchase land within a new development on Auckland's North Shore. Our intent is to develop an initial 10-megawatt hyperscale data center campus on this site with the option to add an additional 30 megawatts in the future. We'll consider appropriate funding models or partnerships for this investment and the broader potential development pipeline as we progress those opportunities. Overall, we're targeting returns of 9% to 10% over time as utilization scales. Finally, I'll touch on our sustainability performance. So to support Aotearoa's economic transformation, we remain focused on investing in the digital infrastructure and technology capabilities in our country and New Zealand businesses need to become more productive and sustainable. We recently released new research into the role advanced technologies can play in addressing New Zealand's well documented and persistent productivity challenges. The opportunity here is significant with just a 20% uplift in the use of these technologies, increasing industry output by up to $26 billion over 10 years and GDP by up to 2% each year. So we're exploring these opportunities now with our customers. Our digital equity broadband product, Skinny Jump, is now supporting over 29,000 households, and we continue to invest in community solutions through the Spark Foundation and increased online protection for our customers. We've completed 5 supplier audits we committed to delivering in the 2023 calendar year. During the half, our Scope 1 and 2 greenhouse gas emissions were down 8% compared to H1 FY '23, and people engagement continues to climb. Overall, we're pleased to see that our continued ESG progress secured our ongoing inclusion in the Dow Jones Sustainability Australia Index during the half. If I stand back and look at the overall result, we've delivered a resilient performance in a tough economic climate, while reorienting the business towards our new strategic growth ambitions. Our business fundamentals are healthy and growing with customer satisfaction up 5 points and people engagement up 3. With an ongoing focus on cost discipline, investment in the new growth and as signs of improvement in our broader economic environment start to emerge, we are well positioned to build further market momentum in the second half. I'm now going to hand over to Stef to talk you through the financial performance in more detail. Thanks, Stef.
Stefan Knight: Thanks, Jolie, and good morning, everybody. So I'll step you through the key financial summaries for the half, starting with the reported results, where the prior year numbers include a $584 million gain on sale from the TowerCo sale and a $52 million provision relating to the exit of Spark Sport. So reported revenue of $1.98 billion was down 22%. Reported EBITDAI of $530 million was down 49% and reported NPAT was $157 million and down 82%. So I'll now focus on the adjusted results, which exclude the impacts of TowerCo and the Spark Sport provision. So adjusted revenue of $1.98 billion was up $26 million or 1.3%. Adjusted EBITDAI of $530 million was up $20 million or 3.9%, and adjusted NPAT was $157 million, down $8 million or 4.8%. So let's actually step through each of the components of the adjusted results in a bit more detail, so we can understand the key movements. So first of all, if we start with revenues, where we maintained top line growth despite the challenging economic conditions. Growth was underpinned by strong performance across key areas such as mobile, momentum in data centers and high-tech, the ongoing stabilization of broadband and a return to growth in IT products. In the telco market, mobile service revenues grew by $30 million, up 6%. And $7 million of this growth related to roaming with volumes now sitting above pre-COVID levels. Service revenue, excluding roaming, grew by 5%, which is also a very strong result and consistent with prior year trends. This was driven by ongoing connection growth and by pay-monthly and prepaid, which grew by 54,000 and 92,000 connections, respectively. Pleasingly, pay-monthly ARPUs grew by $0.55, highlighting ongoing strong demand for data and the impact of price increases. Within the pay-monthly customer base, we saw ongoing growth in consumer segment ARPUs, which grew 4% and a decline in enterprise segment, reflecting the highly competitive nature of this market. Prepaid ARPU declined by $1.17 as the impact of inbound travelers caused dilution. We saw broadband revenues stabilize with a small decline of 1.3%, which was very pleasing in a highly competitive market and following the path through of rising fiber input costs. Voice continued to decline as consumers shift to alternate technologies, and businesses shed lines, reflecting the impact of hybrid working in a tougher economic environment. As Jolie mentioned, IT product revenue returned to growth with cloud revenues up 4%, while the IT services market remains challenging with service management revenues down $8 million or 10%, reflecting lower public sector demand. High-tech revenues grew 13% to $35 million through strong IoT connection growth and data center revenues grew as the new facility at Takanini came online and is now billing. We also saw a decrease in other product revenue, which was driven by the closure of Spark Sport and offset by growth in Entelar as it expanded delivery of 5G products -- projects and increased distribution customers. So if we now shift to look at costs, where total adjusted operating costs were broadly flat, increasing by 0.4% or $6 million, which was pleasing given inflationary pressure in the market. Product costs declined by $5 million as voice costs continue to decline, and we exited Spark Sport. These declines were partially offset by growth in procurement in Entelar in support of revenue growth. Labor costs increased by $10 million or around 4%, reflecting the impact of wage inflation in a low unemployment market and higher headcount in Entelar as we in-sourced field service teams to support additional work and new margins. As Jolie overviewed, as part of the Operate Program, we are redesigning our operating model. And alongside other efficiencies, we are on track to exceed our gross cost reduction target of $40 million to $60 million in FY '24. So with adjusted revenue up $26 million and adjusted operating costs up $6 million, adjusted EBITDAI was up $20 million or 3.9%. While this is an improvement on the prior period, we experienced muted demand in some areas of the business, accompanied by a higher cost environment reflective of the broader economic environment. We expect top line growth, which I'll touch upon in more detail shortly, coupled with a strong focus on labor and operating cost efficiencies to deliver improved performance in the second half to achieve our full year guidance. So if we now shift to the second half outlook as outlined on Page 18. We remain committed to delivering our full year guidance of $1.215 billion to $1.26 billion. We expect to see growing momentum combined with a seasonal weighting of earnings to the second half and improvements in the following areas. So first of all, mobile, where connections continue to grow, and we'll see further positive impacts from the price increases implemented to date. In broadband, we will optimize the margin as we -- as input costs are passed through and wireless broadband continues to grow. We continue to see growth opportunities for hybrid cloud and data centers as favorable market tailwinds support demand in these areas and in high tech as IoT connections continue to scale. Further support for high-tech growth will be provided by MATTR as it moves customers into production, and we focus on growing new digital health revenue streams and expand further into the private sector. We'll implement a refreshed operating model aligned to our new 3-year strategy. And alongside other efficiencies, we're on track to exceed our gross cost reduction target of $40 million to $60 million in FY '24. These improvements will help us set the transition to the new IT services offerings and ongoing inflationary pressures. So now moving to CapEx. So CapEx was heavily weighted to H1 at $286 million as we accelerated investment to gain a fast start on our strategy and continued our simplification and upgrade programs. Maintenance CapEx increased to $235 million as we continue to invest in IT systems, such as our new ERP and better tools to support enterprise service delivery. These tools create the platform to drive greater automation and efficiency across our business. Total spend across 5G and 5G stand-alone increased, and we now have 5G in 95 locations, and our 5G core build is on track. The balance between 5G and 5G stand-alone will flex as we optimize delivery across the program. We continue to invest in data centers aligned with management framework, but spend in H1 was lower following the completion of the expansion of our Takanini site and while we began work on the next phase and investigate through the land purchases to support our growth strategy. While spend in the first half was higher, we remain committed to delivering our overall CapEx envelope within the guidance range of $510 million to $530 million. So moving now to free cash flow. The free cash flow for the period was $46 million and down $69 million or 60% compared to the prior year -- prior period. The primary driver of the decrease relates to the timing of capital investment that I just outlined, where the balance of spend is heavily weighted to H1. This will reduce significantly in H2. Free cash flow has also been impacted by higher interest costs as we saw higher debt levels and higher rates combined with the lease costs paid to Connexa. Looking ahead, we remain committed to delivering free cash flow of $490 million to $530 million. We'll deliver this through higher EBITDAI growth driven by mobile, data centers and high tech and as we drive the cost base lower through new operating model and ongoing cost discipline. The other key driver will be a lower CapEx spend, which is the total spend for the year in line with guidance. So net debt increased by $759 million, reflecting high debt levels as we've almost completed the on-market buyback and invested additional CapEx in growth areas such as data centers and 5G stand-alone. Net debt during the period has also been impacted by an increase in working capital, driven by higher receivables and seasonally higher inventory levels. We would expect net debt to stabilize below 1.7x net debt to EBITDAI as the buyback completes, we see higher EBITDAI and lower CapEx in H2 and as working capital returns to normalized levels. In 2023, a NZD 100 million bond matured and our next long-term maturity is $125 million bond in March 2024. Accordingly, we are considering making an offer of $250 million of unsubordinated, unsecured fixed rate bonds with up to $50 million in oversubscriptions via our wholly owned subsidiary, Spark Finance. And if this proceeds, we expect to release the full details of the offer in the week beginning the 4th of March. So to summarize our outlook for the second half. Spark's well positioned to build further momentum as economic conditions start to improve and as the ongoing demand for data and travel supports our core growth engine of mobile. Our strategy is on track with key digital infrastructure investments accelerating and building a platform for future growth. Our Operate Program is progressing well with a number of initiatives already underway to create a more efficient operating model and benefits starting to flow through in the second half. A lower balance of CapEx spend in H2 will support the delivery of our free cash flow ambition, and we have reaffirmed our FY '24 EBITDAI, CapEx and total dividend guidance. Finally, our business fundamentals remain strong in brand, customer experience, people and sustainability, supporting ongoing competitive advantage. So lastly, on our confirmed guidance for FY '24. Our EBITDAI guidance remains unchanged at $1.215 billion to $1.26 billion. CapEx guidance remains unchanged at around $510 million to $530 million. And guidance of an increased total FY '24 dividend of $0.275 per share, fully imputed, also remains unchanged. So that now concludes the financial summaries. I'd like to hand back to the operator to open the line for questions. Thanks.
Operator: [Operator Instructions] Your first question comes from Arie Dekker with Jarden.
Arie Dekker: Congratulations with the great performance in mobile, in particular. First question on -- just on labor costs. You gave some detail on what drove the increases in the first half, about 3.7% on the PCP. Should we expect lower PCP growth by the time you get to full year?
Jolie Hodson: Yes, Arie, you should. Part of our operating model redesign is really looking at that labor and what we need to support new investment in growth areas, but also a reduction in areas of the business that are not growing as much. And so we've already seen some of that in relation to our cloud cost reset, for example, but more of that will flow through the second half.
Arie Dekker: Yes. Great. And outside of Entelar, which areas are getting increased investment in people at the moment out of the redeployment of some of those gross cost-out savings?
Jolie Hodson: I think if you think about data centers, our AI and data investments in terms of -- and that also helps enable us, obviously, to win above the line, but also in terms of making sure our operating programs within the organization in terms of our OpEx management, et cetera, are well managed using those tools and then also converged tech and areas like that, where we see new opportunities for solutions for customers.
Arie Dekker: Sure. Yes. Just turning to high-tech. Look, I know you're not overselling it in terms of how quickly it will get to scale, and it's great to have the visibility. But gross margin dollars there remains flat on, I guess, a moderate level of revenue growth. So at the moment, in terms of what's happening in the early stages, what sort of driving that lack of gross margin sort of leverage in that business? And also, below gross margin, what sort of investment is going on? And what sort of quantum of labor cost growth are those businesses getting?
Jolie Hodson: So I think if you break it into the different component parts within the high-tech, you've got our IT business, which is much more mature and established and we've got substantial growth in revenue and earnings each year. And then we've got businesses, for example, like MATTR, that we're investing in. We also have Qrious within that business. And that is, for example, the Qrious scenario that is impacted by some of the environment -- economic environment we've seen. So a slowdown in some of that demand around more professional services type work and digital transformation. So there are a number of different things running through that when you look at the components that were in that. In terms of investment, we -- from our high-tech converged technology component, it's early stages. And to your point, we're not looking to oversell that yet. Over the basis of the 3 years, we look to see that grow. We already have the MPI solution in the marketplace from the fishing boats, for example. And we're also looking at water quality, some of the road. So there are a number of different elements that we're investing in there. If you stand back from the labor growth too, when we look at that component that also includes in-sourcing as well. So around some of the field services around Entelar. So when you stand back and strip it all apart, there are a number of moving parts in there. But what you should probably just take from our discussions here today is that there is a focus on making sure we're bringing that back in balance and that a sustained business ahead.
Stefan Knight: The only other thing I'd add is --sorry, the only other thing I'd add is from an investment perspective, clearly, the investments we're making in 5G and stand-alone really set up a lot of the foundation for these. So this is the -- making sure that we've got them the teams to support the product as they come online as well. So it doesn't require a lot of additional capital investment.
Arie Dekker: Sure. And then just a last one. I guess, you mentioned Qrious, MATTR. I mean, those aren't new area, like you've been in those already for a reasonable amount of time sort of not signaling that they'll be doing necessarily a lot in the sort of FY '26 plan. What are the things that you're doing just to test just how long you're willing to stay in something like MATTR?
Jolie Hodson: I think, for example, in MATTR, it's obviously just moved more recently into commercialization. We've had the New South Wales government signed last year. And so as they move towards production, that allows us to grow those businesses more. And so we see that as our longer term build around our -- the global opportunity for that business. I think in Qrious, I think it's more a factor of the current economic environment, not necessarily we don't see that it's delivering good revenues. For us, it is. It's just in terms of the growth versus the previous half, we've seen some of the impacts there around professional services particularly.
Arie Dekker: Cool. And then last one is just on Connexa. We weren't expecting much sort of initially in the first year or so, but when will they start building towers under your build commitment?
Stefan Knight: So I can pick that up. They are -- currently, build program is underway. As you would expect, when you're setting up a new business and a new operating model, it starts with smallish volumes and then ramps up over time, but they have delivered some of the first towers already.
Arie Dekker: Yes. So that is in ramp-up. So I guess just to get a bit of a guide, and I guess you're not cycling a PCP with the full Connexa transaction having gone through, but across interest and principal cash lease costs that went up $15 million on the PCP. Can you give us a bit of a guide to what sort of level we should expect to see in cash lease growth over the next couple of years, particularly with that build commitment now sort of starting to come through?
Stefan Knight: I would think about it as relatively modest over the first couple of years and more kind of aligned with inflationary pressures kind of -- so moving it more in that -- more aligned with inflation, yes.
Arie Dekker: Yes. Okay. So yes, so the build commitment, even though it's underway, it's not going to be putting a lot of upwards pressure on the lease costs, at least in the next couple of years.
Stefan Knight: No. I mean the -- if you really try and stand back from it, I think the impact at NPAT is actually relatively neutral because what you have is avoided depreciation because you don't own the towers anymore. You have lower interest because we've got some of the proceeds in and then that's effectively replaced with those lease costs. And then to your point, Arie, then that kind of grows modestly over time. The bigger component of the build program is a couple of years out. So that next couple of years is not a substantial [indiscernible].
Operator: Your next question comes from Entcho Raykovski with E&P.
Entcho Raykovski: Jolie, Stef. So my first question is on free cash flow. And I know you've got the usual seasonal skew towards the second half, but it does feel pretty substantial this year. So I'm just interested apart from the lower CapEx. Are there any other items that are driving that second half free cash flow skew? And are you perhaps now less confident, you can achieve that full year aspiration than you were back in August? Or do you have pretty good visibility around the second half?
Stefan Knight: The key driver is really the improvement in EBITDAI. And so the way I think about it is it breaks down, some of this we've noted, but just to bring it all together into one place, it breaks effective into 3 parts. So first of all, you've got a seasonal weighting to the second half. We invest marketing and acquisition costs upfront. The customers come on board and then you get the benefit of them in the second half. If you look at then the revenue trends, there's ongoing strong growth in mobile that will continue to deliver plus the impact of the price increases already implemented. There's growth in IT products, which was previously in the prior year was -- had been in decline. And then you've got things like data centers, which also went in the prior period. So that comes along online to help provide that revenue trend. And then the third component is the work we're doing on the Operate Program around cost. And so the new operating model, the -- some of the interventions we've made have actually been executed already to date, and that will see the benefits, while they are only modest in the first half, starting to flow through more into the second half, and that's what gives us the confidence around the lift in EBITDAI into the second half. When you combine that, then with the substantial reduction in CapEx, that's what supports that strong second half and the free cash flow.
Entcho Raykovski: Okay. Great. And maybe to pick up on your comment around productivity and the gross cost-out target of $40 million to $60 million likely to be exceeded. What are the areas where you've seen a better outcome over the past 6 months?
Stefan Knight: I can pick that up. So there are a number of things, opportunities that we are looking at. So to give you some examples, we have redeveloped or redesigned our cost model that supports our cloud operating model. So making sure that we move to a lower cost operating model and effectively taking some of that fixed cost and moving it to make it more variable in nature. We've got ongoing investment in automation, which is supporting efficiency. Some of the capital spend that we've invested in, drive simplification, which in turns allows greater efficiency across our people, and we've got more digital journeys coming online. So it's a combination of all of those factors combined with the operating model review, which effectively drive us to have the confidence in exceeding that $40 million to $60 million.
Entcho Raykovski: And when you say exceeding, I assume it will be modestly in excess, nothing significant?
Stefan Knight: We're not going to give specifics, but we are confident that it's a meaningful change.
Jolie Hodson: More than modest.
Stefan Knight: Yes.
Entcho Raykovski: More than modest. Okay. Great. And final one, you've obviously spoken about the hyperscale data center campus you're intending to pursue. How do you think about the ability to generate the 9% to 10% return that you're targeting? I mean, I'm just conscious, it's always more difficult to get those sort of returns from hyperscalers. So do you think that's achievable? And I mean, do you need some of that external financing that you've spoken about, as always, you sort of alluded to, in order to get to that target?
Jolie Hodson: Well, when we talk about hyperscaler, we're talking about sort of the size and scale of the type of data centers we're building and they can be a combination of different customers included with them most. If you look at our portfolio that we've got in place, already 88% of our customer or capacity is committed. So it's contracted. It has clear revenue pathways and the ability for inflation-driven price increases within that. So we have quite a clear view of what that looks like in terms of ahead, and that's what we've laid out in terms of the data center revenues, for example, for this year. But as we look ahead, we'll be taking the same type of approach to that as well.
Operator: Your next question comes from Aaron Ibbotson with Forsyth Barr.
Aaron Ibbotson: Yes. Just a couple of small ones for me. So first of all, and you may have talked to this before, but on the data center returns of 9% to 10% over time as utilization scales. First of all, what exactly do you mean by returns? And secondly, could we get some sort of IRR equivalent, which I'm sure you have because it can take a little while to scale, particularly if you include the build process? That's my first question.
Stefan Knight: So when we talk about returns, we're meaning effectively net operating profit after tax over around the invested capital. So that's what we target for that 9% to 10%. In terms of an IRR, Aaron, why don't we take that offline? I think that's probably the best approach.
Aaron Ibbotson: Okay. But can you confidently say that you believe your IRR is above your WACC or cost of capital?
Stefan Knight: Well, that's why we set that return base of the 9% to 10%, effectively allowing for a risk premium to sit above our WACC. So yes, we -- that's certainly one of the ways in which we look at it to make sure it is above WACC.
Aaron Ibbotson: But if I include a 4-, 5-year scaling period on a 15, 20-year investment, I don't get to -- there's very little headroom between WACC and what that IRR. But we can take it offline if you want. I'd prefer if we took it on the call, but that's okay. Secondly, just on -- yes.
Stefan Knight: No. Keep going, Aaron.
Aaron Ibbotson: No, I'm going to next question. So just on Connexa, just wondering if you could -- what was the contribution negative, I assume, in this first half? And do you -- could you give us any sort of steer on where you think it's going to be in the second half and maybe the first year or so next year?
Stefan Knight: It sits within our share of losses and it's a combined amount that we put in there, it's around $5 million and that relates to both Connexa and RCG and the line's share of that relates to the Connexa impact.
Jolie Hodson: For our ownership...
Stefan Knight: For our ownership interest of it, yes.
Aaron Ibbotson: And is that a run rate we should expect over the next few periods? Or is this just start-up costs basically?
Stefan Knight: I think that's more in the range of start-up position. You would expect that to improve over time. So they're not going to want to run at a loss on a long-term basis.
Aaron Ibbotson: Okay. Finally, just a little one on imputation credits and how confident you are about imputation, fully imputed dividends going into sort of FY '25, '26. Your EPS is running quite a bit below your DPS. So just trying to get some sort of visibility on your thinking going ahead for that?
Stefan Knight: So for '24, obviously, we've reconfirmed that it's 100% imputed. If you look at in the long term, our capital management framework sees that we look to grow free cash flow to support the payment of dividend. And that's the basis in which we approach it, but we're not going to be able to give you long-term guidance around what those likely imputation levels will be because that's a conversion with the Board based on the appropriate dividend level at the time.
Aaron Ibbotson: Okay. Final one just for me on seasonality. So you delivered 43%, I think, of your midpoint of your EBITDAI guidance in EBITDAI in the first half, similar to last year. This is sort of even higher, if I put it that way, seasonality than historically? And for some reason, I thought it was going in sort of slightly the opposite direction. So I was just curious if you could talk a little bit to if this is sort of a new normal or it's been something unusual this year around the seasonality.
Jolie Hodson: I think Stef touched on the sort of drivers of what drives the H2, if we stand back. Is it a new normal? There are some elements that start to shift when you think about licensing and things like that. A lot of those are weighted to the first half in terms of payments, when also you think about the economic environment we've had in the last half, that has probably had a bigger impact on some of that seasonality. But as we have moved through election and uncertainty that sits around that, I think we're starting to see more of that confidence and then just the nature of the activities we have from an operating model cost perspective, that's what also gives confidence in the second half.
Operator: The next question comes from Brian Han with Morningstar.
Brian Han: On the cost base resets that you did for the cloud business, would that kind of cost base review extend to other areas, such as IT services management and digital health?
Jolie Hodson: Yes. So if you stand back from the overall operating -- that will look at the whole -- looks at the whole business. When you think about service management and what we've done some work on at the end of last financial year and the beginning of this financial year was a new product offering that is currently out of market in terms of being shared with customers, which will lead to in the medium-term greater kind of automation, et cetera, so therefore reduce cost base, but also a service that meets their needs. So we're seeing strong interest in that. And I think as those revenues start to come online, you see that shift there. So overall, everything that we look at when we look at op model, we'll look at all components of what's the cost base we actually need to deliver the revenues that are available. And here, we've got the right next step.
Brian Han: And so Jolie, on digital health, the fall in its revenue, how much of that do you attribute to cyclical factors? Or do you think there's something fundamental that changes you weren't expecting?
Jolie Hodson: Now if you stand back from that, it's really around some of the -- if you think about the New Zealand health sector, a significant amount of this comes from Te Whatu Ora, which is the whole New Zealand health authority effectively [indiscernible], what used to be the former [indiscernible]. So they have been undergoing a bit of changes, obviously, being the uncertainty around election. We expect, if you stand back from digitization of government, that's still going to occur and need to occur. And health is absolutely an area that needs to happen. Equally, there are other opportunity areas when you look at the private health sector, too, in terms of private hospital, primary care and community-driven health providers that we see opportunities ahead. So it's more around the nature of the economic environment, the shift in uncertainty whilst like you have in any country when you go through an election, then as we move into this new phase, we expect to see that revert.
Brian Han: Okay. And lastly, Stefan, the 0.4% increase in OpEx, is that adjusted for the Spark Sport's exit on a like-for-like basis? Or does the prior period include Spark Sport costs?
Stefan Knight: It's not adjusted. So the prior period does include those costs.
Jolie Hodson: Two different parts. There's a provision that was created on exit, which sits outside of that. But the actual ongoing costs, which you can see if you look at the cause of change charts, so I think in the deck, you'll see in other product costs called out there.
Stefan Knight: Yes.
Jolie Hodson: Yes.
Operator: [Operator Instructions] Your next question comes from Phil Campbell with UBS.
Phil Campbell: Just a couple of questions for me. I suppose on the data center business, you obviously, you have kind of talked about a kind of target ROI, 9% to 10%. Obviously, you're spending quite a lot of money on 5G and stand-alone 5G. Like is there any way we can kind of work out what the kind of return is going to be on that spend? I suppose just for the moment, it's probably not as obvious in the market as to products coming through on that side. So just be interested in your views on that.
Jolie Hodson: I think if you stand back and swap them into 2 different areas. So 5G obviously supports the mobile revenue that we help deliver and 5G offers much greater capacity than 4G. Data continues to grow at an exponential rate. So if you weren't investing in 5G, you'd be investing in 4G. So I think about it in that way. The stand-alone component obviously helps with the -- more of the converged, which is still early days, yes, in terms of that. And until that's rolled fully, in terms of network slicing and those components, you won't see that until then. And equally, you wouldn't see a price premium until you have ubiquitous sort of 5G service across the country. So it's effectively a -- I guess, work in progress as the rollout continues within that. I think on data centers, you're starting to see the revenue growth there as we complete and they immediately come online, which happened in August, and you can see the revenue uplift there. For any of the new [indiscernible] that we have planned in terms of the build commitments that we have. Again, we have customer commitments within that. So -- and when you're sitting at 88% utilization, that means there's a fairly reasonable view in line to the revenue that follows.
Phil Campbell: Great. And maybe just coming back to the seasonality question because obviously, last year, we all got a bit of a surprise with that first half, second half skew and obviously, there was some reasons for it. I suppose we were kind of forecasting a bit more normalization this year, but it seems to have been, as Aaron pointed out, kind of similar to last year. So I was just kind of interested in your views on what's causing it? Because obviously, the gross margins were lower than what we're going for, they're obviously better than the PCP, but they were definitely lower than the second half. So I'm just kind of interested in your views on kind of the impact of this half, the economy kind of averse competition and kind of averse seasonality. Just get a flavor for what could be driving those kind of lower gross margins?
Jolie Hodson: Stand back and just break them into the components. Mobile obviously performed well and particularly in a consumer sense in terms of growth and in the pricing flowing through. You did see in our mobile nonservice revenues, so handsets and things like that. We did have impacts there. We saw a more subdued retail environment, particularly as you led into the back end of the year, Christmas, et cetera. So that flows through and has an impact. Voice, while falling at sort of levels that we don't expect that to shift, it did accelerate slightly in the half, but it has an impact from a margin perspective overall. And then really, it's just for us is that we look ahead about the work that we do on operating model often falls into the second half. And so making sure -- and as we're thinking about the end of this FY and the year ahead, we're trying to actually make that shift to a more sustainable shift earlier. Stef, anything else you want to talk?
Stefan Knight: Maybe only things would just be, I guess, you really noticed the impact of the economic environment on areas like IT services and Qrious like Jolie has previously spoken to. That is where it was most evident. And certainly, you can see it in the results, yes.
Phil Campbell: Got you. And I suppose if you look to kind of monthly trading going through the half and then coming out of the half into the second half, I think there was a comment in the result talking about maybe economic conditions looking a little bit better. Is that in relation more to the IT services or enterprise space, kind of post-election, people feeling a little bit more confident. I mean you actually are seeing that in the January, [February] or maybe February trading?
Jolie Hodson: Yes, well, I'm not getting into current period trading. But what I would say is, in any country where you go through an election, there's always uncertainty with it. And as it gets clearer around what's happening, what that looks like in people from a project point of view and investing in those components, we're seeing that. And just generally, I suppose, as inflation starts to drop a little bit, I know it's not fully down, we're -- yes, we're comfortable with what we've obviously affirmed in terms of guidance and our look ahead.
Phil Campbell: And maybe just one last one for me. Just not a lot of commentary in the pack just on competition. Just interested in your views kind of across some of those key segments, how the market is going, how competitive it is or how rational it is?
Jolie Hodson: I think from a mobile perspective, it's always a competitive marketplace. Our share was 44% for our service revenues. I think if you looked across kind of the broad base, it was fairly similar to most, maybe slight pick up [in 2 degrees]. One was pretty stable. And then if you look to broadband, again, sort of similar level share, more movement between the smaller components within that. So market competition remains competitive, but probably haven't seen a significant increase or change. [Stef] anything?
Operator: Your next question comes from Kane Hannan with Goldman Sachs (NYSE:GS).
Kane Hannan: Just three as well. Just the mobile service outlook. You obviously spoke to the -- a lot of comments around the second half outlook and what's going to drive that. Is there any reasons we should think about that flows to service revenue growth back to that 5% target? Or on track means that 6%, 6.5% would be how you consider on track?
Jolie Hodson: I think some of the things to consider around roaming, for example, you really had a lot of those revenues come back into the comparative period. So I think we're now sitting largely at about 107% of where we were pre-COVID. So quite a high level. I think that's unlikely to continue to expect a higher level than that. Although, I could be surprised if more. Unbound airlines continue to return to the country, but certainly from an outbound perspective, it's sitting pretty high. I think in terms of, here's where we gained connections in the first half and that tends to lead through to in the subscription business, continued growth in the second part. And then price increases, as you see the flow-through of them throughout the whole period. So some of those occurred in late in '23, but some occurred in the first half of '24. So you'll have a full year impact of that.
Kane Hannan: Yes, that's helpful. And then just, I suppose, consumer and business telco trends. I mean, I think the mobile consumer performance was relatively stronger, the business broadband subs fared a bit better. So maybe just if you could talk about the dynamics you're seeing across those markets, how the macro is impacting them. I think you called out a bit of enterprise competition on the mobile side would be helpful.
Jolie Hodson: Yes. So in terms of mobile, particularly if you look at pay-monthly and business, what you do see is -- and it has been for quite a long period of time, a more competitive space. So while we've held and grown connections there, the ARPU has declined in line with that. So -- and we're also seeing a little bit of shedding of some lines where there's multiple connections in a place. We're not losing a customer altogether, but that whole, in a tight economic environment, just turning back and looking at that. So business sort of reflects more of that, a tougher price competition area within consumer. And then in prepaid, we've seen a lot of also travelers now return into the market, which has an impact as well in terms of because the base grows substantially with that, but sometimes they're on more casual rates or lower rates. So -- and I guess also with a tougher economic environment, some of those prepaid, too, have moved more to cash flow versus being on monthly plan, but in a small percentage. So I wouldn't want to overcall that. And then in terms of broadband, not a huge amount of shift in the consumer marketplace. It's sort of as competitive as it has ever been. We did talk about the price increases that we took, which at the back end of '23 for the changes that were coming through from input cost increases, which have been executed. And we will continue to look, I guess, as the year ahead as we move into the -- move towards '25 year around what might be required there as well. So there isn't a huge shift in dynamic in that broadband area, the normal -- and obviously, copper decline continues to occur, it's just between fiber and wireless are occurring and the thing that base sitting at 31-odd percent at the end of the half.
Kane Hannan: That's great. And then the cost-out, so on track to exceed the target this year. I mean do I think of that as a pull forward of those '26 targets you had out there? Or is this sort of incremental savings that are coming through with the drivers you were talking to?
Jolie Hodson: I think some be a combination of when you look at our overpull, hopeful, over a 3-year period, what we're doing now versus what are we doing later, but some of it will also be just as you shift and knowledge of the environment you're in, the cost base you can afford, yes.
Operator: There are no further questions at this time. I'll now hand back to Ms. Hodson for closing remarks.
Jolie Hodson: All right. Thank you, everyone, for joining us this morning, and have a good day.
Operator: That does conclude our conference for today. Thank you for participating. You may now disconnect.
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