Operating and Financial Review
Financial Review
- Introduction
- Operating Review
- Financial Review
- Basis of accounting
- Financial performance
- Segmental reporting
- Dividends
- Dividend policy
- Liquidity, resources and capital expenditure
- Treasury policy
- Commodity price hedging
- Commitments and contingencies
- Critical accounting policies
- Related party transactions
- Changes and developments
- Going concern
- US GAAP reporting
- Other matters
Financial performance
- Changes in accounting policies
- Group turnover
- Group operating costs
- Joint ventures
- Adjusted operating profit
- Operating exceptional items
- Goodwill amortisation
- Group operating profit
- Non-operating exceptional items
- Interest
- Taxation
- Minority interests
- Exchange rates
- Pension and other post-retirement benefit costs
- Adjusted profit measures
- Earnings per share
| Years ended 31 March | 2005 £m | 2004 (restated) £m | 2003 (restated) £m |
|---|---|---|---|
| Group | |||
| Group turnover | 8,521 | 9,033 | 9,400 |
| Operating costs excluding exceptional items and goodwill amortisation | (6,316) | (6,827) | (7,247) |
| Joint ventures | 7 | 7 | (5) |
| Adjusted operating profit | 2,212 | 2,213 | 2,148 |
| Operating exceptional items | (251) | (277) | (350) |
| Goodwill amortisation | (109) | (99) | (102) |
| Total operating profit | 1,852 | 1,837 | 1,696 |
| Disposals of tangible fixed assets | 70 | 96 | 48 |
| Other non-operating exceptional items | 13 | 226 | (147) |
| Net interest payable | (783) | (822) | (970) |
| Profit before taxation | 1,152 | 1,337 | 627 |
| Taxation | (245) | (261) | (245) |
| Minority interests | 1 | (2) | (31) |
| Profit for the year | 908 | 1,074 | 351 |
The following discussion compares the results for the year ended 31 March 2005 (2004/05) with those of the year ended 31 March 2004 (2003/04) and of 2003/04 with those of the year ended 31 March 2003 (2002/03).
Further discussion of the financial performance on a segment by segment basis is included in the Operating Review.
Changes in accounting policies
The Group adopted FRS 20 'Share-based Payment' on 1 April 2004. The standard requires the Group to record a charge in its profit and loss account reflecting the value of grants of shares or rights to shares to third parties, including employees. A charge is recognised in the profit and loss account based on the fair value of the shares at the date the grant of shares or right to shares is made. The charge incurred in 2004/05 was £16 million.
As a consequence of this change in accounting policy, the financial statements for 2003/04 and 2002/03 have been restated, with adjusted operating profit reduced by £25 million and £37 million respectively and adjusted basic earnings per share reduced by 0.8 pence and 1.2 pence. Operating profit for these years has been reduced by £25 million and £40 million (of which £3 million was exceptional) and basic earnings per share has been reduced by 0.8 pence and 1.3 pence. Net assets at 31 March 2004 was restated from £1,263 million to £1,271 million.
Group turnover
The decrease in Group turnover from 2003/04 to 2004/05 of £512 million primarily related to a reduction of £435 million arising from the movement in the average US dollar to sterling exchange rate from $1.68:£1 in 2003/04 to $1.87:£1 in 2004/05. Turnover from discontinued operations was £158 million lower as a result of the disposal in 2003/04 of EnMO Limited, which provides the on-the-day commodity market for gas trading in Great Britain. This was partially offset by an increase of £148 million from the acquisition of the UK operations of Crown Castle International Corp. during 2004/05.
The fall in Group turnover from 2002/03 to 2003/04 of £367 million primarily reflected a reduction in turnover relating to discontinued operations which dropped from £567 million in 2002/03 to £158 million in 2003/04, related mostly to EnMO Limited and a reduction in turnover of £231 million arising from the movement in the average US dollar to sterling exchange rate from $1.59:£1 in 2002/03 to $1.68:£1 in 2003/04. After taking these factors into account turnover increased, arising from sales volume growth in UK gas distribution and in US electricity and gas distribution.
Group operating costs
Group operating costs, excluding exceptional items and goodwill amortisation, decreased from 2003/04 to 2004/05 by £511 million. The most significant elements of this movement reflected a change in the US dollar to sterling exchange rate giving rise to a reduction of £370 million and a reduction of £158 million from the discontinued business, EnMO Limited. These reductions were partially offset by the operating costs of acquired businesses during 2004/05 and £86 million from higher replacement expenditure (repex), net of other changes in operating costs.
Group operating costs, excluding exceptional items and goodwill amortisation, decreased from 2002/03 to 2003/04 by £420 million, primarily as a result of a reduction of £454 million due to the impact of discontinued operations, mainly EnMO Limited and from a reduction of £193 million from the movement in the US dollar to sterling average exchange rate.
Joint ventures
Joint ventures contributed £7 million to operating profit in 2004/05, unchanged from 2003/04. Of this, £1 million in 2004/05 related to a discontinued joint venture, Citelec, in which we sold our 42.5% interest in August 2004.
Citelec is the holding company of Transener, which owns and operates a transmission system in Argentina. We accounted for Citelec under hyper-inflationary accounting principles up until its disposal. The application of these principles had no material impact on the results for the year ended 31 March 2005 or 2004, but during the year ended 31 March 2003, they resulted in the recognition of an exceptional interest credit of £67 million and related exceptional minority interest charge of £28 million.
There was a £2 million reduction in the continuing operations operating profit generated by joint ventures in comparing 2003/04 with 2002/03, as our share of joint ventures from continuing operations changed from £9 million in 2002/03 to £7 million in 2003/04. Discontinued joint ventures contributed negative £14 million to adjusted operating profit and £115 million to operating profit in 2002/03.
Adjusted operating profit
Adjusted operating profit in 2004/05 was £1 million lower than 2003/04, reflecting a £65 million reduction as a consequence of the movement in the US dollar to sterling exchange rate and a contribution of £39 million from the acquisition of the UK operations of Crown Castle International Corp.
Adjusted operating profit in 2003/04 was £65 million higher than 2002/03. The main reason for the increase in adjusted operating profit was the strong performance of UK gas distribution, together with a reduction in losses from discontinued operations of £26 million.
Operating exceptional items
Net operating exceptional items included within operating profit that related to both continuing and discontinued operations moved from a net charge of £350 million in 2002/03 to £277 million in 2003/04 and to £251 million in 2004/05.
The operating exceptional items for 2004/05 related to:
- £62 million of restructuring costs associated with our planned disposals of four regional gas distribution networks;
- £148 million of other restructuring costs, relating to cost reduction programmes which comprised: £109 million for UK gas distribution, £23 million in our US businesses, and £16 million for our other businesses; and
- £41 million of increases in provisions for environmental costs, based on higher cost estimates from the continued evaluation of new environmental legislation and the impact of changes in the timing of planned expenditures.
Operating exceptional items in 2003/04 comprised £24 million of restructuring costs associated with the planned sales of four regional gas distribution networks; other restructuring costs of £100 million for US electricity and gas transmission and distribution, £77 million for UK gas distribution, £14 million for UK transmission and £34 million for other businesses; and £28 million of environmental costs.
Operating exceptional costs in 2002/03 for continuing operations of £311 million related primarily to merger related costs and restructuring costs arising from efficiency programmes, which were mainly severance related.
Goodwill amortisation
The increase in goodwill amortisation from 2003/04 to 2004/05 of £10 million relates to additional goodwill amortisation of £20 million for the seven months from 1 August 2004 to 31 March 2005 arising from the acquisition of the UK assets of Crown Castle International Corp., offset by a reduction of £10 million (£6 million from 2002/03 to 2003/04) reflecting the reduced sterling cost of US dollar denominated goodwill amortisation as a result of the weakening of the US dollar during 2004/05 and 2003/04.
Group operating profit
Group operating profit rose by £15 million from 2003/04 to 2004/05, resulting from a reduction in adjusted operating profit of £1 million, an increase in goodwill amortisation of £10 million and a reduction in net operating exceptional charges of £26 million as compared with 2003/04.
Group operating profit rose by £141 million from 2002/03 to 2003/04. This reflected an increase in adjusted operating profit of £65 million and a reduction in net operating exceptional charges of £73 million as compared with 2002/03.
Non-operating exceptional items
Non-operating exceptional items consisted of:
- gains on sales of property and other tangible fixed assets of £70 million (£69 million after tax) in 2004/05, compared with £96 million (£96 million after tax) in 2003/04 and £48 million (£50 million after tax) in 2002/03;
- in 2004/05, a gain of £13 million arising from the disposal of our interest in a joint venture, Citelec;
- in 2003/04, a £226 million gain on assets held for exchange (£226 million after tax) relating to the profit recognised on shares in Energis plc with a carrying value of £17 million, which were delivered to Equity Plus Income Convertible Securities (EPICs) bondholders on 6 May 2003 in settlement of all EPICs outstanding at that date that had a carrying value of £243 million. This transaction represented the culmination of a deferred sale arrangement entered into in February 1999; and
- in 2002/03, £68 million (£68 million after tax) of exceptional costs relating to discontinued operations, and £79 million (£71 million after tax) of exceptional merger related costs.
Interest
Net interest decreased by £39 million from 2003/04 to 2004/05. This was primarily explained by a weaker US dollar and a reduction in the interest charge relating to pensions.
Net interest fell from £970 million in 2002/03 to £822 million in 2003/04. Exceptional financing costs relating to a joint venture of £31 million incurred in 2002/03 did not recur. Excluding exceptional items, the remaining reduction of £117 million from 2002/03 to 2003/04 was primarily explained by the refinancing of debt in the UK and US, lower short-term interest rates, the weaker US dollar, a higher level of capitalised interest, a reduction in joint venture interest costs and a lower level of Group net debt, partially offset by a net increase of £55 million in pension interest costs, most of which arose from the actuarial valuation of the Lattice Group Pension Scheme undertaken as at 31 March 2003.
Taxation
A net charge of £245 million arose in 2004/05, compared with £261 million in 2003/04 and £245 million in 2002/03. This reflects exceptional tax credits amounting to £79 million, £89 million and £128 million in respect of exceptional items in 2004/05, 2003/04 and 2002/03 respectively. The effective tax rate was 21.3%, 19.6% and 39.0% for 2004/05, 2003/04 and 2002/03 respectively.
Excluding the effect of exceptional tax credits, goodwill amortisation and tax credits relating to prior years, the effective tax rate for 2004/05, 2003/04 and 2002/03 was 24.8%, 25.6% and 30.9% respectively, compared with a standard UK corporation tax rate of 30% for all three years. The effective tax rate for 2004/05, 2003/04 and 2002/03, based on profit after goodwill amortisation but before exceptional items and excluding tax credits relating to prior years, was 26.8%, 27.6% and 33.7% respectively.
A reconciliation of the main components giving rise to the difference between the relevant effective tax rate and the UK standard corporation tax rate is shown in note 9 to the accounts.
Minority interests
Excluding exceptional items, minority interests were a £1 million credit in 2004/05, a £2 million charge in 2003/04 and a £3 million charge in 2002/03. In 2002/03, as discussed under 'Joint ventures' above, there were exceptional minority interest charges of £28 million.
Exchange rates
The Group has used the weighted average exchange rate to translate all US dollar results into sterling for 2004/05, 2003/04 and 2002/03, being $1.87:£1, $1.68:£1 and $1.59:£1 for each year respectively. The balance sheets at 31 March 2005, 31 March 2004 and 31 March 2003 have been translated at $1.89:£1, $1.83:£1 and $1.58:£1 respectively.
Exchange rate movements had an adverse effect on the translation of US dollar denominated adjusted operating profit and operating profit for 2004/05 compared with 2003/04. If 2003/04 was translated on a comparable basis, using the 2004/05 average exchange rate of $1.87:£1, adjusted operating profit and operating profit for 2003/04 would have been £65 million and £45 million lower respectively. Similarly, adjusted operating profit and operating profit for 2002/03 would have been £38 million and £29 million lower respectively if translated at the 2003/04 average exchange rate of $1.68:£1.
The effect of movements in the US dollar exchange rate on adjusted operating profit and operating profit was largely offset by the reduced sterling cost of US dollar debt taken out to finance US dollar denominated investments and the reduced sterling cost of US taxes. As a result, adjusted profit for the year and profit for the year for 2003/04 would have been £21 million and £3 million lower respectively if translated at the 2004/05 average exchange rate of $1.87:£1. The adjusted profit for the year and profit for the year for 2002/03, would have been £13 million and £5 million lower if translated at the 2003/04 average exchange rate of $1.68:£1.
Pension and other post-retirement benefit costs
Pension and other post-retirement benefit costs calculated in accordance with Statement of Standard Accounting Practice No. 24 (SSAP 24) were £231 million in 2004/05, with £194 million charged to operating costs and £37 million to interest expense. This was £33 million lower than the charge in 2003/04 of £264 million. This primarily resulted from the spreading of a lower pension deficit in the Lattice Scheme offset by the recognition of a higher pension deficit expense in respect of the National Grid Scheme.
The Group provides additional disclosures on its pension obligations as required by Financial Reporting Standard No. 17 'Retirement benefits' (FRS 17). Substantially as a result of the improvement in world stock markets, the Group's FRS 17 pension deficit, net of deferred tax, reduced from £2,262 million at 31 March 2003 to £1,563 million at 31 March 2004 and to £1,363 million at 31 March 2005.
Adjusted profit measures
The following tables reconcile the statutory or unadjusted UK GAAP measure to the corresponding adjusted measure.
a) Reconciliation of adjusted operating profit to total operating profit
| Years ended 31 March | |||
|---|---|---|---|
| | 2005 £m |
2004 (restated) £m | 2003 (restated) £m |
| Adjusted operating profit | 2,212 | 2,213 | 2,148 |
| Operating exceptional items | |||
| - Continuing operations | (251) | (277) | (311) |
| - Discontinued operations | - | - | (39) |
| Goodwill amortisation | (109) | (99) | (102) |
| Total operating profit | 1,852 | 1,837 | 1,696 |
Adjusted operating profit is presented on the face of the profit and loss account, under the heading Operating profit - before exceptional items and goodwill amortisation.
b) Reconciliation of adjusted profit before taxation to profit before taxation
| Years ended 31 March | |||
|---|---|---|---|
| |
2005 £m |
2004 (restated) £m |
2003 (restated) £m |
| Adjusted profit before taxation | 1,429 | 1,391 | 1,209 |
| Operating exceptional items | |||
| - Continuing operations | (251) | (277) | (311) |
| - Discontinued operations | - | - | (39) |
| Non-operating exceptional items | |||
| - Continuing operations | 70 | 96 | (31) |
| - Discontinued operations | 13 | 226 | (68) |
| Exceptional finance charge | - | - | (31) |
| Goodwill amortisation | (109) | (99) | (102) |
| Profit before taxation | 1,152 | 1,337 | 627 |
Adjusted profit before taxation is presented in note 11 to the accounts, under the heading 'Adjusted profit on ordinary activities before taxation'.
c) Reconciliation of adjusted earnings to earnings (profit for the year)
| Years ended 31 March | |||
|---|---|---|---|
| | 2005 £m | 2004 (restated) £m | 2003 (restated) £m |
| Adjusted earnings | 1,106 | 1,039 | 833 |
| Operating exceptional items | |||
| - Continuing operations | (251) | (277) | (311) |
| - Discontinued operations | - | - | (39) |
| Non-operating exceptional items | |||
| - Continuing operations | 70 | 96 | (31) |
| - Discontinued operations | 13 | 226 | (68) |
| Exceptional finance charge | - | - | (31) |
| Exceptional taxation | 79 | 89 | 128 |
| Exceptional minority interest | - | - | (28) |
| Goodwill amortisation | (109) | (99) | (102) |
| Earnings (profit for the year) | 908 | 1,074 | 351 |
Adjusted earnings is presented on the face of the profit and loss account, under the heading Profit for the year - before exceptional items and goodwill amortisation.
Earnings per share
The following table sets out the adjusted basic earnings per share and basic earnings per share for 2004/05, 2003/04 and 2002/03 and reconciles the differences between them.
| Years ended 31 March | |||
|---|---|---|---|
| | 2005 pence | 2004 (restated) pence | 2003 (restated) pence |
| Adjusted basic earnings per share | 35.9 | 33.9 | 27.1 |
| Exceptional items | (2.9) | 4.3 | (12.4) |
| Goodwill amortisation | (3.5) | (3.2) | (3.3) |
| Basic earnings per share | 29.5 | 35.0 | 11.4 |
Adjusted basic earnings per share for 2004/05 increased by 2.0 pence, primarily resulting from the reduction in interest and tax charges when compared with 2003/04.
Basic earnings per share decreased from 35.0 pence in 2003/04 to earnings of 29.5 pence per share in 2004/05, reflecting a movement from net exceptional credits in 2003/04 to net exceptional charges in 2004/05.
Diluted earnings per share was 29.3 pence in 2004/05, 0.2 pence lower than basic earnings per share, compared with 34.9 pence per share in 2003/04 (0.1 pence lower) and 11.6 pence per share in 2002/03 (0.2 pence higher). The principal reason for the dilution in 2004/05 relates to employee share option schemes.