REG-United Utilities PLC Interim Results - Part 1

05 December 2002

5 December 2002

INTERIM RESULTS FOR THE SIX MONTHS ENDED 30 SEPTEMBER 2002
PROGRESS IN GROWTH BUSINESSES OFFSETS ANTICIPATED
REDUCTION IN REGULATED EARNINGS

• £164 million profit* before tax - growth despite anticipated impact of regulatory price profiles
• Asset management services - operating profit* increased by 85 per cent to £28 million
• Customer management outsourcing - operating profit* increased by 23 per cent to £9 million
• Licensed multi-utility operations - on track to meet £480 million cost savings target
• Telecommunications - business turnover increased by 28 per cent to £64 million
• Interim dividend of 15.5 pence, an increase of 1.3 per cent

* Unless otherwise stated, amounts and percentage movements throughout this document relating to the profit and loss account are stated before goodwill amortisation and exceptional items.

Chief Executive John Roberts said:
"During the first half of the current regulatory period our principal focus was on the delivery of our £480 million operating cost savings target. Now that we're progressing well in delivering these efficiencies on our current asset base, we're also turning our attention to the future. By standardising the design and specification of our assets, and adopting more modern maintenance practices, we're aiming to lay the foundation for a new generation of savings,which will bring benefits to shareholders and customers, in the next review period and beyond.

"United Utilities Contract Solutions, which exploits our core skill of asset management, has seen a substantial increase in profit as the period of start-up costs which accompanied last year's growth in turnover has come to an end. Further growth will come from the £225 million contract with British Gas Trading, which was mobilised in November.

"Vertex, our customer management outsourcing business, has continued to increase operating profit by growing revenues and improving margins. During the last six months the business also reported a significant increase in the size of its order book, which grew by around 35 per cent to £1.9 billion, boosted by major public sector contracts wins with Westminster City Council and the Department for Work and Pensions. These contract awards, in one of our key target markets, are expected to accelerate Vertex's revenue growth in the second half of this year. We've also recently signed an extended 10-yearcontract with TXU Europe, whose retail base has since been acquired by Powergen. Powergen has confirmed publicly that it intends to continue this relationship, and we're now in the process of progressing the contract novation.

"Our telecommunications business, Your Communications, continues to make progress. Year-on-year business sales increased by 28 per cent, reflecting our change in focus from premium rate services to higher margin business sales. During the first half of this year we've secured new business customers which are expected to boost turnover further during the next six months. Net cash investment for the full year is expected to fall to less than £25 million,compared to £45 million in the previous year, reflecting continued progress of the business towards financial self-sufficiency, which we're targeting to achieve in the next financial year. With the construction of the network now completed, we've carried out a review of its carrying value, which has confirmed substantial value in the network. This has resulted in an adjustment to value of £25.5 million, equivalent to 11% of the telecoms assets book value. Based on conservative long-term growth and cost of capital assumptions, we're confident that the valuation is robust."

Commenting on the outlook for United Utilities, John Roberts said:
"In our preliminary announcement of last year's results I commented that this year would be challenging, due to our regulatory price profiles and acceleration of our capital programmes. Our half-year results show that,through growth in our support service businesses and improved efficiency in our regulated businesses, we're successfully meeting this challenge. Looking ahead,we expect this performance to be continued in our full-year results.

"We're pleased that Ofwat has taken further steps to reduce regulatory uncertainty. In particular, we welcome the decision to change companies'licences so that the minimum notice period of termination will be 25 years rather than 10 years. This benefits all stakeholders and brings the water industry in line with other utilities. Ofwat has also recently published a consultation paper on the process that will determine price limits from April2005, to which all stakeholders are encouraged to respond. Given the probable size of future capital programmes, Ofwat must ensure that returns are sufficient to attract new investment into the industry.

"Although we didn't identify the need for an interim price determination this year, a number of companies have applied for interim determinations during the current regulatory period. Whilst there may be exceptional circumstances which necessitate an interim determination, we believe that undue reliance on this mechanism as a part of the regulatory process may increase the capital markets'perception of regulatory risk, and ultimately impact on the cost of capital in the water industry.

"In our support services businesses we've won key contracts in our target utility and public sector markets during the last six months. We're continuing to target steady growth in these businesses by exploiting our core skills in growth markets."

In conclusion the Chairman, Sir Richard Evans, said:
"I am pleased with the progress that the group has made in growing its non-regulated businesses, and in continuing to achieve multi-utility efficiencies in its licensed businesses. The board's confidence in the group's performance is reflected in its decision to increase the interim dividend by1.3 per cent - more than the 0.9 per cent inflation-related increase in our regulated water and wastewater revenues."

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For further information, please contact:

Communications

A presentation to investors and analysts will commence at 8.30 am on Thursday,5 December 2002 at the City Presentation Centre, 4 Chiswell Street, London. The presentation can also be accessed via a one-way listen in conference call facility, by dialing: +44 (0) 208 240 8244, then inputting access code 458647.This recording will be available for 7 days following the presentation.

The presentation, together with further information on United Utilities, will be available later in the day on our web site at: http://www.unitedutilities.com/. Photographs for media use supporting these results can be downloaded via http://www.vismedia.co.uk/.

Dividend

The board has declared an interim dividend in respect of the six months ended30 September 2002 of 15.5 pence per share, an increase of 1.3 per cent. This dividend will be paid on 10 February 2003 to shareholders on the register at the close of business on 20 December 2002.

Financial Performance

Turnover (including share of joint ventures) rose 0.5 per cent to £914.8million, reflecting growth in customer management outsourcing and telecommunications, offset by a real regulatory price reduction in licensed multi-utility operations and the impact of exiting asset management services in the Americas.

Operating profit* (including share of joint ventures) rose 1.1 per cent to £278.0 million compared with the same period in the previous year. This increase resulted from improved operating profits in asset management services and customer management outsourcing, offset by an anticipated reduction in profit in licensed multi-utility operations.

Goodwill amortisation in the period was £3.5 million, compared with £4.3million in the corresponding period last year.

Deferred tax on ordinary activities in the period was £49.4 million, compared with£27.4 million in the corresponding period last year. This increase is principally due to a reduction in long-term gilt rates, which result in a lower deferred tax discount rate.

Earnings per share increased by 1.8 per cent to 22.9p. Adjusted earnings per share fell by 7.3 per cent to 21.5p largely as a result of the increase in the deferred tax charge. Excluding deferred tax, adjusted earnings per share increased by 7.8 per cent to 30.4p.

During the period, United Utilities completed its exit from asset management services in the Americas by selling its 50 per cent interest in US Water and withdrawing from IEBA, the Argentinean electricity utility, which, with effect from August 2002, ceased to be accounted for as a joint venture. The exit from asset management services in the Americas resulted in a net exceptional credit to the profit and loss account of £34.0 million.

In addition, the group has reviewed the carrying value of its telecoms assets,in accordance with FRS 11. Based on an assumed pre-tax nominal weighted average cost of capital of 16 per cent, and a long-term real growth rate of 2.25 percent, an adjustment to value of £25.5 million has been made, equivalent to 11per cent of the telecoms assets book value.

An exceptional charge of £3.0 million, reflecting a reduction in headcount associated with the transition of Your Communications from its network building phase to a more mature revenue-generating business, was recorded in the period.The combined effect of these exceptional items is a pre-tax credit to the profit and loss account of £5.5 million and an underlying positive cash flow effect of £10.1 million.

The group has made two accounting policy changes in the period which have given rise to prior period adjustments. The impact of these changes is set out in note 2 to these interim accounts.

UITF 34 limited the circumstances in which pre-contract costs should be recognised as an asset. The adoption of UITF 34 in respect of pre-contract costs has resulted in the profit for the period being reduced by £1.0 million(net of tax). The results for the six months ended 30 September 2001 and the year ended 31 March 2002 have been increased by £0.2 million (net of tax) and reduced by £1.4 million (net of tax) respectively.

The group has reviewed current accounting practice in respect of telecommunications network capacity sales and has adopted a revised policy that treats such transactions as grants of operating leases, unless legal title passes. Consequently the income from such transactions will now be recognised over the life of the lease rather than as a sale in the accounting period in which the transaction is concluded. As a result of this change in policy,profit for the period has been reduced by £0.8 million (net of tax), and turnover reduced by £1.3 million. Profit for the six months ended 30 September2001 has been reduced by £1.2 million (net of tax) and turnover has been reduced by £1.9 million. For the year ended 31 March 2002 profit has been reduced by £1.8 million (net of tax) and turnover has been reduced by £4.8million.

Net debt at 30 September 2002 increased by £37 million to £3,097 million compared with 31 March 2002. Gearing at 30 September 2002 remained at a similar level to 31 March 2002.

Cash and short-term investment balances at 30 September 2002 were £483 million and un drawn facilities exceeded £1 billion. This provides the group with substantial pre-funding for its capital investment programme.

Operating Performance - Licensed Multi-Utility Operations

• Turnover increased by 0.5 per cent to £604.1 million

• Operating profit fell by 3.9 per cent to £251.7 million

Turnover increased by 0.5 per cent to £604.1 million, reflecting stable real prices for our water and wastewater customers and a 3 per cent real reduction in electricity distribution charges, in line with our regulatory reviews.As anticipated, operating profit fell by 3.9 per cent to £251.7 million for the period, reflecting higher operating costs due to the expanding asset base resulting from capital expenditure on quality related obligations.

Through standardising the design and specification of our assets, United Utilities is targeting to deliver capital savings in the current regulatory period. This programme, together with the progressive introduction of more modern maintenance techniques, is also intended to reduce further the whole life costs of assets, delivering improved performance in the next review period and beyond. It is expected that up to 15 per cent of United Utilities' aboveground water and wastewater assets will have been procured in line with our asset standardisation policy by the end of the next review period.

United Utilities has decided to commit at least another £10 million in addition to the amount allowed under the current regulatory determination, in order to reduce further the number of foul flooding incidents in North West England.This represents a total AMP3 investment of at least £40 million on foul flooding, and recognises that the regulatory review cycle should not constrain the resolution of these incidents.

Capital investment in the period was £288 million, of which £239 million related to water and wastewater and £49 million to electricity distribution. United Utilities is responsible for delivering the water, wastewater and electricity distribution capital programmes in North West England. At their peak, these capital programmes require more investment in the region's infrastructure than is being proposed in all of the rail, gas, road and air travel industries combined. Through the use of construction framework agreements, the business has put in place robust processes to manage its capital programmes. Construction is currently under way on 90 sites, and this will rise to around 480 sites, in the next financial year, mainly due to the large number of unsatisfactory combined sewer overflow projects.

By the end of September 2002, around 65 per cent of the water and wastewater capital programme for the current regulatory period had either been completed,constructed or was at the detailed design stage where contract documentation was being drawn up. The majority of the remaining projects are at the stage where capital solutions are assessed against environmental requirements.

Asset Management Services

• Turnover (excluding revenues from asset management services in the Americas) increased by 17.4 per cent to £167.6 million

• Operating profit* (including share of joint ventures) increased by 85.4 per cent to £28.0 million

United Utilities Contract Solutions is a rapidly growing asset management services business which operates and manages utility activities serving over 10million people throughout the UK and overseas.

Operating profit* (including share of joint ventures) increased by 85.4 percent to £28.0 million, as the period of start-up costs which accompanied last year's growth in turnover has come to an end.

Operations management

Operations management develops and operates contracts in selected markets based on the group's core asset management skills. It has a focused approach to pursuing opportunities with the objective of securing long-term investment and operational sources of income whilst limiting financial exposure. Concessions in Central and Eastern Europe, and our contract with Welsh Water,which made the group the largest manager of water and wastewater assets in the United Kingdom, continue to perform well in terms of cost and service levels.The withdrawal from Argentina and sale of US Water represents an important step in changing the focus of the business to the better opportunities that are available in the United Kingdom and Central and Eastern Europe.

Green energy

United Utilities has an option to develop an offshore wind farm at Scarweather Sands, which has a potential capacity of 90MW. Nearly all environmental surveys and investigations with regard to the site are now complete, and a planning application is now being prepared.

United Utilities is also developing a number of schemes, with a potential capacity of 80MW, that capitalise on the group's presence as owner of electricity, water and land assets in North West England.

Network services

United Utilities Networks is a national market leader in the rapidly developing multi-utility metering and connections markets. The business provides gas,water, electricity and telecommunications connections and metering to domestic,commercial and industrial developers. It also operates private gas networks.The £225 million five-year contract with British Gas Trading for the provision of metering services to around 5 million customers in the North West and NorthEast of England and North Wales was successfully mobilised in November. United Utilities Networks is developing a telephone and data transmission unit to support this contract, which will replace traditional paper-based methods, to supply real-time information to British Gas Trading when new meters are installed.

Customer Management Outsourcing

• Turnover increased by 6.3 per cent to £142.8 million

• Operating profit* increased by 22.9 per cent to £8.6 million

• Operating margin* increased from 5.2 per cent to 6.0 per cent

Vertex provides business process outsourcing services to utilities, private enterprise and the public sector, and specialises in the front and back-office management of customer relationships. This is particularly relevant to clients with large customer bases, such as in the public sector, who require customer management expertise when outsourcing their business processes. Sales growth in the period moderated to 6.3 per cent reflecting a slowdown inactivity in the telecoms sector. Revenue growth in the second half of the year is expected to accelerate, principally due to contributions from recently won public sector contracts with the Department for Work and Pensions and Westminster City Council.

The contract with the Department for Work and Pensions was successfully mobilised in October, and included the delivery by Vertex of supporting IT systems to time, scope and budget.The first phase of the Westminster City Council contract was successfully mobilised in November. The contract, which is worth up to £422 million over 15years, covers the integration and delivery of 67 council services in seven departments by Vertex. Around 200 employees have already been transferred to Vertex as part of the contract, and a new flagship contact centre has been opened in Westminster.

In September Vertex signed an extended 10 year contract with TXU Europe for the provision of customer management outsourcing services. Since acquiring TXU Europe's retail business, Powergen has confirmed publicly that it intends to continue this relationship. Accordingly, Vertex and Powergen are now in the process of progressing the contract novation.

Vertex has purchased the UK contact centre operator, 7C, and its shareholding in 7C India. The acquisition includes the transfer of 7C's key clients,including lastminute.com, Vodafone and Free view, four existing contact centres in the UK, and the 75% shareholding of its Indian customer management operation, which is based in New Delhi. The acquired business has annualised revenues of around £20 million, and net assets of around £4 million. 434directly employed 7C employees, in the UK and India, will transfer to Vertex as part of the deal.

As anticipated, the operating margin* improved from 5.2 per cent in the corresponding period last year to 6.0 per cent, reflecting the increasing maturity of the external contract portfolio and progress in the achievement of cost reductions in intra-group contracts.

Telecommunications

• Turnover increased by 8.0 per cent to £79.3 million

• Operating loss* reduced by 19.0 per cent to £10.2 million

Your Communications offers voice, basic and advanced data communication services to the public sector, and small and medium-sized corporate customers,predominantly in the Midlands and North of England. Business sales from voice and data services increased by 28.3 per cent to £63.5million, whilst premium rate services fell by 33.9 per cent to £15.8 million.This reflects further progress in the changing of Your Communications' sales mix to higher margin business customers, which now make up 80 per cent of sales.

Revenues are expected to accelerate in the second half of the year as sales flow from new customers secured during the last six months.With the construction of Your Communications' network now completed, the group has reviewed the carrying value of its telecoms assets, in accordance with FRS11. An adjustment to value of £25.5 million has been made, equivalent to 11 percent of the telecoms assets' book value. This represents a robust valuation of the business, having been based on prudent assumptions, the principal ones being a pre-tax nominal weighted average cost of capital of 16 per cent, and along-term real growth rate of 2.25 per cent.

Although network capacity sales are not a significant part of Your Communications' revenues, the group has reviewed current accounting practice in respect of these sales, adopting a revised policy that treats such transactions as grants of operating leases, unless legal title passes. Consequently, the income from such transactions will now be recognised over the life of the lease rather than as a sale in the accounting period in which the transaction is concluded.