NGG

Business Context and Reporting Period

Company: National Grid Transco plc (NGT)

Reporting Period: Year ended 31 March 2003

Filing Date: 21 May 2003

Context: This is the first full-year report following the merger of National Grid Group plc and Lattice Group plc, completed on 21 October 2002. The results are presented using merger accounting principles, treating the entities as if they had always been combined. The Group operates regulated energy businesses in the UK and US, with a significant contribution from the New York operation (Niagara Mohawk) included for the first full year.

Key Financial Metrics

Note: "Underlying" figures exclude goodwill amortisation and exceptional items, which management considers the primary measure of performance.

Material Changes vs. Prior Period

• Revenue Growth: Turnover increased by 24% primarily due to the full-year contribution of the New York operation (Niagara Mohawk), which joined the Group in January 2002.
• Profitability: Underlying operating profit rose 23% to £2,185m. Statutory results improved significantly from a loss to a profit due to the absence of the large impairment charges recorded in the prior year regarding telecom assets.
• Cost Reduction: The Group delivered over £140m in real controllable cost reductions. Merger savings targets were increased to at least £135m annually.
• Exceptional Items: Total net exceptional charges were £477m before tax. Key components included £209m in restructuring costs, £184m in merger-related costs, and a £191m write-down of telecom assets (186k). These were offset by net credits of £104m from joint venture losses and property sales.
• Currency Impact: The weakened US dollar reduced underlying operating profit by approximately £34m, though the impact on earnings was largely neutralized by lower sterling costs for dollar-denominated interest.

Guidance, Outlook, and Risks

• Outlook: Management expects 2003/04 to be another strong year, citing cost reduction and synergy programs exceeding targets.
• Dividend Policy: The Board aims to increase dividends per share in sterling by 5% in real terms annually through March 2006. The recommended final dividend is 10.34p per share.
• Operational Targets:
  • UK Electricity: On track to achieve a 30% real reduction in controllable costs by March 2006 (currently 22% achieved).
  • UK Gas: Met the first-year target to reduce operating costs to the Ofgem allowance level.
  • US Operations: Aim to reduce controllable costs by 20% by March 2005; currently achieved 6.5%.
• Risks and Contingencies:
  • Regulatory: Ongoing separation of Transco's distribution price controls and potential sale of individual networks.
  • Pensions: Significant FRS 17 deficits exist (£1,217m for Lattice scheme, £303m for UK National Grid, £742m for US operations). Future cash contributions depend on actuarial valuations.
  • Market: Exposure to currency fluctuations, energy market prices, and weather patterns affecting demand.

Investor Verification Checklist

• Merger Accounting: Verify the impact of merger accounting vs. acquisition accounting (US GAAP) on comparability, as US GAAP would show different equity and income figures.
• Pension Liabilities: Review the FRS 17 pension deficits and the potential for increased future cash contributions following the next actuarial valuations.
• Exceptional Items: Analyze the sustainability of the £477m exceptional charges, specifically the one-off telecom asset write-downs and restructuring costs.
• US Currency Exposure: Assess the sensitivity of future earnings to US dollar/sterling exchange rate fluctuations given the significant US operations.
• Regulatory Separation: Monitor the progress of the UK gas distribution network separation and potential asset sales.