Sir Roy Gardner

Chief executive’s review

We have a strong business with leading market positions and I am confident that our strategy will continue to deliver value for our shareholders.

In 2002 the group continued its strong overall financial performance, in particular from our leading UK energy operations, where improvement in margins and growth were accompanied by new momentum in our services to business customers and expansion of our upstream energy asset portfolio.

Our AA roadside and personal finance operations continue to deliver solid underlying profit growth. Despite slow regulatory progress in our UK telecoms and North American energy markets, we are expanding in both businesses. Goldfish brand development continues with a more focused product line. Our reinvestment in growth areas is proceeding selectively, with a constant focus on economic value creation.

Global energy markets were hit in 2002 by turbulence and the retrenchment or exit of certain market participants, and the UK was no exception. Positive underlying progress in the transparency and competitiveness of the UK wholesale electricity market resulted in financial pressure on some asset owners, and poor performance for those market participants that had not anticipated the fundamental impact on wholesale pricing.

However, the wholesale gas and electricity markets are resilient, with ample commodity supply enabling British Gas to benefit from both retail brand leadership and the hedging effect of our energy asset management. The value strategies that we are pursuing in both the upstream and downstream markets within the UK continue to afford the group a competitive advantage.

Turnover and profitability

Group turnover (excluding Accord trading revenue) was £10 billion in 2002, up 11% from the prior year period. Higher sales to our business customers – through Centrica Business Services – were complemented by an increase in residential electricity sales as well as growth in North America, the AA’s roadside and personal finance units, home services and One.Tel. UK gas sales volumes were lower, largely due to unusually warm weather in the first and fourth quarters of the year.

Operating profit by business* (£m)
	2002	2001
British Gas residential	244	(46)
Centrica Business Services	65	44
Centrica energy management group (CEMG)	520	573
The AA	73	72
Goldfish Bank	(40)	(32)
One.Tel	2	4
Centrica North America	63	68
Other operations	5	(4)
Group	932	679
*Before exceptional charges and goodwill amortisation, including joint ventures and associates.

 

Group operating profit (including joint ventures and associates, before exceptionals and goodwill amortisation) of £932 million was up 37% from £679 million in 2001, with improved performance across most brand units, particularly British Gas. Aggregate group gross and operating margins (excluding Accord) were 30% and 9%, up from 26% and 7% respectively in 2001.

Operating profit (£m)	Operating profit (£m)
Before exceptionals and goodwill amortisation, including joint ventures and associates.	After exceptionals and goodwill amortisation, including joint ventures and associates.

 

Customer service

We maintained our focus on improving customer service levels across all of our brands. We are now placing greater importance on qualitative and value-based measures of customer service which are built into a scorecard evaluation and reflected in the remuneration of staff at all levels.

As testament to our focus on these areas, we continue to be highly rated by external agencies. In particular, the AA won the JD Power & Associates 2002 UK Roadside Assistance Study award for customer satisfaction for the third time in five years. Further accolades include Which? magazine naming the AA as the UK’s best motoring organisation, and www.house.co.uk winning the 2002 Customer Management National E-commerce Customer Service Award.

Outlook

Whilst the economic outlook remains uncertain, we are moving from a period of considerable investment in growth opportunities and strategic market entries, to a period of delivery from these investments, underpinned by new customer relationship management (CRM) platforms and common competencies in securing value from deeper customer relationships.

For British Gas, we expect continuing recovery in residential gas gross margins and further electricity growth to generate further profit improvement, partially offset by the higher costs of the government’s Energy Efficiency Commitment and peak CRM system implementation expenses through to 2004. Annual CRM cost synergies will drive further medium term growth in British Gas operating margins.

In the UK retail energy sector competition remains tough, although we believe that the transaction prices paid recently by acquirers should result in retail pricing consistent with positive supply margins. In addition, reduced doorstep selling in the industry appears to be leading to lower churn rates. While we expect the result of this reduced industry churn to be slower growth in our residential electricity customer base than we had previously anticipated, reduced customer acquisition expenses should contribute to better electricity profits.

We expect to increase market share and profitability in the UK commercial energy sector. The launch of Centrica Business Services has resulted in increased management focus and growing product portfolios in this unit.

It is anticipated that output volumes from our Morecambe Bay gas production facilities will decrease by around 10% per year, offset over time by greater output from other currently held gas assets and future acquisitions. We expect our cash petroleum revenue tax (PRT) payments to decline significantly over the next few years.

Profitability of the AA is expected to continue to improve, and expenditure in information technology will peak in 2003. For One.Tel, we expect that regulatory improvements will warrant renewed organic investment in brand and product marketing at the same time as developing our growing mobile and internet businesses. For Goldfish, significant improvement to credit card and loans contributions are expected in 2003 and with a more focused rollout of new products, breakeven will occur towards the end of the year.

North America continues to offer a significant value creation opportunity, given our focus on the marketing and service elements of deregulated energy supply. We continue to lobby regulators to maintain legal frameworks and incumbent pricing levels which allow sufficient and stable gross margin headroom to attract new market entrants. Without this regulatory commitment to proper competitive markets, current organic growth prospects and customer renewals are being negatively affected. In this environment, we expect to focus in 2003 primarily on the integration of our existing customer bases and on profitability. We will maintain a flexible approach to customer acquisition, seeking to acquire incumbent supplier customer bases and playing a key role in markets at early stages of deregulation. Our organic growth will be focused in a few larger state and provincial markets which offer sufficient scale for successfully marketing our energy and related services. As a result of this industry environment and our strategic focus, the timing for achievement of our broader ambition in North America will depend upon the availability and pace of key acquisition opportunities.

Our strategy in continental Europe is to build a significant customer base in the medium term. Although the pace of deregulation varies across the individual markets there are now clear timetables for commercial and residential market openings. The whole of the European Union household energy market is expected to be liberalised by mid 2007. We are focusing on those countries where the speed of market opening and legal and political conditions, including unbundling and independent regulation, are more advanced.

Employees

Our employees are central to the delivery of our strategy and we need to continue to attract and retain high quality, highly motivated people. I am pleased that we have recruited some excellent people over the last year to complement our existing team. We are also developing programmes to ensure that we have the leadership capability to drive our strategy forward.

I am committed to making Centrica an employer of choice and the recent accreditation of our AA brand unit as ‘Investors in People’ is one indication that we are developing the highest standards of employment policies and practices. Increased scores in our satisfaction survey in 2002 demonstrate that our employees share our vision and are committed to delivering our strategy. I would like to join the chairman in thanking them all for their ongoing and valued commitment.

Conclusion

To sum up, we have a strong business with leading market positions. Our core businesses are growing and are strongly cash generative and our investment in new businesses is proceeding as market opportunities emerge. I am therefore confident that our strategy will continue to deliver value for shareholders.

Sir Roy Gardner
Chief Executive

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