Directors' report

The directors present their report and the audited group accounts of Centrica plc for the year ended 31 December 2002.

Principal activities

The principal activities during the year were:

• the provision of gas, electricity and energy related products and services in Great Britain, North America and Europe;
• the operation of gas fields in Great Britain and North America and power stations in Great Britain;
• energy trading in the UK, North American and European markets;
• roadside assistance and other motoring services in the UK and Europe;
• the provision of financial services in the UK; and
• the provision of telecommunications services in the UK.

Business review

The chairman’s statement, and the operating and financial review report on the activities of the group during the year, recent events and any likely further business developments.

Financial results

The financial results of the group are discussed in the group financial review.

Major acquisitions and disposals

In May, the acquisition of the Toronto based home and business services operation Enbridge Services Inc for C$1 billion (£438 million) was completed. The acquisition comprised 1.75 million customer relationships and 1.3 million waterheaters which were leased to customers. In December, the waterheater assets were transferred to the Consumers’ Waterheater Income Fund (CWIF), which listed units and debt securities on the Toronto Stock Exchange, implying an enterprise value of C$1 billion. The group retained a 41.9% equity and voting interest in the CWIF.

In June, agreement was reached to dispose of non-core interests in the Liverpool Bay Fields in consideration for a package of offshore gas assets in the North Sea and a cash balance, with a total value of approximately £88 million.

In June, Regional Power Generators Ltd, which owns and operates the 240MW Glanford Brigg power station in Lincolnshire, was acquired for £37 million.

In August, the acquisition of 212,000 natural gas customers of NewPower Holdings, Inc and its subsidiaries in Ohio and Pennsylvania was completed for US$26 million (£17 million). In August, Electricity Direct (UK) Ltd, the UK’s largest independent commercial electricity supplier, was acquired for £50 million.

In November, offshore gas storage facilities in the North Sea and an associated onshore terminal were acquired for a net cash consideration of £488 million. The Secretary of State for Trade and Industry has to decide whether to clear the acquisition, refer it to the Competition Commission for further investigation or accept undertakings in lieu of a reference.

In November, the group’s liquefied petroleum gas (LPG) business was sold for £40 million.

In December, the group acquired the electricity supply operations of Texas based Central Power and Light Company and West Texas Utilities Company, for a purchase price of approximately US$246 million (£154 million).

In December, agreement was reached to acquire the retail gas and electricity supply businesses of ATCO Group in Alberta, Canada, with 988,000 customers, for C$128.5 million (£52 million), payable over two years. This acquisition is conditional on legislative changes and regulatory consents in 2003.

Post balance sheet events

Details of post balance sheet events are disclosed in note 30 to the financial statements.

Dividends

An interim dividend of 1.4 pence per ordinary share was paid on 27 November 2002. The directors recommend that, subject to approval at the annual general meeting (AGM) on 12 May 2003, a final dividend of 2.6 pence per ordinary share be paid on 18 June 2003 to those shareholders registered on 2 May 2003. This makes a total dividend for the year of 4.0 pence per share (2001: 3.1 pence per share).

Related party transactions

Details of related party transactions are set out in note 28.

Creditor payment policy

It is the group’s policy to:

• agree the terms of payment in advance with the supplier;
• ensure that suppliers are aware of the terms of payment; and
• pay in accordance with contractual and other legal obligations.

The number of days’ purchases outstanding as at 31 December 2002 was 34 (2001: 32) for the group (excluding Accord Energy Trading Limited) and 41 days (2001: 42 days) for the company.

Employment policies

The group employed an average of 38,051 people during 2002. 35,563 were employed in the UK, 301 in the rest of Europe and 2,187 in North America.

The group is committed to pursuing equality and diversity in all its employment activities, with particular emphasis on recruitment and selection, training and development, appraisal and promotion. By supporting and encouraging the diversity of our people, we aim to increase employee motivation and provide better service to our diverse customer base in the community at large. This approach is reflected in our employee policies and procedures and we are proud to offer a range of benefits that go beyond the requirements of legislation. For example, we have a comprehensive ‘carers policy’, which enables employees to balance the demands of long term caring commitments with the requirements of their job.

The group continues to support the Government’s New Deal for people with disabilities, the aim of which is to recruit unemployed disabled people and carers into the group’s operations. Centrica’s experience of embracing diversity is being shared with other UK employers through its membership of the Employers’ Forum on Disability and the Employers’ Forum on Age.

We comply with national gender pay policies and are committed to implementing them through a programme of equal pay audits.

Employee communications

Employees are regularly provided with a wide range of information concerning the direction and performance of the group by means of employee briefing arrangements such as team briefs, intranet, CDs and company magazines. We also actively seek employee involvement through regular employee surveys and action planning forums. Employees’ views are also taken into account by means of local consultative bodies. The group continues to be a strong supporter of Investors in People.

Employee share schemes

The group encourages employee share ownership through the operation of tax authority approved share schemes open to all eligible employees, including executive directors.

Each year, the company operates sharesave schemes in the UK and Ireland which enable eligible employees to acquire shares in the company at the end of a three or five year saving period. A total of 17,446 employees in the UK and Ireland participate in the schemes.

During the year, the company launched a share incentive plan, which enables eligible UK employees to buy Centrica shares, subject to monthly limits, out of pre-tax pay. In addition, the company awards one free matching share for every two shares an employee buys, subject to a monthly limit of 20 matching shares. A total of 5,065 employees participate in the plan.

Corporate responsibility

Information relating to the group’s impact on society, the economy and the wider environment is given here. A comprehensive guide on these matters including the company’s policies and procedures is available at www.centrica.com/responsibility.

The company’s reporting on such matters is being developed having regard to the ABI’s disclosure guidelines. The system of internal control described below covers significant risks associated with social, environmental and health and safety matters.

Charitable and political donations

An outline of the group’s involvement in the community appears here. Charitable donations in the UK during the year amounted to £4.7 million (2001: £4.0 million). In line with group policy, no donations were made for political purposes.

Share capital

The company’s authorised and issued share capital as at 31 December 2002, together with details of shares issued during the year, is set out in note 20.

Material shareholdings

At 17 February 2003, the following material shareholdings were recorded in the register maintained in accordance with the Companies Act 1985:

Legal & General Investment Management Ltd		150,067,973	3.53%
Aviva plc		145,117,187	3.41%
Barclays plc		134,330,258	3.16%

Directors

The board of directors section gives details of all directors who served during the period between 1 January 2002 and the date of this report. On 13 May 2002, Sir Sydney Lipworth retired as a director of the company. It was announced on 4 February 2003 that, by agreement of the company, Mike Alexander would be retiring from the board with effect from 28 February 2003. Helen Alexander and Robert Tobin were appointed as non-executive directors on 1 January 2003. On 19 February 2003, Paul Walsh agreed to become a non-executive director of the company with effect from 1 March 2003.

In accordance with the articles of association, Sir Michael Perry, Sir Roy Gardner and Sir Brian Shaw will retire by rotation at the 2003 AGM. Sir Michael and Sir Roy will be proposed for re-election. Sir Brian will not be seeking re election, having by then reached the age of 70.

It being the first AGM since their appointment, Helen Alexander, Robert Tobin and Paul Walsh will be proposed for election. All have considerable experience of leading consumer facing international businesses.

The biographical details of all directors being proposed are given in the notice of AGM. Full details of directors’ service contracts, emoluments and share interests can be found in the remuneration report.

Auditors

Following the conversion by PricewaterhouseCoopers to a Limited Liability Partnership (LLP) from 1 January 2003, a resolution to appoint the new firm, PricewaterhouseCoopers LLP, as auditors to the company will be proposed at the AGM.

Authority to purchase shares

The directors were authorised at the 2002 AGM to purchase the company’s own shares, within certain limits and as permitted by the Articles of Association. Although no such purchases have been made to date pursuant to this authority, the directors will seek to renew the authority at the 2003 AGM.

Corporate governance

The group is committed to high standards of corporate governance. Following the recommendations in the reports on the Role and Effectiveness of Non-Executive Directors (the Higgs Report) and Audit Committees (the Smith Report), the board is reviewing its governance arrangements and will consider making changes as necessary and appropriate. Throughout the year, the company fully complied with the provisions of the Combined Code on Corporate Governance (the Code) and applied the principles of the Code as follows:

The board

An effective board of directors leads and controls the group. The board, which meets at least 10 times a year, has a schedule of matters reserved for its approval. One of its meetings each year is substantially devoted to the development of strategy. During 2002, there was full attendance at board and audit, remuneration and nominations committee meetings, other than by one director who missed one board meeting.

Comprehensive briefing papers including management accounts are circulated to each director one week prior to board meetings. A procedure is in place to enable all directors to obtain independent professional advice in respect of their duties. They also have access to the advice and services of the company secretary.

The names of the directors and their biographical details including committee memberships appear here. Throughout the year, the chairman and the other non-executive directors were independent of management and the senior independent director, as required by the Code, was Patricia Mann. The non-executive directors, including the chairman, meet independently of management on a regular basis.

All directors joining the board are required to submit themselves for election at the next AGM. They are subject to re-election every third year thereafter. The non-executive directors are initially appointed for a three year term and, subject to review and re-election, can serve up to a maximum of three such terms.

The board has delegated authority to a number of committees to deal with specific aspects of the management and control of the group. These committees have specific terms of reference and meet on a regular basis. The minutes of the meetings of these committees are made available to all the directors on a timely basis.

Executive committee

The executive committee, chaired by Sir Roy Gardner, meets weekly. It oversees the management of the group and is the decision making body for those matters not reserved to the board and within the limits set out in the group’s delegated authority and expenditure control policies.

There are five sub-committees of the executive committee: the group risk management committee; the group financial risk management committee; the corporate responsibility committee; the health, safety and environment committee; and the business continuity steering group.

Audit committee

The audit committee, which meets four times a year, consists entirely of independent non-executive directors. It was chaired throughout the year by Roger Carr.

The audit committee considers the nature and scope of the audit process and its cost effectiveness. It reviews the internal audit programme, matters brought to its attention by both the internal and external auditors and the annual and interim financial statements before submission to the board. It also reviews the system of internal control and reports its findings to the board.

The audit committee also monitors the independence of the external auditors. Note 4 to the financial statements, sets out the group’s policy to seek competitive tenders for all major consultancies and advisory projects.

From the beginning of 2002, in recognition of increasing public concern over the effect of consulting services on auditors’ independence, this policy was strengthened such that the external auditors’ consulting arm, PwC Consulting, would not be invited to tender for any further general consultancy work unless their proprietary skill base was uniquely valuable. In addition, the external auditors may still be used in respect of taxation advice and financial due diligence on transactions. All such assignments are reported to the audit committee on a quarterly basis, along with a full breakdown of all non-audit fees incurred during the year.

As a matter of best practice and in accordance with auditing standard 610, our external auditors have held discussions with the audit committee on the subject of audit independence and have confirmed their independence in writing.

Remuneration committee

The remuneration committee, which meets four times a year, consists entirely of independent non-executive directors. It is chaired by Patricia Mann. The role of this committee and details of how the company applies the principles of the Code in respect of directors’ remuneration are set out here.

Nominations committee

The nominations committee, chaired by Sir Michael Perry, makes recommendations to the board for appointments of replacement or additional directors. It met formally on two occasions during the year.

Customer service committee

This committee, which determines and monitors customer service targets, is one of the key drivers of the long term success of the group. It was chaired by Sir Sydney Lipworth until his retirement from the board on 13 May 2002. From then until January 2003, it was chaired by Mark Clare. Helen Alexander was appointed chairman of this committee with effect from February 2003.

AA motoring policy committee

This committee, chaired by Sir Brian Shaw, acted as an advocate on public policy issues affecting motorists. With effect from January 2003, this committee was disbanded and its work has been carried out by the independent AA Motoring Trust.

Relations with shareholders

The company has a programme of communication with its shareholders. As well as share price information, news releases and the annual report, the Centrica website includes speeches from the AGM, presentations to the investment community and a section for shareholder services.

The board believes that the AGM presents a useful opportunity for dialogue with private shareholders, many of whom are also customers. At the AGM, the chief executive presents a review of the businesses of the group. Representatives from the group’s brand units are available for discussion in the exhibition area both before and after the meeting. Centrica also holds regular meetings with its major institutional shareholders.

All shareholders have the opportunity to cast their votes at the AGM by proxy, by post or via the internet. Shareholders can register to receive all their communications online, benefiting both themselves and the company.

Internal control

The board of directors is responsible for the group’s system of internal control, which is designed to manage rather than eliminate the risk of failure to achieve business objectives and can provide only reasonable, and not absolute, assurance against material misstatement or loss.

Identification, assessment and management of risks

The company places great importance on internal control and risk management. A risk aware and control conscious environment is fostered throughout the group. The board, directly or through its committees, sets objectives, performance targets and policies for management of key risks facing the group. These include strategic planning, acquisitions, investments, expenditure control, treasury, environment, health and safety, trading and customer service.

Across the group, each business has a risk management committee that seeks to identify, assess and advise on the management of operational risks. In addition, the group risk management committee considers the risks which might affect the company at group level.

The processes of newly acquired companies are integrated with those of the group.

Assurance

The business assurance function undertakes internal audit reviews according to an annual plan approved by the audit committee. The results of their work is reported to the audit committee on a quarterly basis.

The board’s review of the system of internal control

The board of directors, with the advice of the audit committee, has reviewed the effectiveness of the internal control system operated (as described above) throughout the period 1 January 2002 to the date of this report and is satisfied that the group complies with the guidance contained in the Turnbull Committee report on Internal Control.

Going concern

After making enquiries, the board has a reasonable expectation that the company has adequate resources to continue in operational existence for the foreseeable future. For this reason, we continue to adopt the going concern basis in preparing the financial statements.

By order of the board

Grant Dawson
General Counsel and Company Secretary
20 February 2003

Registered office:
Millstream
Maidenhead Road
Windsor
Berkshire SL4 5GD
Company registered in England and Wales No. 3033654

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