Group operating cash flow (£m)

Including dividends from joint ventures and associates before exceptional payments.

Group operating cash flow (£m)

Excluding dividends from joint ventures and associates after exceptional payments.

Centrica share performance

Group financial review

We aim to grow our earnings and cash flow within a prudent risk management framework. During the year our share price out performed the FTSE 100 by 3.1% and since demerger in February 1997 to the end of 2002 we out performed the index by 187%.

Centrica’s aim is to achieve a total shareholder return (TSR) ranking in the first quartile of UK FTSE 100 companies, taking account of share price growth and dividends received and reinvested over a sustained period. Centrica promotes continuing growth in earnings and cash flow and seeks to maximise the return on capital it achieves within a prudent risk management framework. The remuneration report summarises our TSR performance over recent years against our FTSE 100 comparator group.

The company’s closing share price on 31 December 2002 was 171 pence (31 December 2001: 222 pence), resulting in a market capitalisation of £7.3 billion (2001: £8.9 billion). World stock markets continued to fall in 2002, the FTSE 100 index dropping by 24.5%. The company’s share price still out performed the FTSE 100 by 3.1% (2001: 2.1%) and since demerger to the end of 2002 we out performed the index by 187%.

Earnings

Earnings increased by £155 million to £478 million in 2002. This reflected improved operating profits* up £253 million and lower exceptional charges offset by taxation up from £155 million to £250 million and higher goodwill amortisation, up by £35 million to £123 million.

Earnings before exceptional charges and goodwill amortisation were up 32% to £636 million. This represents a return on capital employed over the year of 32% or 7.9% on our average market capitalisation.

Operating profit

Operating profit* was £932 million (2001: £679 million). Most of the improvement came from our UK residential gas supply business, and growth in our business services and home services operations.

Exceptional charges and goodwill amortisation

During the year, non-operating exceptional charges arose of £26 million net of tax (2001: £71 million operating exceptionals net of tax). These related to changes in our Golf England operation and disposal of our LPG cylinder business. In addition, a £9 million (2001: £ nil) exceptional tax charge arose (see Taxation below). The goodwill amortisation charge for the year was £123 million (2001: £88 million), in line with our programme of continuing acquisitions.

Net interest

Net interest charged to the profit and loss account was £62 million compared with £43 million in 2001 and was covered 15 times by operating profit* compared with 16 times a year earlier. The increase in interest payable was due to higher average indebtedness mainly as a result of acquisitions, offset by lower interest rates and the net proceeds of the share placement during the year.

Taxation

The ongoing taxation charge of £243 million for 2002 represents a 28% rate on profits adjusted for goodwill amortisation and exceptionals (2001 comparative rate: 26%). The increase in the effective rate is principally due to the introduction of a 10% corporation tax surcharge on UK offshore gas production, with effect from 17 April 2002. This surcharge increased the tax charge for the year by £12 million and resulted in a restatement of the deferred tax liability of £9 million, which has been treated as exceptional. The overall charge is still less than the UK 30% statutory rate, primarily because previously unrecognised deferred tax assets of £35 million have been utilised during 2002.

Earnings per share and dividends

Basic earnings per share grew from 8.1 pence to 11.4 pence and adjusted earnings per share from 12.1 pence to 15.2 pence. Over the last three years the adjusted performance measure has grown by an average compound growth rate of 24% and facilitated a progressive dividend policy. We are proposing a final dividend of 2.6 pence giving a total of 4.0 pence (2001: 3.1 pence), an increase of 29%.

Cash flow

Group operating cash flow (including dividends from joint ventures and associates, from continuing operations before exceptional payments) was £790 million for 2002, compared with £885 million in 2001. An increase of £299 million in operating profit* before depreciation and amortisation of investments was more than offset by changes in working capital, including growth in trade debtors, the timing of gas transportation payments, petroleum revenue tax (PRT) and gas production royalty payments.

Total capital expenditure was £449 million this year, up from £312 million in 2001. This includes £180 million of costs capitalised for information systems investments associated with our new customer relationship management (CRM) infrastructure. Acquisition expenditures (net of cash and overdrafts acquired) were £989 million in 2002 (2001: £1,204 million), consisting primarily of our purchases of the Brigg power plant and Rough gas storage facilities in the UK, Enbridge Services Inc in Canada and WTU Retail Energy LP and CPL Retail Energy LP in the US. The group’s net cash outflow before liquid resources and financing was, as a result, £918 million, against a net outflow of £342 million in 2001.

Capital funding - 31 December 2002

Balance sheet

The net assets of the group increased during the year from £1,536 million to £2,402 million.

Fixed assets

Net intangible fixed assets of £1,813 million (2001: £1,524 million) represented goodwill, which has arisen on acquisitions. During the year, £466 million (2001: £314 million) was added, including £193 million for the acquisition of Enbridge Services Inc, £167 million for WTU Retail Energy LP and CPL Retail Energy LP and £80 million for Electricity Direct. Goodwill is amortised by way of charges against profits over periods ranging from 5 to 20 years.

Tangible fixed assets, mainly comprising gas field assets and power stations, had a net book value of £2,763 million (2001: £2,058 million). During the year gas field assets, including the Rough gas storage facilities, and power stations totalling £590 million were acquired. At the year end, the proven and probable gas reserves represented by our field interests amounted to 2,846 billion cubic feet (bcf) (2001: 3,232 bcf), which included 404 bcf (2001: 446 bcf) in North America. At the year end, hardware and software costs relating to our major investments in CRM had a net book value of £237 million.

The group’s investment in joint ventures stood at £74 million (2001: £112 million), comprising its share of gross assets of £810 million and share of gross liabilities of £736 million, of which £629 million related to borrowings. These investments related principally to the investments in 60% of Humber Power Limited, 50% interest in the AA’s joint ventures with HBOS and 50% of Luminus NV.

Working capital

Current assets less current liabilities, excluding net indebtedness and Goldfish funding amounted to a deficit of £243 million (2001: deficit of £625 million). Excluding Goldfish, growth in trade debtors and accrued energy income has given rise to a net increase of £565 million in working capital.

Goldfish Bank

Goldfish Bank debtors, mainly in respect of credit card balances receivable, were £792 million (2001: £673 million), offset by customer savings account balances of £286 million (2001: £nil). Goldfish Bank borrowings amounted to £430 million (2001: £610 million).

Net debt

Net debt (excluding the Goldfish Bank facility of £430 million and the £196 million of non-recourse debt raised on the water heater assets acquired with Enbridge Services Inc) increased to £529 million at 31 December 2002 from £433 million at the previous year end.

Issue of share capital

In February 2002 £426 million, net of expenses, was raised via the issue of 232 million ordinary shares.

Provisions and other creditors due after more than one year

Together these increased during the year to £1,384 million (2001: £1,218 million). Increases in respect of decommissioning costs, mainly from acquisitions, and deferred corporation tax have more than offset the decrease in provisions for deferred PRT.

Financial risk management

The board has established objectives and policies for managing financial risks, to enable Centrica to achieve its long term shareholder value growth targets within a prudent risk management framework. These objectives and policies are regularly reviewed.

Currency, interest rate, liquidity and counterparty risks are managed centrally by a treasury and risk management team, within parameters set by the board. This team is also responsible for managing the relationships with the agencies setting the company’s credit ratings and managing the cost of its debt capital. Energy market price and weather risks are managed by business led energy and risk management teams operating within group established policies. Where appropriate, financial instruments are used to manage financial risks as explained below and in note 29. Goldfish Bank interest rate risks are managed by a treasury team with Lloyds TSB Bank plc within parameters set by the Goldfish Bank board.

Credit rating

The company’s credit ratings from Moody’s Investors Service/Standard & Poor’s remain unchanged at A2/A (long term) and P1/A-1 (short term) and with a stable outlook.

Currency risk

Through wholly-owned US and Canadian subsidiaries, the group has operational exposure in Canadian and US dollars. Canadian dollar translation exposure is hedged by maintaining a portfolio of Canadian dollar financial liabilities, which approximate to the net asset value of the Canadian operations. US dollar exposure has been hedged by borrowing on a short term basis through a combination of US commercial paper programme and currency instruments. In addition there is an element of exposure to the euro through the 50% interest in Luminus, which has been hedged by selling euro forward on a rolling basis. Exposures to foreign currency movements from operating activities are also hedged through the use of forward foreign exchange contracts. All debt raised in US dollars through the US commercial paper programme, apart from that hedging the US translation exposure, is either swapped into sterling or another functional currency as part of the translation hedging operations described above.

Interest rate risk

Throughout the year, the group’s policy has been to maintain approximately 50% of long term borrowings at a fixed rate of interest. This is achieved by using derivative financial instruments, such as interest rate swaps, to adjust the interest basis of the portfolio of long term debt (see note 29). At the year end debt has been raised on both a fixed and floating rate basis.

Liquidity

Cash forecasts identifying the liquidity requirements of the group are produced frequently. These are reviewed regularly by the board to ensure that sufficient financial headroom exists for at least a 12 month period. The group policy includes maintaining a minimum level of committed facilities and an objective that a proportion of debt should be long term, spread over a range of maturities. Details of the maturity profile of borrowings are given in note 29. At 31 December 2002, the group had undrawn committed facilities of £1 billion (2001: £935 million), which were used as a backstop for the US commercial paper programme.

Counterparty risk

The board’s policy is to limit counterparty exposures by setting credit limits for each counterparty, where possible by reference to published credit ratings. Exposures are measured in relation to the nature, market value and maturity of each contract or financial instrument. Surplus cash is invested in short term financial instruments and only deposited with counterparties with a minimum credit rating of A3/A- or P1/A-1 in Moody’s Investors Service/ Standard & Poor’s long term and short term ratings respectively. Energy trading activities are undertaken with counterparties for whom specific credit limits are set. All contracted and potential exposures are reported to the financial risk management committee of the board.

Commodity price risk

The key commodity price risks facing the group are first, natural gas and electricity prices both in the short term market and in respect of long term contracts and, secondly, escalation indices on long term gas contracts, of which the most influential are oil product prices and general price inflation.

The group’s policy is to hedge a proportion of the exposure for a number of years ahead matched to the underlying sale and purchase risk profiles. The group aims to manage its risk by using financial instruments such as oil and gas swaps and gas derivatives and bilateral agreements for gas and power, as well as asset ownership.

The financial risk management committee regularly monitors the extent of the group’s commodity price exposure and the level of hedging activity alongside the availability of forward prices and market liquidity.

The acquisition of the Glanford Brigg power station has further contributed to the company’s target to cover around a quarter of its electricity requirement from its own sources in 2002.

Weather risk

Gas sales volumes, and to a lesser extent electricity volumes, are influenced by temperature and other weather factors. In Britain, the weather derivatives market remains relatively immature. We again entered into a number of weather derivative transactions for the winter period October 2002 to March 2003 in order to hedge part of the group’s weather exposure.

Accounting policies

The principal accounting policies remain unchanged over last year and are described in note 1 to the financial statements. Where appropriate, wording has been expanded to more fully explain policies, particularly in relation to financial instruments, and energy trading activities.

In keeping with many other major companies, adoption of FRS 17 Retirement Benefits, has been deferred in line with the revised timetable announced by the Accounting Standards Board. Accordingly, the group has continued to report under SSAP 24 Accounting for Pension Costs.

In accordance with FRS 17, additional disclosures are contained in note 26. If the standard had been fully adopted in 2002, profit would have been reduced by £47 million (2001: £16 million) and net assets would have been reduced by £507 million (2001: £117 million). Full adoption is not mandatory until 2005, but the group will continue to keep this under review.

*Before exceptional charges and goodwill amortisation, including joint ventures and associates.

Phillip Bentley
Group Finance Director

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