18th May 2005 07:01
Scottish & Southern Energy PLC18 May 2005 Scottish and Southern Energy plc 18 May 2005 PRELIMINARY RESULTS FOR THE YEAR TO 31 MARCH 2005 Chief Executive's Statement "Scottish and Southern Energy delivered an excellent financial performance in2004/05, achieving results well in excess of expectations at the start of theyear. These results were supported by a strong operational performance.Consequently, the company has continued to meet its core objective, which is todeliver sustained real growth in the dividend. In summary: • The Board is recommending a final dividend of 30.3p per share, making a full-year dividend of 42.5p - an increase of 12.7%. This is well ahead of our target of at least 4% real growth for the year to March 2005 and reflects the underlying strength of the business and its prospects. It also represents a significantly higher base from which to grow the dividend in future. • Profit before tax grew by 17.2%, from £609.7m to £714.8m, before goodwill, net finance income from pension assets and exceptional items. • Earnings per share increased by 15.0%, from 54.1p to 62.2p, before goodwill, net finance income from pension assets, deferred tax and exceptional items. • SSE had 6.1m energy supply customers at 31 March 2005, having gained 850,000 during the year, including 300,000 acquired from Atlantic Electric & Gas. In line with its policy of responsible pricing, SSE delayed price rises for domestic customers until the end of the winter. It has now committed to keeping electricity prices for domestic customers at their current levels until at least the start of 2006. It will seek to do the same with gas prices, but this will be determined by trends in wholesale gas prices. • SSE has the second largest, and most diverse and flexible, generation portfolio in the UK following the acquisition of 4,000MW of generation capacity at Ferrybridge and Fiddler's Ferry power stations and their coal stocks for £136.0m. • The investment programme achieved important milestones in gas storage and renewable energy in particular, with SSE in the process of applying for consent to develop an additional 318MW of new wind farm capacity. • There were two exceptional items: the successful progress of SSE's claim on the administration of TXU businesses, which resulted in a first distribution of £159.1m being received from the administrator, plus a share of the distribution to Barking Power Ltd; and the decision, following the end of a 'structural' agreement, to write down certain parts of the original Peterhead Power Station, resulting in an exceptional impairment of £61.0m being taken as a charge to the results for the year. • The agreement reached with Ofgem on the Distribution Price Control for 2005-10 will allow SSE to deliver a quality service for customers while achieving a reasonable return for investors. • SSE's joint venture investment in the Scotland and the South of England gas distribution networks, which will make it the second largest energy distributor in the UK, is on course for completion on 1 June 2005. SSE's focus has always been, and remains, the delivery of sustainable long-termreal dividend growth. We have assessed the value that we expect to createthrough operational excellence, the successful integration of ourrecently-acquired assets and the delivery of our programme of investment inrenewable electricity generation, electricity networks and gas storage. On thisbasis, we are recommending a final dividend of 30.3p per share, an increase of14.8%, leading to a full-year dividend of 42.5p, an increase of 12.7%. This is designed to provide a significantly higher base for future dividendgrowth. From this new, higher base our new target is to deliver at least 4% realgrowth in the dividend paid to shareholders in each of the three financial yearsto March 2008, with sustained real growth thereafter. Our carefully-maintained financial strength, and our continuing focus on thedelivery of strong operational performance, means we are in a good position todeliver the new dividend growth target for our shareholders in the years tocome." Ian MarchantChief Executive FINANCIAL OVERVIEW Note: This preliminary results statement describes profits and earnings beforegoodwill, net finance income from pension assets ('FRS 17') and the impact ofdeferred tax. In 2004/05, SSE again achieved increases in profit before tax, earnings pershare and the dividend. Profit before tax, before goodwill, net finance income from pension assets andexceptional items, grew by 17.2%, from £609.7m to £714.8m. There was profitgrowth in Power Systems, Generation and Supply, Gas Storage and Telecoms. Themost significant growth was achieved in Generation and Supply, reflecting SSE'ssuccess in delivering value from its growing customer base and its investmentin, and acquisition of, generation assets in recent years. 2004/05 2003/04 Change £m £m % PBT 785.3 607.3 29.3 - TXU distribution (133.5) - - - Peterhead write down 61.0 - - - Property disposal - (10.2) - PBT before exceptionals 712.8 597.1 19.4 - FRS 17 income (13.4) (2.2) - - Goodwill 15.4 14.8 - Underlying Profit Before Tax 714.8 609.7 17.2 To monitor financial performance over the medium-term, SSE continues to focus onearnings per share before the non-cash items of goodwill, the impact of deferredtax and net finance income from pension assets. On this basis, and afterexcluding the impact of the exceptional items, earnings per share increased by15.0%, from 54.1p to 62.2p. The Board is recommending a final dividend of 30.3p, an increase of 14.8%,making a full-year dividend of 42.5p, an increase of 12.7%. This compares with27.5p five years ago, in 2000, since when the dividend has increased by 54.5%,which represents a compound annual growth rate of 9.1%. The dividend increase for 2004/05 is significantly ahead of SSE's target for theyear of 4% real growth, reflecting the underlying performance of the businessand its prospects. It is also being recommended to establish a new, higher basefrom which the dividend is expected to grow in future years. The continuing delivery of strong performance in SSE's businesses, allied to theprospects for securing benefits from recent acquisitions and investmentopportunities, means SSE is in a position to target at least 4% real growth inthe dividend payable to shareholders in each of the three years to March 2008,with sustained real growth thereafter. ENERGY SYSTEMS Power Systems Overview Operating profit in Power Systems increased by 2.3%, from £317.5m to £324.7m,contributing 40.3% of SSE's total operating profit. • Southern Electric Power Distribution's operating profit fell by 2.8% to £193.9m, following the over-recovery of allowable revenues that occurred in 2003/04. • Operating profit for Scottish Hydro Electric Power Distribution and Scottish Hydro Electric Transmission increased by 10.8% to £130.8m. This followed the under recovery of allowable revenues that occurred in the previous year. The key responsibility of SSE's Power Systems businesses is to maintain safe andreliable supplies of electricity, and to restore supplies as quickly as possiblefollowing interruptions. In line with that, SSE has invested £760m in itselectricity networks since 2000, including £172m in 2004/05. Ofgem's valuation of the physical assets of the transmission, distribution andmetering businesses (the Regulated Asset Base) was £2.47 billion on 1 April 2005and is expected to grow by around £120m over the next five years, excluding anymajor transmission investment, thus supporting the ongoing value of the PowerSystems businesses. Southern Electric Power Distribution In 2004/05, Southern Electric Power Distribution distributed 34.1TWh ofelectricity, an increase of 0.36TWh. The average number of minutes of lostelectricity supply per customer was 83.9, which was within the target set byOfgem under its Information and Incentives Project (IIP), which gives financialbenefits to distribution network operators that deliver good performance forcustomers. The number of supply interruptions per 100 customers was 97.6.Subject to the outcome of the forthcoming Ofgem review of exceptional events,which should reduce these figures, this performance is expected to lead toadditional revenue of around £5m. The programme to upgrade and refurbish the network continued during 2004/05,with 1,680km of high voltage overhead lines and 775km of low voltage linesrefurbished. The substantial programme of network automation continued, withanother 86 urban substations completed, together with 220 new radio-controlledautomated switching units in rural areas, allowing for faster restoration ofsupply to customers. There has also been significant investment in theunderground network, with 50km of high voltage cable replaced. Scottish Hydro Electric Power Distribution and Scottish Hydro ElectricTransmission In the Scottish Hydro Electric area, 8.748TWh of electricity were distributedduring 2004/05, compared with 8.743TWh in the previous year. Excluding the 11January storm, the average number of minutes of lost electricity supply percustomer was 86, which was within the IIP target, as was the number ofinterruptions per 100 customers, which was 89. Subject to the Ofgem review ofexceptional events, which should reduce these figures, this should lead toadditional revenue of around £3m under IIP. The January storm was described as the worst to affect the north of Scotland for20 years. It resulted in more than 2,000 separate instances of damage beinginflicted on the electricity network in the Scottish Hydro Electric area andaround one in five customers losing their electricity supply. The company'sresponse to it drew praise from, amongst others, the First Minister of Scotland. The ongoing programme of investment in the Scottish Hydro Electric areacontinued during 2004/05, with another 1,990km of high voltage overhead linesbeing refurbished, along with 245km of low voltage lines. The programme ofnetwork automation has also continued, with another 16 urban substationscompleted, together with 315 new radio-controlled automated switching units inrural areas. Distribution Price Control Review Throughout the process for determining the new electricity distribution pricecontrol for 2005 to 2010, SSE's objective was to reach agreement with Ofgem onan overall package of measures in respect of Southern Electric PowerDistribution and Scottish Hydro Electric Power Distribution which would allow itto deliver a quality service for customers while achieving a reasonable returnfor investors. Agreement was reached in December 2004. Ofgem's review confirmed that SSE is the most efficient operator in electricitydistribution in Great Britain. Looking forward, SSE believes that, takentogether, the arrangements for future allowed operational and capitalexpenditure, operational expenditure efficiency assumptions, the treatment ofpensions costs and rising tax charges, the level of real post-tax cost ofcapital, the incentive framework for delivery of better than expectedperformance and the treatment of other company-specific issues meet itsobjective. For example, during the review, SSE argued that the incremental costs associatedwith balancing electricity generation and demand on Shetland should become aliability of Scottish Hydro Electric Power Distribution under BETTA (the newBritish Electricity Trading and Transmission Arrangements - see below) and thatthese costs, of around £7m a year, should in future be recoverable from allelectricity customers. Ofgem agreed, and this outcome confirms the importance ofadopting a thorough and constructive approach to engagement with the regulatorand other stakeholders. More broadly, the review resulted in significantly increased allowances forcapital expenditure to maintain and improve electricity networks. As a result,SSE's regulated capital expenditure in Power Systems is likely to increase byover 20%, to around £210m, in 2005/06. Overall, SSE expects the outcome of the distribution price control review toenable it to increase the revenue earned by its electricity distributionbusinesses in future years. The priority now is to maintain the higheststandards of customer service and efficiency within the new price controlframework. Transmission SSE also reached agreement with Ofgem on the price control for Scottish HydroElectric Transmission for the two years to 31 March 2007. This will enable a newfive-year price control to be set for Great Britain's three electricitytransmission companies at the same time. Since BETTA was introduced on 1 April 2005, National Grid Transco has becomeGreat Britain System Operator, responsible for balancing the supply and demandof electricity across Great Britain. Scottish Hydro Electric Transmissionremains responsible for operating, maintaining and investing in the transmissionnetwork in its area, which covers around 70% of Scotland. These newarrangements have worked well so far. In August 2004, Ofgem stated that investment had been approved to allow thereplacement of the electricity transmission line connecting Beauly in theHighlands with Denny in the Central Belt of Scotland to go ahead. This work hasto take place if the government's targets for the generation of electricity fromrenewable sources are to be achieved. It is likely that the construction of thereplacement line will require an investment of around £250m. SSE expects tosubmit within the next few weeks an application to Scottish Ministers forconsent to build the line. On this basis, and subject to the timely progress ofthe planning application, the replacement line could be operational in 2008/09. In addition, a preliminary public consultation document on options forconnecting possible renewable generation in the Western Isles to thetransmission infrastructure on the Scottish mainland has led to theidentification of three options which require further technical andenvironmental study. While this work remains at a relatively early stage, itcould require investment of around £400m towards the end of this decade. Gas Distribution Networks In August 2004, a consortium (now named Scotia Gas Networks) in which SSE holds50% of the equity entered into an agreement to acquire the Scotland and theSouth of England gas distribution networks from National Grid Transco. Intotal, they comprise 73,000km of gas mains, delivering gas to around 5.6mindustrial, commercial and domestic customers. The total value of the acquisitions will be £3,162m, of which £2,082m isexpected to be funded by already-committed non-recourse borrowings, with thebalance being funded by equity. This means that, in return for a cashconsideration of £540m, SSE will receive 50% of the distributable earnings fromthe networks. Upon completion of the acquisitions, SSE will also providecertain corporate and management services for the gas networks under anagreement with Scotia Gas Networks. When completed, the acquisitions will makeSSE the second largest energy distributor in the UK. The acquisitions received approvals from the Department of Trade and Industryand Ofgem in January 2005 and from the Office of Fair Trading in April 2005, andthe two networks became separate companies within the NGT group on 1 May 2005.Final approvals from Ofgem and the Health and Safety Executive are stillrequired, but the acquisitions are on course for completion at the start of June2005. A programme of work to complete the acquisition process, and to put in place allthe necessary arrangements for the change of ownership, is now well advanced.Payroll, materials management, finance, billing and human resources systems havebeen developed for the two gas networks. To support the implementation of thesesystems, a major training programme, involving over 2,000 Scotia Gas Networksstaff and over 1,000 staff of contractors, is now close to completion. Longer-term, it is clear that there are significant opportunities to createvalue through delivering efficiencies. The acquisitions may also provide otherbusiness opportunities, such as in gas metering and in the provision andmaintenance of gas equipment. The first priority will, of course, be to delivergas safely and reliably. SSE will equity account for the networks as a joint venture and its Accountswill show SSE's share of profit. As their borrowings will be non-recourse, theywill not be consolidated on SSE's balance sheet. The networks are expected toenhance SSE's earnings from the first year. GENERATION AND SUPPLY Generation and Supply Overview Operating profit in Generation and Supply rose by 29.5%, from £298.5m to£386.5m, contributing 48.0% of SSE's total operating profit. Within SSE'sintegrated business model, the use of generation assets supports performance inenergy supply and value in Generation and Supply is, therefore, assessed as asingle value chain. During 2004/05, SSE's power stations (wholly-owned and owned by joint ventures)generated 37.9TWh of electricity, an increase of 14.7TWh on the previous year.SSE supplied 47.5TWh of electricity to industrial, commercial and domesticcustomers, an increase of 8.1TWh on the previous year. With the acquisition of Ferrybridge and Fiddler's Ferry, SSE now owns andoperates nearly 10,000MW of electricity generation. Comprising a balanced mix ofbaseload, mid-merit and peaking plant, SSE's portfolio of power stations is nowthe second largest and the most diverse in the UK. Growth in operating profit was achieved mainly as a result of benefits from fivemain factors. These were: the first full year of ownership of Medway Power; theending of the contract under which SSE took output from Scottish Power'scoal-fired power stations in Scotland, resulting in lower capacity costs; theacquisition of the Ferrybridge and Fiddler's Ferry power stations; increasedoutput from hydro electric stations, including more output qualifying forRenewable Obligation Certificates (ROCs); and sustained growth in energy supplycustomer numbers. These benefits were partly offset by the impact of risingwholesale gas prices. In addition, SSE's flexible generation assets continued to perform well in NETA(the New Electricity Trading Arrangements), with success in the balancing marketcontributing £24m to operating profit during the year. NETA has now beensuperseded by BETTA. Generation and Supply accounted for almost all of the £2.3bn increase in SSE'sturnover in 2004/05. This was mainly due to: retail sales to the significantlyincreased number of electricity and gas customers; higher wholesale and retailprices; and new businesses acquired. Around one third of the increase reflectsadditional wholesale trading of both electricity and gas necessary to optimisethe short-term position in volatile energy markets. EU Emissions Trading Scheme and BETTA The electricity generation market in the UK was the subject of two importantdevelopments in the first few months of 2005: the launch of the EU EmissionsTrading Scheme (EU ETS) and the introduction of BETTA. It is regrettable that, despite the launch of the EU ETS on 1 January 2005,there remains a dispute between the UK government and the European Commissionabout the total number of carbon emissions allowances to be issued to operatorsof participating installations in the UK. It is very disappointing that anyshortfall between the UK government's proposed National Allocation Plan and thatagreed by the EC will be met by reducing the number of allowances given to theelectricity generating sector. Nevertheless, SSE's allocation of emissionsallowances, of around 20 million tonnes, is reasonable in comparison to the restof the UK generation sector, although less than the level of emissions that islikely to be required in practice. The BETTA arrangements were successfully introduced on 1 April 2005. Asexpected, the establishment of the England-Scotland interconnector as part ofthe wider transmission system has made it easier for the output from SSE'sflexible power stations in Scotland to be deployed to meet demand from theelectricity market in England and Wales. Gas-fired Generation SSE now owns 4,300MW of gas-fired electricity generation capacity, including itsshare of joint ventures. The 120MW power station in Fife was acquired for £12.5min February 2004, and during the year SSE invested £4.0m in upgrading the plantto support its operational performance. It returned to full service on schedule,in December 2004. SSE's acquisition of the balance of the equity interests which it did notalready own in Medway Power for £241.1m in November 2003 added another modern,flexible and efficient power station to its group of generation assets and gaveSSE the economic benefit from having a 100% interest in Medway's contracts tosupply power. As a result of this acquisition, Medway Power contributed anadditional £41.0m operating profit in 2004/05, an increase of £25.0m on theoperating profit achieved, also as a result of the acquisition, in the finalfive months of 2003/04. As with NETA, good performance in BETTA will be dependent on plant reliability,and the number of unplanned outages at SSE's wholly-owned gas-fired powerstations was slightly fewer than in 2003/04 and around 50% lower than in theyear before that. SSE believes that this is a good performance, but one whichcan be improved in future years. Coal and Biomass Generation SSE acquired the Ferrybridge and Fiddler's Ferry power stations, with a totalcapacity of almost 4,000MW, and associated coal stocks, for £136.0m on 30 July2004. This equates to around £20 per kilowatt of installed capacity. Fuel intransit and contracts to supply fuel for the power stations were acquired for£43.0m and £80.3m respectively. Both are flexible, mid-merit stations which have added to the diversity of SSE'sgeneration portfolio and help it to meet peak demand for electricity. They alsoallow SSE to manage its exposure to changes in fuel prices by balancing its gasportfolio with a coal portfolio. In the first eight months of ownership, the twopower stations contributed around £50m to operating profit after amortising£53.0m of the payment for the contracts to supply fuel. One of the benefits arising from the acquisition of the stations was that SSEreceived with them a significant allocation of carbon emissions allowances. Inaddition, they also 'co-fire' fuels from renewable sources in order to displacefossil fuels, thus reducing the level of carbon emissions resulting from theiroperation. This output qualifies for ROCs. From the date of the acquisition,their output qualifying for ROCs was 573GWh, an increase of 79% on the sameperiod in the previous year, when they were under their former ownership. At the time of the acquisition, SSE undertook to examine all options formaximising the longer-term value of the assets, particularly with regard tobiomass. In line with this, SSE is now investing around £20m in the developmentof additional facilities to increase further the ability to co-fire fuels fromrenewable sources at both power stations. The installation of new 'directinjection' burners at the stations is expected to give them the ability togenerate around 1,500GWh per year of output qualifying for ROCs. The work toinstall the burners is expected to be completed by the end of the financial year2005/06. Having experienced the benefits arising from owning a mix of gas-fired andcoal-fired capacity in its generation portfolio, SSE is also examining in detailthe case for opting in to the Large Combustion Plant Directive some of thecapacity at Fiddler's Ferry and/or Ferrybridge. To do this would require theinstallation of Flue Gas Desulphurisation (FGD) equipment and an investmentestimated to be in the range of £75m-£90m per GW of capacity. A detailed tenderexercise is now under way and, in line with the Directive, a final decision onthis must be made by the end of 2005. More broadly, it is becoming increasingly recognised that coal and other fossilfuels will play a central part in meeting future energy needs. New technologieswill have to be developed to reduce and capture carbon dioxide emissions causedby the use of all of these fuels and SSE is actively involved in developments inthis field. Hydro Generation Performance in Generation and Supply during 2004/05 benefited from the increasein SSE's electricity output qualifying for ROCs, which attracted a premium priceof around £45/MWh. The increase was attributable to the growing proportion ofSSE's hydro electric capacity which has been refurbished, so that its outputqualifies for ROCs, and to higher than average 'run-off' of water flowing intoSSE's reservoirs. The output of refurbished hydro electric stations with capacity of up to 20MWqualifies for ROCs, and, in total, SSE has 394MW of capacity in its sub-20MWstations. During 2004/05, refurbishment was completed on 95MW of hydrocapacity, taking the overall total of refurbished capacity to 370MW. Therefurbishment of the remaining 24MW will be completed by the end of December. Water running off into reservoirs during 2004/05 was 14% above the long-termaverage and the 6th highest in over 30 years. This unusually high level ofrun-off added around £15m to operating profit compared with an average year.Total hydro output was 3,544GWh, compared with 2,640GWh in the previous year.As a result of this and of the investment in refurbishing hydro capacity, SSE'sROC-qualifying hydro output increased to 1,448GWh, compared with 916GWh in 2003/04. Assuming average 'run-off', SSE's ROC-qualifying output from hydro electricstations is again expected to be over 1,400GWh in 2005/06. The new 3MW hydro electric station at Kingairloch, near Fort William, begangenerating electricity earlier this year and work on the development of the 7MWof ROC-qualifying capacity at Fasnakyle is well under way. The planning application for consent to build a new 100MW hydro electric stationat Glendoe near Loch Ness is still being considered and the initial tenderingprocess for the project has now been completed. The project is unique, and SSEwill determine whether to proceed with the development following a full risk/reward analysis, focusing on: any conditions which must be met as part of theplanning consent; the outcome of the tendering process; and further assessmentsof the income which the station would be likely to generate. The abolition of Hydro Benefit on 1 April 2005, announced by Ofgem in 2003, andits replacement by a separate scheme to assist customers with the high costs ofdistributing electricity in the north of Scotland, means SSE's profit from itsgeneration activities will increase by around £37m a year from 2005/06. Theprofitability of its distribution businesses will be unaffected. Wind Generation The increase in the UK's target for electricity generated from renewablesources, to 15% by 2015, emphasises the important part that wind generation willhave to play in helping to reduce emissions of carbon dioxide and in increasingthe amount of electricity that can be generated from the UK's indigenousresources. The framework for investment in renewable energy remains encouraging. SSE's first wind farm, at Tangy in Argyll, has been operating successfully forover two years and SSE is seeking consent to add another 6MW (Tangy 2) to itscapacity. Its second wind farm, at Spurness on the Orkney Islands, wasofficially opened in March, taking SSE's operational wind farm capacity to 22MW.Construction work at the 20MW wind farm at Artfield Fell in Wigtownshire, and onthe 120MW wind farm at Hadyard Hill in Ayrshire, is advancing well and bothshould begin to generate electricity during 2005/06. The progress of other applications for consent to build wind farms, includingthose proposed by SSE, is proving to be slow, reflecting a planning regime whichthe Scottish Executive itself has described as 'stringent'. The applications tobuild wind farms at Drumderg (32MW) and Gordonbush (87MW) have been in theplanning process for 21 months and two years respectively, but have yet to befinally determined. These seven developments comprise the first phase of SSE's wind energydevelopment plans and around £80m has now been invested at Tangy, Spurness,Artfield Fell and Hadyard Hill. An additional £140m will be required tocomplete Artfield Fell and Hadyard Hill and to develop Drumderg, Gordonbush andTangy 2. SSE is also continuing to develop plans for the second phase of its investmentin wind energy and is in the process of applying for consent to develop afurther 318MW of capacity at four sites in Scotland. The development of thesefour sites, if consented, will require investment of around £250m over the nextfew years. Other sites are also being developed with a view to seeking planningconsent in future years. As a result of its ongoing programme of investment in renewable energy, SSEremains on course to have around 1,000MW of ROC-qualifying wind and hydrogenerating capacity by 2008. Of this, it already has in place, or has securedconsent to develop, 566MW of capacity (395MW in operation and 171MW inconstruction or refurbishment). New Technologies Investment in the research, development and demonstration of new technologiesfor generating electricity is a key part of the government's energy policy, andis part of SSE's strategy to remain the UK's leading generator of electricityfrom renewable sources. • In August 2004, SSE and Talisman Energy (UK) announced plans to construct a £28m wind farm demonstrator project, with a capacity of up to 10MW, adjacent to the Beatrice Oil Field, 25km off the coast of Scotland, in deep water in the Moray Firth. The project is being funded by the Scottish Executive, Department of Trade and Industry and the European Commission, in addition to the two companies. SSE is contributing £7m to the project. Electricity from the demonstrator project should begin to be generated by 2007. • Renewable Technology Ventures Ltd (RTVL), the joint venture between SSE and The Weir Group, has invested £2.4m on the development of a tidal power generating device. Following this work, RTVL is now seeking to build a full-sized commercial demonstrator device, with a capacity of 2.4MW, and hopes to deploy the device at the European Marine Energy Centre in Orkney. This is subject to ongoing discussions with the Department of Trade and Industry and the Scottish Executive, and could require investment by SSE of around £2m. The device would be the largest of its kind in the world and includes unique design features. • SSE entered into an agreement with Renewable Devices Swift Turbines Ltd, a technology company providing accessible renewable energy solutions, in October 2004. It has developed what is believed to be the world's first feasible rooftop-mountable wind energy system, which is capable of delivering significant amounts of energy to businesses, offices and homes. Under the agreement, SSE is investing almost £300,000 in Renewable Devices to acquire 20% of the share capital and will also provide opportunities to market its rooftop wind system to a wide range of customers. Devices are being installed at a number of locations around the country, including the NaRECentre in Newcastle and a zero-emissions property development at Bow in London. • SSE has acquired a 7.5% stake in solarcentury, the largest independent solar photovoltaics company in the UK, for £1m. The two companies have also entered into a collaboration agreement. As a result of this, solarcentury's expertise in solar energy will be brought together with SSE's electrical contracting business to market the provision and installation of solar energy solutions to a growing number of customers throughout the UK. They have already combined to provide and install solar PV for a variety of organisations, including the National Trust in Swindon and Spitalfields market in London. With growing interests in emerging technologies, allied to its establishedcapability in generating electricity from the more mature technologies of hydro,onshore wind and biomass, SSE is now a genuinely pan-renewables company, and iswell-placed to maintain its current position as the UK's leading generator ofelectricity from renewable sources. Energy Supply SSE's energy supply business had 6.1m customers at 31 March 2005. It grew by16% in 2004/05, with a net gain of 850,000 customers, including over 300,000customers from Atlantic Electric and Gas (Atlantic) in April 2004. Growth incustomer numbers has continued at a similar rate since the end of March.Overall, SSE now has 1.5m more customers than at the start of 2002, an increaseof one third. The final acquisition cost of the Atlantic customers and the customer debt bookwas £85.2m. Since April 2004, £60m from the debt book has been collected. Ayear on from the acquisition, the number of customers with Atlantic is stillover 300,000. Growth achieved during the year also includes a net gain of business customerscovering around 85,000 sites throughout Great Britain. SSE won the tender tosupply electricity to the NHS's 800 large sites in England in a three-year dealworth over £220m. In total, SSE's business customers now cover 415,000 sitesthroughout Great Britain. The increase in customer numbers has been aided by growing success in retainingexisting customers. By the end of 2004/05, the number of customers leaving SSEfor other suppliers had fallen by around 20% compared with the previous year. Although all the other major energy supply companies raised their prices fordomestic customers at least twice during 2004, SSE made just one increase, inline with its policy of responsible pricing. It eventually raised prices formost customers in March 2005 but, in doing so, gave a commitment to holdelectricity prices at their revised levels until at least the start of 2006. SSEaims to do the same with gas prices, but its ability to do so will be determinedby trends in wholesale gas prices. SSE remains the most efficient energy supplier in the UK, incurring the lowestcost when serving customers, according to a study by Datamonitor published inJanuary 2005. The study said that SSE's 'cost to serve' is between 10% and 23%lower than that of other suppliers. Customer Service Equally important to success in energy supply is maintaining the highestpossible standards of customer service. SSE's 'one-stop' fully integrated customer service system continues to offer oneof the broadest range of functions in the sector and was enhanced during 2004/05to improve further standards of service while at the same time keeping pace withchanging technology. Since December 2004, on-line billing services have beenavailable to SSE energy supply customers, allowing them to view and pay theirbills, submit meter readings and raise enquiries. Already, around 25,000customers have registered for this new service. Despite the significant growth in customer numbers, SSE secured during 2004/05 areduction of 48% in the number of customer complaints sent to energywatch forresolution, to fewer than 1,400 (excluding Atlantic). This follows the 23%reduction achieved during the previous year. In the statistics published byenergywatch in March 2005, SSE had the lowest rate of complaints in respect ofall three categories: account and billing matters, transfers between companiesand direct selling. The leading independent study, by JD Power, published in November 2004, foundthat SSE has the highest level of customer satisfaction among UK gas suppliersand the third highest among electricity suppliers. Product Development During the year, SSE launched new products, demonstrating the strength of itscommitment to product development as a key contributor to long-term success inenergy supply. • power2 is a unique package which offers customers a commitment that electricity will be generated from SSE's hydro electric schemes along with a tree-raising scheme to offset carbon emissions resulting from their consumption of gas and disposal of household waste. It has already attracted almost 20,000 customers. • easywarm is a fixed-price energy product for customers aged over 50 which has been piloted in south Wales. It has attracted over 20,000 customers. SSE is assessing whether to offer easywarm to customers in other parts of the country. • energyplus care is a new tariff and package of services for SSE's most vulnerable customers which should enable a qualifying family living in a three-bedroom semi-detached house to reduce their total energy bills by around 30%, or £200 a year. It was described by energywatch as 'a big stride forward in the development of effective and innovative social tariffs'. The energyplus care product is designed to help customers with multipleproblems: a low income that needs to be supported by particular benefits;special needs such as a disability; and a home that has particularly poor energyefficiency. While SSE does not believe that the energy supply industry isresponsible for fuel poverty, it does believe that it is in the long-terminterests of the industry to make a real effort to play its part in dealing withthe problem. Overall, SSE believes that its work on product development, emphasis on customerservice and its policy of responsible pricing means that its energy supplybusiness should be able to extend further the period of growth which began atthe start of 2002. Energy Services An increasing number of supply customers are likely to seek a wider range ofenergy-related services, covering renewable, sustainable and energy efficientproducts. With well-established Contracting, Connections and Appliance Retailbusinesses, and a growing portfolio of micro-generation technologies, SSE isvery well-positioned to capture a significant proportion of this developingmarket. SSE's ability to provide a broad energy services offering should also increaseits scope to secure additional business opportunities in electrical contracting,'local' electricity networks, street lighting and energy supply to majorcustomers. With that aim in mind, SSE's Energy Services Unit was established during 2004 toprovide a comprehensive range of 'beyond the meter' services. The work of theunit will focus initially on public sector organisations such as localauthorities, and then extend to customers in the commercial sector such ashousebuilders and other developers. In due course, the aim is to market SSE'spackage of energy services to domestic customers. CONTRACTING AND CONNECTIONS Contracting and Connections delivered operating profit of £47.5m during 2004/05,compared with £48.7m in the previous year. The Contracting businesses are already leaders in their sector and their plansfor future growth are continuing to develop effectively. • Southern Electric Contracting acquired the electric contracting division of what was previously Eastern Contracting in January 2005, in a transaction with a value of around £2m. As part of the deal, SEC also acquired the Eastern Contracting name. The acquired business is based in Bury St Edmunds, employs around 200 staff and extends significantly SEC's area of operation. • A joint venture comprising SEC and Interserve was awarded the Ministry of Defence's 'Prime' contract covering London and the south-east of England. The contract is to provide mechanical and electrical maintenance for over 100 MoD sites, and is worth around £400m over an initial seven years. Work started in April 2005. • In partnership with the asset finance division of The Royal Bank of Scotland, SEC has contracts worth around £350m to replace and maintain street lights for three local authorities in England under the Private Finance Initiative. These contracts are progressing well. • Thermal Transfer has significantly increased its presence in the healthcare sector, acting as a specialist contractor in the design and build of laboratories, containment areas, cleanrooms and support facilities at major hospitals throughout the country. The Connections business completed around 42,000 electrical connections during2004/05, a similar number to the previous year. In addition, it has continued toexpand its portfolio of electricity networks outside the Southern Electric andScottish Hydro Electric Power Distribution areas. SSE's Connections businessnow owns and manages 16 electricity networks outside SSE's two electricitydistribution areas. It is also a licensed gas transporter, owning and operating gas mains andservices in many parts of the country. The rate of connecting new premises toits gas networks continued to grow, and during the year, it connected a further7,000 premises, up 20% on the previous year, taking the total number ofconnections to more than 27,000. An illustration of the business' progress is its success in winning a majorcontract to provide, own and operate the electricity and gas networks for theBraehead development at Renfrew, part of the Clydeside area regenerationproject. The development consists of around 2,000 residential units, with retailand commercial accommodation, including a large indoor ski slope and leisurecentre. Preliminary work has started on site and the first connection isexpected in the second half of this year. GAS STORAGE Gas Storage delivered an operating profit of £18.3m, an increase of 60.5%compared with the previous year. Demand for gas storage facilities in the UKremains high and, in a volatile gas market, SSE has continued to enter into newcontracts to provide storage at a significantly higher value than the contractsthey replace. The onshore gas storage facility at Hornsea, which SSE acquired in 2002, iscurrently the largest in the UK and has a good record of reliability. Ittherefore provides customers with a means of managing their changing supply/demand position. In this respect, meeting customers' nominations is vital andHornsea has continued to be 100% available to customers except in instances ofplanned maintenance. Looking ahead to the 2005/06 winter, all of the capacity atHornsea has already been sold. SSE's joint venture with Statoil (UK), in which SSE is investing £150m, todevelop what will become the UK's largest onshore gas storage facility atAldbrough, is continuing to make good progress. With a total new capacity ofaround 420 million cubic metres, of which SSE will have the ownership interestin 280 million cubic metres, Aldbrough will provide essential additional gasstorage for the UK energy industry. Consent was received in March 2005 from DEFRA to begin 'leaching' the ninecaverns that will be used to store gas. Leaching at the first cavern is now wellunder way and work on other caverns will follow during 2005/06. The process willtake around four years to complete, with the first cavern expected to be readyto store gas in 2007. TELECOMS SSE's combined Telecoms business (SSE Telecom and Neos) achieved an operatingprofit of £10.6m in 2004/05, compared with £3.5m in the previous year. Thebenefits from establishing in 2003/04 a national telecoms network, a UK-widesales force and a competitive range of products targeted at commercial andpublic sector customers are now being realised. As part of SSE, Neos is alsoable to position itself as one of the UK's most financially secure telecomsnetwork operators The improvement in performance is partly the result of higher sales, andimportant contracts have recently been signed with major companies includingOpal Telecom and O2. In addition, an improvement in gross margins and areduction in overhead costs has been achieved, partly through synergy savingsachieved by combining the SSE Telecom and Neos businesses. EXCEPTIONAL ITEMS TXU Europe Group plc On 31 March 2005, SSE received its first distribution, of £159.1m, from theadministrators of TXU Europe Group plc and certain of its subsidiaries, withregard to its agreed claim of £294.2m in respect of a 14-year contractoriginally entered into in 1997. After extinguishing a debtor balance, the net receipt of £111.2m was taken as anexceptional credit to the results for 2004/05. To this has been added SSE'sshare (£22.3m) of the distribution paid by the administrator to Barking PowerLtd, the operators of Barking Power Station. SSE expects to receive further distributions of up to a total of £100m from theadministration, in the autumn of 2005 and the spring of 2006, but these have notbeen recognised in the results to date as the value and precise timing of thereceipts are uncertain. Overall, SSE now expects that over 85% of its agreedclaim will be settled. Peterhead Power Station In line with the decision announced in November 2003, the 'structural' agreementunder which ScottishPower paid a capacity fee each year for the use of part ofthe capacity of Peterhead Power Station ended on 31 March 2005. The agreementwas in respect of the original station, which was not re-powered in 2001, andhad been intended to run until 2012. Its end has led to a reappraisal of thepower station and, in particular, the carrying value of the assets which weresubject to the contract. This concluded that certain parts of the originalstation ought to be written-down. Consequently an exceptional impairment of £61mhas been taken as a charge to the results for the year. The re-powered station, which comprises three combined cycle gas turbines and asteam turbine, with a total capacity of 1,140MW, continues to be held at itsfull net book value as it remains one of the most flexible power stations inEurope and is considered to be an asset with very significant future economiclife. GROUP CAPITAL EXPENDITURE Group investment and capital expenditure, excluding acquisitions, totalled£383.5m during 2004/05, compared with £289.7m in the previous year. Capital expenditure in Power Systems was £176.7m, compared with £147.9m in theprevious year. Of this, £100.3m was invested in network refurbishment and £76.4mon network expansion. Following the distribution price control review for2005-10, SSE's capital expenditure in Power Systems is likely to increase toaround £210m in 2005/06. Another important feature of capital expenditure in 2004/05 was investment of£119.3m for growth in generation, with the refurbishment work being carried outat hydro electric power stations and the development of new hydro electric andwind energy schemes which will lead to the production of ROC-qualifying energy.In addition, £31.7m was invested in the ongoing development of the new gasstorage facility at Aldbrough. Within the overall total, capital expenditure for growth was £174.0m during 2004/05. This mainly comprised renewable energy and gas storage. As previouslystated, capital expenditure will be significantly higher in the next few years,with investment in renewable energy, electricity networks and gas storage, andis expected to be around £500m in 2005/06. All investments are expected toachieve returns which are greater than the cost of capital and are expected toenhance earnings. NET DEBT AND CASH FLOW During 2004/05, SSE's net debt increased by £31.7m to £1,448.8m, followingacquisitions totalling £339.0m and capital expenditure for growth, principallyin renewable energy and gas storage, totalling £174.0m. The fact the increase in net debt was small reflects the strong underlying freecash flow generated by SSE and the inflows of: £159.1m cash from the TXUadministration; the recovery of £60m from the debt book of Atlantic; and thecash generation of £53m from the contract book purchased with Fiddler's Ferryand Ferrybridge. As already stated, these positive benefits were offset by cashoutflow on higher capital expenditure for growth and the acquisitions of the twopower stations and Atlantic. FINANCIAL MANAGEMENT Treasury Policy SSE's operations are financed by a combination of retained profits, bankborrowings, long-term debt issuance and commercial paper. As a matter of policy,a minimum of 50% of SSE's interest rate exposure is kept at fixed rates ofinterest. Within this policy framework, SSE borrows as required, at both fixedand floating rates, with interest rate swaps and forward rate agreements beingused to achieve the desired profile. All borrowings in foreign currencies areswapped back into Sterling. At 31 March 2005, 97.6% of SSE's borrowings were at fixed rates, after takingaccount of interest rate swaps. Liquidity policy requires SSE to ensure that it has committed borrowings andfacilities equal to at least 105% of forecast borrowings over a rolling 12 monthperiod. As at 31 March 2005, SSE had undrawn committed bank facilities of £650m,with a weighted average period, until maturity, of 4.7 years. There is relatively little direct exposure to foreign currency risk as theUnited Kingdom is SSE's main area of operation. If either fuel or plant arecontracted in foreign currency, SSE's policy is to hedge all material purchasesthrough the use of forward purchases of foreign currency and derivativeinstruments. Indirect foreign exchange exposures created through SSE's gaspurchases are similarly hedged on an ongoing basis. Borrowings and Facilities The objective for SSE is to maintain a balance between continuity of funding andflexibility, with a range of maturity dates. Its average debt maturity profileas at 31 March 2005 was 12.0 years, compared with 13.9 years as at 31 March2004. The maturity profile continues to reflect the medium to long term nature ofSSE's underlying assets and means its debt structure is in a strong positiongoing forward, with around £1.65bn of borrowings in medium to long-term fundingin the form of issued Bonds and European Investment Bank borrowings. A total of1.7% of SSE's total borrowings will mature in the 12 months to March 2006. SSE issued its first convertible bond, of £300m, in October 2004. Holders ofthe Bond may elect to convert their holdings into ordinary shares of SSE at aconversion price of 900p per share until its final maturity date in October2009. In return, SSE benefits from a low interest coupon of 3.75%, contributingto the reduction in its average interest rate payable. The net proceeds of theBond were partly used to reduce SSE's existing borrowings, with the balance heldas cash on deposit to contribute to the funding of the gas networks acquisition. In November 2004, a new five-year £650m committed Revolving Credit Facility wassigned to provide standby liquidity and to backstop SSE's commercial paperprogramme which was increased to Euro 1.5bn during the year. This facilityreplaced more expensive facilities at both SSE plc and Southern Electric PowerDistribution plc, while an increase in the total size of available committedfunding reflects the larger potential borrowing requirements of SSE goingforward. Interest SSE's net interest charge in 2004/05 was £90.9m, compared with £85.5m in theprevious year. This reflects the acquisitions made during the period, offset bycontinuing strong cash flow. The average interest rate for SSE during the yearwas 5.91%, compared with 5.96% in the previous year. Underlying interest coverwas 9.0 times, compared with 8.4 times the previous year. TAX The effective current tax rate, before exceptional items, was 25.5%, comparedwith 24.1% in the previous year. As deferred tax liabilities are only apotential exposure, discounting has been applied to reflect the long-term natureof the assets and this impacts on both the profit and loss account and on thebalance sheet. An additional discounted liability of £21.5m has been recognisedon the balance sheet as at 31 March 2005. The tax charge, before exceptionalitems, including the deferred tax element, was 30.1%, compared with 26.3% inthe previous year. BALANCE SHEET SSE continues to maintain one of the strongest balance sheets in the globalutility sector, which continues to give it significant competitive advantage interms of cost of funding and supporting new developments. In February 2005, therating agency Moody's re-affirmed SSE's credit rating as Aa3 (or 'strong'). In line with the FRS 17 treatment of pension scheme assets, liabilities andcosts, a net pension scheme liability of £143.6m is recognised in the balancesheet at 31 March 2005, including, for the first time, £19.6m of deficit inrespect of the scheme for employees at Ferrybridge and Fiddler's Ferry. During 2004/05, employer cash contributions to the Scottish Hydro Electricscheme amounted to £8.9m and £3.0m was contributed to the scheme for employeesat Ferrybridge and Fiddler's Ferry. Contributions to the Southern Electricpension scheme amounted to £10.0m during 2004/05. The actuarial valuation of the Southern Electric scheme as at 31 March 2004 wasfinalised. As expected, the results showed a gross deficit of £275.5m, comparedwith the FRS 17 deficit on the same date of £253.0m. The FRS17 gross deficit on31 March 2005 was £282.0m. Following discussions with the Trustees on how thisdeficit might be repaired, a contribution towards the deficit of £29.5m per year(increasing each year in line with RPI) was agreed in March 2005, in addition toan ongoing contribution rate of 19.9% of salaries. As part of the DistributionPrice Control for 2005-2010, it was agreed that allowances for 76% of deficitrepair contributions should be included in price controlled revenue. Similar discussions have been concluded with the Trustees of the pension schemethat exists for the benefit of employees at Fiddler's Ferry and Ferrybridgepower stations where a gross deficit of £13.7m had been calculated as at 31March 2004. An additional contribution of 8% of salary (around £1.3m per year)has been added to the employer's contribution rate in order to repair thedeficit. PURCHASE OF OWN SHARES During 2004/05, the Directors of SSE did not exercise their authority topurchase, in the market, the company's own shares. In the previous year,1,760,000 of the Company's 50p ordinary shares were purchased and cancelled atan average price of 633p per share. The Directors will seek renewal of theirauthority to purchase, in the market, the Company's own shares at the AnnualGeneral Meeting on 28 July 2005. It remains the policy of the Board of SSE totake opportunities to return value to shareholders through the purchase of theCompany's own shares should the conditions be appropriate. INTERNATIONAL FINANCIAL REPORTING STANDARDS SSE's interim results for 2005/06, to be published in November 2005, will complywith International Financial Reporting Standards (IFRS), as adopted by theEuropean Union. In advance of that, SSE will re-state its accounts for 2004/05in accordance with IFRS, and make the re-stated accounts available via itswebsite. A seminar for analysts and investors on the transition to IFRS will beheld in September, and the presentation will also be made available on SSE'swebsite. SSE does not believe that the adoption of IFRS will have any impact onits dividend policy. A description of the issues in respect of IFRS will appearin SSE's Annual Report and Accounts 2005. SAFETY AND THE ENVIRONMENT SSE aims to create value for shareholders by running the business with a strongemphasis on safety and on caring for the environment. During 2004/05, the numberof lost time and reportable accidents within the company was 17, which was thelowest ever and which compared with 27 in the previous year. The number ofserious, or potentially serious, road traffic accidents involving employeesdriving company vehicles fell from 0.52 per 100 vehicles to 0.42 in 2004/05. To benchmark its environmental activities, SSE took part in Business in theCommunity's Environment Index, the results of which were published in April2005. Its score was 98.8, making SSE the joint top performing company in itssector and placing it in BitC's 'Premier League' of participating companies. The Environment Index is part of a wider Corporate Responsibility Index, inwhich SSE participated in full for the first time. Its score was 93%, whichpositioned it joint 14th out of 144 participating companies. EMPLOYEES The progress made by SSE is largely due to the outstanding work done byemployees in every part of the business. There is no doubt that 2004/05 was themost eventful year so far in the development of SSE. At the same time, one ofSSE's eight principles of corporate responsibility is to provide opportunitiesfor employees to become shareholders in the company. In support of this principle, and in the light of a wish to give additionalrecognition to employees' performance in the year, the Board has decided to makea special award of 50 free shares in the company to everyone employed by SSE on31 March 2005 and still in employment on the date the shares are awarded. Underthe arrangements for the award, the shares will be held in trust for threeyears. STRATEGY AND OUTLOOK SSE has consistently set out four areas in which it can enhance and create valuefor shareholders: maintaining and investing in energy networks; adding to itsleading-edge generation portfolio; growing its energy supply business; anddeveloping its growing presence in businesses such as contracting, connections,Related Shares:
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