Introduction
BT’s earnings of 31.6 pence per share for the year ended 31 March 1996 were 13.7% above the previous year’s, principally because of lower redundancy and interest costs. The results have benefited from the strong growth in demand for BT’s products and services and the improved efficiencies brought about by the redundancies of recent years, but the continuing impact of price reductions has offset much of these benefits. The group’s results are summarised in the following table:

Regulation and prices
BT’s main UK services, principally inland and outgoing international call services and exchange line rentals, are subject to price regulation. BT reduced its overall prices for its main UK services by over 7% in the price control year ended 31 July 1995 in accordance with the regulatory arrangements in force from August 1993 to July 1997, under the RPI minus 7.5 formula. These price reductions included those made at the end of June 1995 to coincide with the change to the per second method of pricing calls and those introduced in September 1994.

The RPI minus 7.5 price control is estimated to have affected about 52% of the group’s total turnover for the year ended 31 March 1996. And, if the RPI at June 1996 shows an annual increase at the same rate as the 2.4% increase experienced for the twelve months to April 1996, the price control will require the group to reduce prices of its main services during the year commencing 1 August 1996, by about 5.1%. A further reduction of about 1.4% must also be made before the current price control year ends on 31 July 1996.

Oftel is currently consulting with BT and other interested parties, including competitors, consumers and others outside the industry, on the structure of the successor price control to the current RPI minus 7.5 formula, which expires on 31 July 1997.

Competition and the UK economy
BT has a significant market share in its main UK markets for telephone calls and provision of exchange lines. However, competition has eroded BT’s market share signficantly in key market sectors and in particular areas of the UK and for certain products and services. Cellnet faces strong competition from its direct competitor and the two personal communications operators in the UK.

BT expects a continuing increase in competitive pressure as a result of the growth in market share of recent entrants to the UK telecommunications industry. BT will defend its markets vigorously but nevertheless the company expects that the overall impact of these competitors will become increasingly material.

The strength of the UK economy is an important determinant of BT’s business volumes and the gross domestic product grew by 2.0% in the year ended 31 March 1996, compared with 3.9% in the previous year.

Turnover
Total turnover grew by 4.0% to £14,446 million in the year. The strong growth in demand for the group’s products and services of approximately 8% was partially offset by the effect of price reductions which averaged nearly 4% across the business.

The group’s turnover is analysed as follows:

Price reductions had a major impact on inland telephone call turnover for the second year in succession. The combined effect of the price changes described above totalled over £330 million, which was equivalent to a 7% reduction in call prices following a 12% fall in the previous year. Call volume growth of 6% largely mitigated the price reduction effect, resulting in total inland call turnover declining by 1.2% in the year.

International call turnover rose by 2.3% as a result of strong call volume growth of 9% offset by price reductions averaging about 7%.

Turnover from exchange line rentals grew by 6.0%. The increased turnover was the combined result of a 5% price increase in February 1995 and the growth in business line connections. The number of these connections grew by 5.2% in the year with high speed digital ISDN services contributing significantly to the growth. For the first time, the numbers of residential lines declined due mainly to the new competition from the cable operators. Although the decline was slight, being limited to 113,000 lines, it partially offset the growth in business lines and BT’s total exchange line connections grew by 0.8% to 27.3 million.

Cellnet added 655,000 telephone users to its network in the year to bring its total to just under 2.4 million, almost matching that of its major UK competitor. Mobile communications turnover consequently grew by 30% in the year to £856 million. The continuing high costs of this expansion have been included in the results.

BT’s expansion worldwide with Concert services was a primary reason for the 17.5% increase in other sales and services. Concert, BT’s joint venture company with its US partner, MCI Communications Corporation, specialises in products and services for multinational businesses and provides services in 60 countries.

Operating costs
Total operating costs increased by 1.0% in the year. Significant decreases in redundancy and employment costs were more than offset by higher sales related costs and payments to other operators for terminating calls on their networks.

Total operating costs as a percentage of total turnover decreased from 80.8% in the previous financial year to 78.5%. Excluding redundancy charges, operating costs as a percentage of turnover increased by nearly one percentage point over the previous year.

The group’s operating efficiency continued to improve with a reduction of 6,800 people employed in the year, compared with a reduction of 18,500 in the previous year. Staff costs were reduced by 5.9% as a result of savings from these reductions more than offsetting pay increases.

Payments to other telecommunication operators increased by 16.0% as the result of the growing number of calls terminating on UK competitors’ networks, the increased volume of outgoing international calls and BT’s expanding operations overseas.

Other operating costs, which rose by 11.6% in the year, include the maintenance and support of the networks, occupancy costs and the cost of sales of customer premises equipment. The rapid expansion of Cellnet’s services has resulted in additional costs being incurred in winning new business and supporting additional customers. Higher expenditure on these cellular and other marketing activities were the main factors behind the increase in costs. A further contributor to the increase was the cost of Concert’s expanding operations.

The redundancy costs incurred as a result of the workforce reductions discussed above totalled £421 million in the year, compared with £820 million in the previous year. The lower costs reflect the fewer number of people leaving the group during the year. BT will be continuing to reduce the number of employees, but at a slower pace than in recent years.

Operating profit
Operating profit for the year of £3,100 million was £437 million higher than in the previous year. Of this increase, £399 million was attributable to the lower redundancy costs and, after adjusting for this, the group’s underlying operating profit was 1.1% higher than in the previous year.

Associates, disposals and interest charge
The group’s £82 million share of profits of associated undertakings consists primarily of the company’s share of MCI’s profits less BT’s share of start up losses in its joint ventures in Germany and Sweden. The amount is stated after taking into account BT’s £73 million share of a restructuring charge incurred by MCI in the year. MCI, in which BT has held a 20% interest since September 1994, is growing rapidly with turnover up by 14% in its last financial year.

The profit on disposal of group undertakings in the previous year arose primarily from the sale of AT&T Corporation shares which had been converted in 1994 from BT’s interest in McCaw Cellular Communications, Inc., a former associate.

The net interest charge of £170 million was £89 million or 34.4% lower than the interest charge in the previous year, after excluding the premium of £75 million incurred on repurchasing Government held bonds in that year. The lower charge was due to strong positive cash flow and the repayment of significant amounts of high coupon debt in the previous year. The net interest charge was covered 18.2 times by operating profit.

Profit and taxation
The group’s profit before taxation for the year was £3,019 million, an increase of 13.4% on the previous year. The tax charge of £1,027 million as a percentage of profit before taxation was 34.0%, compared with 34.8% for the previous year.

Earnings and dividends per share
Earnings per share, based on a profit for the financial year of £1,986 million, were 31.6 pence.

The dividends paid and recommended of 18.7 pence per share represent a 5.6% increase on the previous year and are covered 1.7 times by earnings. The dividends comprise the interim dividend of 7.45 pence per share, which was paid in February 1996, and the proposed final dividend of 11.25 pence per share which, if approved at the annual general meeting, will be paid on 16 September 1996 to shareholders on the register on 13 August 1996. The dividends absorb £1,184 million.

Financing

Tax paid in the year, principally on the prior year’s profit, amounted to £784 million. The decrease of £391 million on the previous year is mainly due to the timing of tax payments made.

Net cash outflow from investing activities of £3,156 million mainly comprises expenditure on plant, equipment and property of £2,547 million.

In the year, the group drew down £175 million in long-term loans and long-term debt repaid totalled £133 million. During the year, the group also received £130 million for new shares subscribed by employees under share option schemes.

Treasury policy and capital resources
The group has a centralised treasury operation. Its primary role is to manage liquidity, funding, investment and the group’s financial risk, including risk from volatility in exchange and interest rates and counterparty credit risk. The treasury operation is not a profit centre and the objective is to manage risk at optimum cost.

The Board sets the department’s policy and its activities are subject to a set of controls commensurate with the magnitude of investments and borrowings under its management. Counterparty credit risk is closely monitored and managed within controls set by the Board. Derivative instruments including forward foreign exchange contracts are entered into for hedging purposes only.

At 31 March 1996, the group had cash and short-term investments of £2,689 million. At that date, £13 million of short-term debt was outstanding.

The ratio of net debt (borrowings net of cash and short-term investments) to shareholders’ equity and minority interests was 7.4% at 31 March 1996, compared with 17.8% at 31 March 1995. The group had £948 million net debt at 31 March 1996, a decrease of £1,319 million in the year through cash flow.

The directors have a reasonable expectation that the group has adequate resources to continue in operational existence for the foreseeable future and therefore they continue to adopt the going concern basis in preparing the financial statements.

Capital expenditure
Capital expenditure on plant, equipment and property totalled £2,771 million in the year, £100 million higher than the amount spent in the previous year. Continued modernisation of the local access network, telephone exchanges and construction of Cellnet’s digital GSM network constituted the main areas of spend. Nearly 88% of customer lines are now served by digital exchanges and Cellnet has over 350,000 connections on the GSM network.

The group expects capital expenditure in the year ending 31 March 1997 to be at a slightly higher level than that in the year under review. BT expects that future capital expenditure will be provided from net cash inflows from operating activities supplemented, if appropriate, by external financing.

Goodwill
MCI completed a significant acquisition of an information technology business in November 1995 for approximately $1,100 million. BT’s share of goodwill arising on this acquisition is the main element of the £302 million written off to group reserves in the year, in line with BT’s accounting policies.

Return on capital employed
The group made a return of 18.3% on the average capital employed, on an historical cost basis, in its business in the year ended 31 March 1996, compared with a return of 15.6% in the previous year. The higher return is due to the lower level of redundancy costs in the year under review.

Foreign currency exposure
Most of the group’s turnover is invoiced in pounds sterling, and most of its operations and costs arise within the UK. The group’s foreign currency borrowings, which totalled £1,032 million at 31 March 1996, are used to finance its UK operations and to finance the group’s overseas investments, including MCI, in order to reduce the currency exposure on the underlying assets. Cross currency swaps have been entered into to minimise the foreign currency exposure on the borrowings used to finance the group’s operations. The group also enters into forward foreign exchange contracts to hedge interest expense, purchase and sale commitments. The commitments hedged are principally US dollars. As a result of these policies, the group’s exposure to foreign currency arises mainly on the residual currency exposure on overseas investments and on any imbalances between the value of outgoing, transit and incoming international calls with overseas telecommunication operators. To date, these imbalances have not been material. As a result, the group’s profit has not been materially affected by movements in exchange rates.

BT’s expanding overseas operations are likely to lead to a gradual increase in its foreign currency exposure in the future.

Monopolies and Mergers Commission
The Monopolies and Mergers Commission (MMC) reported during the year on the matter referred to it by Oftel relating to the responsibility for bearing the costs of number portability. The MMC decided that BT should bear a significant part, but not all, of these costs and, indeed, less of the costs than proposed by Oftel. Number portability, which has yet to be introduced on a wide scale, will make it easier for BT’s customers to switch to an alternative operator and may lead to a loss of turnover.

The MMC also reported on BT’s Yellow Pages directories business referred to it by the Office of Fair Trading, in view of its large market share in the specialised classified directory advertising industry. As a result of the report, BT’s directory advertising prices are to be controlled under an RPI minus 2 formula, similar to that on BT’s main services discussed above, and BT will be limited to publishing one directory in any one area. BT will be required to publish financial information relating to this business.