Report of operations and financial review

Operating performance
The 2004 financial year was marked by the continuing transformation of our business operations and markets, where the pace of change is accelerating. We are driving the change by providing our customers with new technology and services with greater capabilities and lower cost. The focus on delivering the strategy continued and the group’s performance benefited from the growth in new wave activities such as Information and Communications Technology (ICT) solutions, broadband, mobility and managed services and continued cost efficiency programmes.

Profit and loss account
Group turnover from new wave businesses showed strong growth of 30% to £3.4 billion in the year driven by growth in ICT solutions and broadband. Turnover from our traditional business was impacted by regulatory reductions in mobile termination rates. These reductions are passed on to BT customers resulting in lower charges but are profit neutral and contributed to the decline in traditional turnover of 6% to £15.1 billion. Group turnover of £18.5 billion declined by 1%, but was flat after excluding the impact of the regulatory reductions in mobile termination rates. Group operating profit before goodwill amortisation and exceptional items increased by 4% to £2.9 billion. This reflects cost efficiency savings achieved during the year, the improved performance of BT Global Services and lower leaver costs. Our share of operating results in our ventures declined following the sale of our interest in Cegetel in January 2003. Net interest payable before exceptional items was £0.9 billion for the year, an improvement of £0.3 billion, reflecting the reduction in net debt. Earnings per share before goodwill amortisation and exceptional items were 16.9 pence, an increase of 19%.

Lines of business
The following table sets out the group turnover and group operating profit (loss) for each of our lines of business.

BT Retail
BT Retail is the UK’s largest communications service provider, by market share, to the residential and business markets, supplying over 20 million customers with a wide range of communications products and services, including voice, data, internet and multimedia services, and offering a comprehensive range of managed and packaged communications solutions.

The total number of BT Retail lines, including voice, digital and broadband was more than 29 million at 31 March 2004.

The BT Together pricing packages had around nine million customers as at 31 March 2004. During the year we announced that we will be abolishing the standard rate for residential customers from 1 July 2004. Existing standard rate customers will move to join those already on BT Together Option 1.

At 31 March 2004, BT Retail had 928,000 broadband customers, an increase of 116% over the previous year.

During the financial year, BT and Yahoo! relaunched the Openworld consumer internet service as BT Yahoo! Broadband, and rebranded our business broadband products and information portal.

BT Business Broadband remained the leading internet service provider for SMEs (companies with between one and 500 employees) in the UK with more than 240,000 business customers.

At 31 March 2004, our BT Local Business initiative to build closer relationships with smaller business customers was active in 73 locations around the country and managing £1.1 billion of annual billed turnover.

BT Wholesale
BT Wholesale provides network services and solutions to around 500 communications companies, fixed and mobile network operators and service providers. Its UK network consists of 873 local and trunk processor units, 121.7 million kilometres of copper wire and 7.3 million kilometres of optical fibre. BT Wholesale has the most extensive IP backbone network in the UK.

As at 31 March 2004, BT Wholesale’s installed base of broadband lines was 2.2 million – up 177% on the previous year – and we were taking an average of 50,000 orders a week in March 2004. 2,465 exchanges had been upgraded for broadband at the end of the 2004 financial year, and more than 85% of the UK’s homes and businesses were connected to a broadband-enabled exchange. In May 2004, the number of broadband lines increased to 2.45 million, 2,652 exchanges had been upgraded and total UK coverage reached 90%.

As one of our strategic priorities, BT Wholesale is working to create an intelligent, flexible and customer-focused network for the 21st century (21CN). BT’s 21CN is designed to support the next generation of services and revenues for BT and for our wholesale customers, while enhancing the customer experience and reducing costs through greater network intelligence and automation.

BT Global Services
BT Global Services is BT’s managed services and solutions provider. Its core target market is the top 10,000 multi-site corporations and European multi-site organisations. BT Global Services provides global reach and a complete range of ICT solutions and services.

Our extensive communications network and strong strategic partnerships enable us to serve customers in the key commercial centres of Europe, North America and the Asia Pacific region. In Europe, this network links more than 270 towns and cities in 19 countries back into our UK network, and beyond into the Americas and the Asia Pacific region.

Our larger, and more complex and global customer contracts are delivered through or managed by our BT Global Solutions and BT Syntegra businesses, which between them won business worth more than £7 billion during the year. The highest profile contracts in the year were three NHS contracts, which are expected to be worth more than £2.1 billion.

Research and development and IT support
BT Exact is BT’s research, technology and IT operations business, with a team of 6,000 technologists and one of the world’s largest communications research and development facilities. The work done by BT Exact is part of our investment of £334 million in research and development made by BT in the 2004 financial year.

Balance sheet
The group balance sheet continued to strengthen during the year and provides confidence to our customers and suppliers. Net debt of £8.4 billion declined by a further £1.2 billion and is now 30% of the level it was three years ago. Fixed assets totalled £16.1 billion, of which £15.5 billion were tangible fixed assets, principally the UK fixed network. The return on capital employed, before goodwill amortisation and exceptional items on the average capital employed, was 15.3%.

Cash flow
Cash inflow from operating activities was £5.4 billion and includes early payment of £0.4 billion deficiency contributions to the BT Pension Scheme, which represents most of the deficiency contributions for the 2005 and 2006 financial years. Capital expenditure of £2.7 billion increased by 4%, reflecting the rising investment in our network transformation programme. Free cash flow (before acquisitions, disposals and dividends) of £2.1 billion was generated, an increase of 21%.

Dividend
The Board recommends a final dividend of 5.3 pence per share to shareholders, amounting to £454 million, taking the full year dividend to 8.5 pence per share, an increase of 31% on the previous year. This year’s dividend pay out ratio is 50% of earnings before goodwill amortisation and exceptional items and we expect this to increase to around 60% for the 2006 financial year.

Customer satisfaction
Customer satisfaction is at the heart of our strategy. During the 2004 financial year we reduced customer dissatisfaction by 22% following an improvement of 37% in the 2003 financial year.

Our people
As at 31 March 2004, we employed 99,900 people throughout the world, of whom around 91,600 worked in the UK. During the financial year, we invested more than £61 million on the training and development of our workforce, and we have achieved a 40% reduction in workplace injuries over three years.

For the 2004 financial year, we allocated £20 million to provide free shares to our employees under the BT Employee Share Investment Plan (employees outside the UK receive a cash payment equivalent to the value of the shares). The amount allocated was linked to corporate performance measures determined by the Board.

Corporate social responsibility
We aim to manage social, ethical and environmental issues in ways that grow shareholder value and help promote sustainable development. For the 2004 financial year, BT was ranked as the top telecommunications company in the Dow Jones Sustainability Index for the third year running. We commit a minimum of 0.5% of our UK pre-tax profits to direct activities in support of society. Our contribution in the 2004 financial year was £5.6 million, including £1.2 million to charities.

More details of our social and environmental performance are available at www.bt.com/betterworld

Statement of business practice
BT’s policy is to achieve best practice in our standards of business integrity in all our operations, in line with our published statement of business practice – The Way We Work, which is available from the company’s website.

Going concern
The company’s financial statements for the year ended 31 March 2004 have been prepared on a going concern basis as, after making appropriate enquiries, the directors have a reasonable expectation that the group has adequate resources to continue in operational existence for the foreseeable future.