Financial analysis

Introduction

Regulation and prices

Competition

Performance

Turnover

Operating costs

Operating profit

Disposal of subsidiary companies

Interest

Profit before taxation

Taxation

Minority interests

Earnings and dividends per share

Financing

Capital resources

Capital expenditure

Return on capital employed

Early release schemes

McCaw Cellular Communications

Asset lives

Pensions

Introduction

During the year under review, BT's financial performance has been adversely affected again by the tight regulatory control of prices in the UK, strong competition and the state of the UK economy; but this has been partially offset by management's emphasis on cost control which included a reduction in the number of employees of 39,800.

The group's earnings per share in the year of 19.8 pence were 40.5% lower than in the previous year. In addition to those factors which affected the group's operating environment stated above, three specific factors which adversely affected the group's 1993 financial results were: the costs of BT's workforce reduction programme, the loss arising on the disposal of subsidiary companies and the premium paid on a repurchase of bonds held by HM Government.

The group incurred costs of £1,034 million associated with redundancies in the year, including the costs of providing incremental pension benefits to employees leaving the group which required a provision of £550 million. The group incurred net losses totalling £132 million on the disposals of its interests in Mitel Corporation and three other subsidiary companies (the divested subsidiary companies), as part of BT's strategy of concentrating on core activities. BT expensed a £56 million premium paid on the repurchase of bonds held by HM Government with a face value of £320 million. Earnings per share, excluding redundancy costs, the loss on disposal of subsidiary companies and the premium paid on repurchase of bonds, were slightly higher than in the previous year.

Regulation and prices

Under the price control arrangements agreed with HM Government and OFTEL in force from 1 August 1991 until 31 July 1993, the RPI minus 4.5 formula was changed to RPI minus 6.25 and was also extended to cover international telephone calls made from the UK. Since the RPI increased by less than 6.25 percentage points in each of the twelve month periods to 30 June 1991 and 1992, the company has been required to lower its overall prices for its main UK services accordingly. In addition, the group may not increase its prices for most UK private circuits and international private circuits by more than the increase in the RPI. These price controls are estimated to have affected about 65% of the group's total turnover for the year.

Prices on the majority of calls to North America were reduced in January 1993. At the same time the company increased exchange line rental charges by an average of 5.8%, in accordance with its policy of making charges more closely reflect the costs of providing services. The group also introduced improved volume discounts on call charges. The effect of these changes was an overallreduction in the prices of the company's main services of 0.1%. In order to comply with the RPI minus 6.25 formula, BT will be lowering overall prices by another 0.85% before the end of July 1993. The group raised its private circuit prices, under the separate price control arrangements, by 1.7% in January 1993.

Competition

Competition continues to increase in all major areas of BT's business. BT believes that it had the following estimated market shares in the year:

Performance

The group's recent financial performance should also be considered in the context of a UK economy which had been in recession for around two years. Overall demand for the group's services began to improve slightly in the second quarter of the year and this slight improvement continued for the remainder of the year.
The regulatory regime, competition and the state of the UK economy will continue to be important for the group's financial performance in the future. The group has initiated marketing programmes to stem the loss of market share and continues to seek further operational improvements, through modernisation of the network and firm control of costs. In particular, BT expects to make reductions in the number of employees of around 15,000 in each of the next two financial years.

Turnover

Total turnover fell 0.7% to £13,242 million in the year. The decline was due primarily to the disposal of subsidiary companies early in the year. Turnover, excluding that attributable to the divested subsidiary companies, increased by 1.0%.

Inland telephone call revenues have been static for the last three financial years and there was no volume growth in the year ended 31 March 1993.
International telephone call revenues were also static in the year. International call volume growth of 6% was attributable in part to an increase in outgoing calls and in transit traffic through the UK. Call volume growth and the weakening of the pound sterling against other major currencies each had a beneficial effect on revenues, but were broadly offset by price reductions on outgoing calls and on some incoming calls. The weakening of the pound led to an offsetting increase in costs (see below).
Revenue from telephone exchange line rentals increased by 5.5% in the year. As part of BT's policy of rebalancing prices, telephone exchange line rental charges were increased by around 6% in January 1993 following an increase of around 8% in September 1991. The increased revenues in the year were the result of these price increases and, to a lesser extent, the growth in the UK telephone network. Total exchange line connections grew by 1.9% in the year, of which business and residential exchange line connections grew by 1.8% and 2.0%, respectively.
Revenues from the supply of customer premises equipment declined 18.1% in the year, with a substantial part of the decline due to the disposal of Mitel.
Revenues from other sales and services increased by 0.8%. This increase was primarily due to growth in revenues from private circuits and mobile communications, including Cellnet, partially offset by the effect of the divested subsidiary companies.

Operating costs

Operating costs increased by 8.8% in the year. The £871 million increase was predominantly the result of the £1,034 million charge for redundancy costs, which was partially offset by the reductions in costs caused by the disposal of subsidiary companies and reductions in the numbers of employees.

The group's programme of improving operating efficiency led to a reduction of 39,800 people employed in the year. The reduction included 5,400 people employed by the divested subsidiary companies. The remainder, mainly under voluntary early release schemes providing special termination benefits, was spread throughout the group. The number of people employed at 31 March 1993 was about 30% lower than the number of people employed in March 1990 when the group announced its restructuring. The reduction in people employed was the primary reason for the 8.1% fall in staff costs in the year.

The depreciation charge rose by 2.9% in the year, a smaller increase in the year compared to recent years.

Payments to telecommunication operators, both overseas and other UK companies, grew by 7.1% to £1,020 million in the year. This reflected the growth in international traffic and in competing UK networks, compounded by the weakness of sterling against other major currencies but partially offset by reduced prices.
Redundancy costs, incurred as a result of the workforce reductions discussed above, totalled £1,167 million in the year, of which £133 million, relating to managers and other professional people, was charged against the group restructuring provision established in 1990, thereby fully utilising it, and the remaining £1,034 million was charged as redundancy costs. The amount charged against profit included the cost of providing incremental pension benefits for early retirements, which amounted to £550 million.

Other operating costs, which fell by 1.9%, include the maintenance and support of the networks, occupancy costs and the cost of customer premises equipment sold and rented. Other operating costs, excluding the effect of the divested subsidiary companies, increased by 1.3% in the year.

Operating profit

Operating profit for the year of £2,449 million was £966 million (28.3%) lower than in the previous year. £33 million was allocated to the employee share ownership scheme.

Disposal of subsidiary companies

A net loss of £132 million in the year arose from the disposal of the group's interests in the divested subsidiary companies. These subsidiary companies had a negligible effect on the group's operating profit and cash flows in both the years ended 31 March 1992 and 1993 and their net assets were immaterial to the group's financial position. The loss included goodwill of £127 million which had been written off to retained earnings in prior years.

Interest

Interest payable for the year declined by £55 million to £507 million. The decline reflected substantially a reduction in long term debt.
The group expensed in the year a premium of £56 million paid on the repurchase of bonds, carrying a high rate of interest, held by HM Government. The group paid £376 million for the bonds, with a total face value of £320 million, when HM Government auctioned off a portion of its portfolio of privatised companies' bonds and loan stock in December 1992.

The interest charge, after deducting interest income, was covered 9.6 times by operating profit, compared with 11.2 times in the previous year.

Profit before taxation

The group's profit before taxation for the year was £1,972 million compared with £3,073 million in the previous year.

Taxation

The tax charge for the year of £724 million compares with £999 million for the previous year. Tax as a percentage of profit before taxation was 36.7%, compared to 32.5%

for the previous year. The difference between the year's higher effective tax rate and the statutory tax rate of 33% was primarily due to the loss on disposal of subsidiary companies and the premium paid on the repurchase of bonds held by HM Government, neither of which is deductible for tax purposes.

Minority interests

The minority interests for the year of £28 million largely comprised the outside interest in the profit after taxation of the Cellnet subsidiaries.

Earnings and dividends per share

Earnings per share, based on a profit attributable to shareholders of 91,220 million, were 19.8 pence.

The dividends paid and recommended of 15.6 pence per share represent an 8.3% increase on the previous year and are covered 1.3 times by earnings. The dividends comprise the interim dividend of 6.15 pence per share, which was paid in February 1993, and the proposed final dividend of 9.45 pence per share which, if approved at the annual general meeting, will be paid on 30 September 1993 to shareholders on the register on 1 September. The dividends absorb £967 million.

The retained profit for the year of £253 million is transferred to reserves.

Financing

Net cash inflow from operating activities in the year amounted to £5,127 million, compared with 25,710 million in the previous year. The £583 million decrease was largely due to increased redundancy payments as a result of the significant workforce reductions in the period.

Net cash outflow from investing activities in the year amounted to X1,756 million, down from £2,938 million in the previous year. The decrease was the result of net realisations of short term investments and lower capital expenditures. BT views its short term investments as funds available for use in the group.
Debt repaid in the year of £1,070 million included the repurchase of bonds held by HM Government with a face value of £320 million.

Capital resources

At 31 March 1993, the group had cash and short term investments of £1,966 million. At that date, £145 million of short term debt was outstanding.

In addition, substantial unutilised committed and uncommitted short term bank facilities were available to the group.

The ratio of net debt (borrowings net of cash at bank and in hand and short term investments) to ordinary shareholders' equity and minority interests was 14.3% at 31 March 1993, compared with 21.1% at 31 March 1992, primarily reflecting the reduction of £743 million in net debt to £1,762 million at the end of the year.

Capital expenditure

Capital expenditure on property, plant and equipment totalled £2,155 million in the year, in comparison with £2,446 million in the previous year.

Expenditure on transmission equipment fell by £338 million to 2835 million. This expenditure was mainly on the continuing renewal, modernisation and expansion of the transmission network. Expenditure on telephone exchanges declined to £545 million, down from £722 million in the previous year. These lower expenditures reflect the advancement of the group's current modernisation programme.

Expenditure on motor vehicles and other assets rose by £141 million to £272 million in the year, largely as a result of a programme to upgrade BT's van and car fleet.

Return on capital employed

The group made a return of 13.6% on the average capital employed in its business in the year ended 31 March 1993, compared with 19.3% in the previous year.
The reduced return was caused by the redundancy charges in the year.

Early release schemes

The group expects to reduce the number of employees by around 15,000 during each of the next two financial years. The group estimates that its voluntary early release scheme in the year ending 31 March 1994 will cost around £500 million, which includes the cost of providing incremental pension benefits for early retirement, estimated at around £250 million.

McCaw Cellular Communications

In November 1992, BT announced a provisional agreement for the sale of its interest in McCaw to American Telephone and Telegraph Company (AT&T). The sale is dependent on transactions between McCaw and AT&T and the resolution of a number of legal, regulatory and other issues in the US, and there are no assurances that the negotiating parties will reach a final agreement. Under the terms of the provisional agreement, the group would realise about $1.8 billion from the sale of its investment at $49 per share, an amount which increases at the rate of 4.5% per annum from 31 December 1992 until the earlier of 30 September 1993 or the closing date. The group will not recognise any gain, expected to be in excess of £250 million, before tax, until after the sale is completed.

Asset lives

As part of its ongoing review of asset lives and, in the light of developing technology and the increasingly competitive environment, BT has decided to make three important changes in the estimated useful lives over which it will depreciate its assets from 1 April 1993.

At present, digital exchanges with a net book value of £3,217 million are depreciated over 10 years. This period will be lengthened to 11 years for trunk exchanges and to 13 years for local digital exchanges, reflecting the proven nature of this technology. BT's underground ducts, carrying its cables, with a net book value of £2,536 million, are currently depreciated over 45 or 60 year periods. Although they are expected to have physical lives of at least these periods, BT recognises the uncertainty caused by the changing technological and competitive environment and, as a measure of prudence, has decided to, reduce the period over which ducts are depreciated to 25 years. The estimated useful lives of small and medium computers, together with their ancillary equipment, with a net book value of £295 million, will be reduced by one year to three or four years in response to the rapid technological changes in computing.

The combined effect of these and other less significant changes will cause a fall of £40 million in the depreciation charge for the year ending 31 March 1994. In each of the following two financial years, the changes are expected to reduce the annual depreciation charge by some £100 million, with smaller effects thereafter.

Pensions

The group's two main pension funds were merged on 1 January 1993 without affecting members' benefit entitlements. BT has received recently the results of the actuarial valuation of the merged scheme as at that date, made for the purposes of determining the future pension charges in the accounts of the group. These results revealed the scheme to be in deficit to an amount of approximately£750 million, with assets of the fund at £13,440 million covering 95 percent of the fund's liabilities, in contrast to an asset coverage of 109 per cent at 31 March 1992. The decline in asset coverage has been caused by a combination of three principal factors: the cost of providing incremental pension benefits to the early leavers in the period, the impact of recession on the returns achieved on the funds' investments and the consequences of HM Government's proposed advance corporation tax measures on future gross dividend income announced in its March 1993 Budget.

In view of the pension fund deficit, the cost of £550 million relating to the incremental pension benefits for early leavers has been charged against profit in the year, as noted above.

From 1 April 1993, the annual pension charge based on the January 1993 valuation will increase by approximately £90 million to around £250 million. This amount excludes the cost of providing incremental pension benefits for early leavers, and it is expected that, for the year ending 31 March 1994, this cost, estimated at £250 million, will be charged against profit in the period in which people leave.

The company has resumed payment of contributions in respect of all active members of the pension fund from 1 April 1993. In addition, the company intends to make a contribution to the pension fund of £800 million in the year ending 31 March 1994.

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