Pennon Group Annual Report 2005

FY2005 Annual Report · Pennon Group

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ANNUAL REPORT & ACCOUNTS
AND NOTICE OF ANNUAL GENERAL MEETING
2005

PENNON GROUP PLC OPERATES AND INVESTS IN THE
AREAS OF WATER AND SEWERAGE SERVICES AND WASTE
MANAGEMENT. IT HAS ASSETS OF £2.7 BILLION AND
EMPLOYS AROUND 2,600 PEOPLE.

There are two main subsidiaries – South West Water Limited and Viridor Waste Limited.

South West Water Limited holds the water and sewerage appointments for Devon,

Cornwall and parts of Dorset and Somerset.

Viridor Waste Limited is one of the leading waste treatment and disposal businesses in

the United Kingdom.

HIGHLIGHTS OF THE YEAR

Turnover up 17.6% to £554.2 million

Operating profit up 9.1% to £151.5 million*

Profit before tax up 10.9% to £87.4 million*

Earnings per share up 9.4% to 63.1p**

Dividend per share up 4.9% to 43.0p

* Before net exceptional items in 2004/05 of £0.1 million (income of £5.0 million less costs of £4.9 million; 2003/04 cost £6.5 million)

** Before deferred tax and exceptional items. Basic earnings per share are 54.6p.

CONTENTS

Chairman’s statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

Business review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4

Operating and financial review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Board of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37

Directors’ remuneration report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38

Corporate governance and internal control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45

Report of the Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

Independent auditors’ report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50

Financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51

International Financial Reporting Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86

Five year financial summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .89

Notice of Annual General Meeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .90

Shareholder information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .96

CHAIRMAN’S STATEMENT

Ken Harvey – Chairman – Pennon Group Plc

THE GROUP HAS DELIVERED EXCELLENT RESULTS THIS
YEAR. THEY DEMONSTRATE FURTHER PROFITABLE
GROWTH AND AFFIRM OUR STRATEGY OF FOCUSING ON
OUR TWO KEY BUSINESSES, SOUTH WEST WATER LIMITED
AND VIRIDOR WASTE LIMITED.

FINANCIAL OVERVIEW

Group turnover rose by 17.6% to £554.2 million, due
mainly to increased revenue generated by the Ofwat
approved tariff increases in South West Water and from
another year of strong trading by Viridor Waste.

Before exceptional items and goodwill, operating profit
increased by 9.1% to £151.5 million, profit before tax
increased by 10.9% to £87.4 million and earnings per share
(before deferred tax) saw an increase of 9.4% to 63.1p.

The Directors are recommending a final dividend of 29.2p
per share, a 5.0% increase in line with the Board’s
previously stated progressive dividend policy. Together
with the interim dividend of 13.8p, this will result in a
total dividend for the year of 43.0p, a 4.9% increase on
the total dividend for the previous year.

As confirmed at the time of the Group’s interim results in
December 2004, the Board intends to continue to
increase the Group dividend in real terms, at least up to
2009/10 and following its successful re-introduction two
years ago, the Board also intends to offer shareholders a
scrip dividend alternative.

SOUTH WEST WATER LIMITED

The year was dominated by the final stages of the Periodic
Review process
for the period 2005-2010. This
culminated in Ofwat confirming average price increases
of around 25% in real terms over the five year period.

A great deal of time, energy and expertise was devoted to
the whole Review process throughout which South West
Water endeavoured to strike the right balance between
value for money investment, financeability and customer
affordability. This was achieved against a backdrop of
acknowledging that further price
increases were
inevitable in order that the company would be able to
meet Governmental and regulatory requirements.

The Final Determination represents another very tough
challenge for South West Water, but the company has
already instigated a number of restructuring and
organisational initiatives aimed at delivering the
demanding efficiency targets imposed.

During the year, South West Water continued to provide
high levels of product and customer service whilst the
successful delivery of its environmental enhancement
programme continued to ensure the region is able to
boast some of Europe’s finest bathing waters, beaches
and rivers.

Excellent progress was also made in the area of water
mains rehabilitation where the company’s enhanced
programme delivered record lengths of renovated
water mains.

Another creditable success during the year was South
West Water’s progress within the 2003/04 Ofwat ‘Overall
Performance Assessment’, which saw the company
achieve one of the best performance improvements of all
the sector companies.

VIRIDOR WASTE LIMITED

Viridor Waste delivered strong financial performance
during the year with turnover showing a 35.6% increase
and operating profit before goodwill a 31.3% increase.

Since 2000/01, operating profit before goodwill has
grown at a compound rate of 22.8% per annum, with
approximately 12% from organic income streams and the
remainder via acquisitions.

The previous year’s acquisition, Churngold Holdings
Limited, has been fully integrated into the business and
was earnings enhancing after goodwill amortisation one
year earlier than predicted at acquisition.

Pennon Group Plc

Thames Waste Management Limited was acquired in April
2004 and this too has been fully integrated into the
business and is performing well ahead of forecasts. Both
acquisitions reinforced Viridor Waste’s stated strategy of
capitalising on its strong position in the landfill waste
disposal market, exploiting opportunities in renewable
energy from landfill gas and pursuing profitable
opportunities in line with the Government’s developing
waste strategy.

In addition to its existing activities, Viridor Waste is
developing a range of new technologies at various
locations throughout the UK in anticipation of the
importance of technology as councils endeavour to meet
their European Landfill Directive targets via the diversion
of an increasing proportion of municipal waste from
landfill sites.

STRATEGY AND PROSPECTS

The Board’s priority continues to be the creation of
shareholder value via its strategic focus on water and
sewerage services and waste management. The Group
financial results for the year are testament to the Board’s
strategy of focusing on these key business areas and
underpin its resolve to continue its existing progressive
dividend policy of increasing the Group dividend in real
terms until at least 2009/10.

The Board is confident that South West Water will
successfully deliver the regulatory challenges imposed
for the K4 period – 2005-2010 and significantly increase
its regulatory asset value up to 2010. Viridor Waste’s
successful philosophy of creating long-term sustainable
profit growth is expected to continue as it pursues its
previously stated strategy.

BEST PRACTICE

The Pennon Group prides itself in being in the vanguard
of change, especially in the areas of innovation and best
practice. Indeed, the Group has received many accolades
for various elements of its business including its ‘green’
credentials, its progress in the area of corporate
responsibility and financial reporting.

For financial years beginning 1 April 2005, Directors of
UK quoted companies are required to provide an
Operating and Financial Review (OFR) in their Annual
Reports. Whilst Pennon is not required to provide an OFR
in this Annual Report, it has decided to provide further
information about the Group and its business in an OFR
format. The aim is to achieve the principal objectives of
the OFR which are designed to assist investors in
assessing the strategies adopted by the Company and the
potential for those strategies to be achieved.

The OFR reporting standards have been confirmed only
very recently. Whilst the Company has endeavoured to
take them into account, the OFR produced for this Annual
Report, although being comprehensive, will not be
totally compliant with the full reporting standards.

Preparations for the adoption of International Financial
Reporting Standards (IFRS) are well underway. These
come into effect from 1 April 2005 and the principal
differences between the previous UK and international
accounting standards likely to impact on the Group are
detailed on pages 86 to 88.

EMPLOYEES

Throughout the many structural and organisational
changes that have taken place within the Group over the
years, our employees have adapted to change, adopted
new working practices and philosophies and have always
performed superbly to ensure the Group remains
profitable, successful and a leading player in its sector. I
thank them and my fellow Directors most sincerely for
their unstinting support and loyalty which has helped the
Group achieve its goals yet again.

KEN HARVEY, Chairman, Pennon Group Plc
23 June 2005

Pennon Group Plc

BUSINESS REVIEW

Bob Baty – Chief Executive – South West Water Limited

IN A YEAR DOMINATED BY THE FINAL STAGES OF THE
PERIODIC REVIEW PROCESS FOR THE PERIOD 2005 – 2010,
SOUTH WEST WATER CONTINUED TO DELIVER EXCELLENT
FINANCIAL PERFORMANCE, FIRST CLASS LEVELS OF
PRODUCT AND CUSTOMER SERVICE AND OUTPERFORMED
CHALLENGING REGULATORY TARGETS.

SOUTH WEST WATER LIMITED

The company’s turnover increased by 6.2% from £291.8
million to £309.8 million with Ofwat approved tariff
increases accounting for £21.2 million of the increase
together with 7,300 new customer connections and
incremental commercial sales. 25,400 customers
switched from an unmeasured to a measured charging
basis offsetting the turnover increase by £6.3 million.

South West Water’s operating profit increased by £2.8
million to £121.7 million before the exceptional
restructuring charge of £3.4 million. Operating costs
increased by £15.2 million to £188.1 million including
£5.7 million for the operation of new capital schemes,
inflation of £4.4 million and £9.2 million of other costs
mainly pensions, direct cost of sales and bad debts. These
costs were offset by efficiency savings of £4.1 million.

An ongoing programme of restructuring and continuous
improvement in order to reduce significantly overhead
and operating costs is in progress. The company, which
has an excellent track record in this area, has since 1995
reduced base costs by £50.1 million.

In line with regulatory requirements, capital expenditure
remained at virtually the same level as the previous year
at £141.9 million. £66.1 million was invested in water
supply improvements, including water mains renovation,
water treatment works enhancement and leakage
control. Ofwat’s latest report on leakage noted that South
West Water continues to be one of the leading companies
in managing water leakage and continues to deliver
results in line with the regulatory leakage target. Over
600 kilometres of water mains were laid, replaced or
refurbished during the year, a major increase on the
previous year. Drinking water quality is at an all time high
and the region features the highest proportion of high
quality rivers in England.

Pennon Group Plc

In December 2004, Ofwat announced
its Final
Determination on price level increases for the period
2005 – 2010, which confirmed average price increases of
around 25% in real terms over the five year period.
Throughout the Periodic Review process, South West
Water endeavoured to strike the right balance between
value for money investment, financeability and customer
affordability whilst acknowledging that further price
increases were inevitable in order that the company
would be able to meet the Governmental and regulatory
demands.

The Determination represents a very tough challenge for
the company, but one it has accepted and will overcome.
It has already implemented a number of reorganisational
and restructuring initiatives in order to attain the
demanding efficiency targets imposed, including a
manpower reduction programme which will see employee
levels reduced by 100 over the period.

Waste water investment expenditure totalled £75.8
million for the year. Commissioning of the Ilsham Valley
Pumping Station in Torbay commenced in early April
2004 and its operation signalled the completion of the
final major project in the company’s 15 year original
‘Clean Sweep’ coastal sewage treatment improvement
programme. ‘Clean Sweep’ has transformed the coastal
environment around the South West and 81% of the
region’s bathing waters now meet the stringent EU
guideline standards and 98% of bathing waters conform
with EU mandatory standards. These quality achieve-
ments are amongst the very best in the UK.

The successful delivery of both coastal water and river
water quality improvement programmes has been a
pivotal factor in the region’s attainment of higher levels
of environmental enhancement in support of economic
prosperity.

the 2003/04 Ofwat

A further measure of the company’s success has been its
progress within
‘Overall
Performance Assessment’ which has seen South West
largest performance
Water achieve one of the
improvements during the year as capital expenditure,
previously constrained in a range of business areas whilst
the coastal clean-up was delivered, is now being invested
in other areas.

Pennon Group Plc

BUSINESS REVIEW

Colin Drummond – Chief Executive – Viridor Waste Limited

VIRIDOR WASTE DELIVERED FURTHER STRONG GROWTH
BOTH ORGANICALLY AND BY ACQUISITION.

VIRIDOR WASTE LIMITED

Viridor Waste made continued excellent progress with
its focused strategy of:

– capitalising on its strong position in landfill
waste disposal

– exploiting opportunities in landfill gas power
generation in line with the Government‘s target of
increasing the proportion of electricity generated
from renewable sources

– pursuing profitable opportunities arising from the
Government‘s developing waste strategy.

Financial results for the year were particularly strong.
Turnover at £248.3 million increased by 35.6% on the
previous year. Operating profit before goodwill at £29.8
million increased by 31.3% driven by good performance
from the underlying landfill, power generation and
collection businesses and the positive impact of the
Thames Waste Management Limited acquisition. Since
2000/01 operating profit before goodwill has grown at a
compound rate of 22.8% per annum, of which around
12% has been organic, with the rest being achieved
through acquisitions. Profit before tax in the year at
£18.0 million increased by 22.4% on the previous year.
This financial performance reflects the success of Viridor
Waste’s focused strategy.

The previous year’s acquisition, Churngold Holdings
Limited – now renamed Viridor Waste (Bristol Holdings)
Limited – has been fully integrated into the business and
was earnings enhancing after goodwill amortisation, one
year ahead of forecast at the time of acquisition.

In April 2004, Viridor Waste acquired Thames Waste
Management – now renamed Viridor Waste (Thames)
Limited – for £30.8 million. This company comprised one
operational landfill of four million cubic metres of
consented void strategically located within the M25
motorway near Sutton, Surrey, 5 megawatts (MW) of
landfill gas power generation capacity and four liquid
treatment facilities together with an associated tanker
fleet. This acquisition also included a contract to handle
the disposal of Thames Water’s sewage sludge. Since
acquisition, it has won a similar contract with Southern
Water. This acquisition has also now been fully integrated
into the business and was earnings enhancing after
integration costs and goodwill amortisation, one year
ahead of forecast.

During the year Viridor Waste gained planning approval
for an additional 3 million cubic metres of void, along
with associated recycling and composting at its strategic
landfill at Heathfield in Devon. After taking account of
this and usage of 5 million cubic metres plus other minor
gains and losses, Viridor Waste’s consented void was 80
million cubic metres at 31 March 2005.

Pennon Group Plc

Landfill inputs excluding cover were 4 million tonnes
including Thames Waste Management. (Excluding the
effect of the Thames Waste Management acquisition,
volumes on a like-for-like basis increased 2% on the
previous year). Revenues per tonne were 10% up. In July
2004, the disposal of various types of hazardous waste to
non-hazardous landfills was banned which resulted in
particularly strong landfill volumes and prices in the first
half of the year in advance of the ban.

During the year, Viridor Waste brought a further 7MW of
landfill gas power generation on stream in line with its
policy of exploiting its landfill gas for generation of
electricity and benefiting from premium prices under the
Government’s system of renewable obligation certificates
(ROCs). This brings the company’s total capacity
(excluding a small amount handled by third party
subcontractors) to 52MW compared with 28MW in 2002
the ROCs scheme.
before
Approximately 56% of this capacity benefits from ROCs.

introduction of

the

During the year, the Government, as part of its
developing waste strategy, announced specific targets
for the diversion of municipal waste from landfill in the
period up to 2020, along with a system of penalties for
councils who fail to meet their targets. These targets flow
from the European Landfill Directive. There are no
specific targets for other waste streams such as
industrial, commercial and construction/demolition
waste which account for roughly two thirds of the landfill
market. This may be expected to lead to a decline in the
total volumes of waste going to landfill in the long-term.
However, with only around six years consented landfill
capacity in the UK (according to Environment Agency
estimates), and with new consents becoming increasingly
difficult to obtain, Viridor Waste’s 80 million cubic metres
of consented void are expected to become an increasingly
valuable resource.

At the same time, municipal landfill diversion creates new
opportunities as councils seek to let long-term integrated
waste management contracts in order to meet their
diversion targets and avoid penalties. These contracts
will often attract Private Finance Initiative (PFI) funding.
Viridor Waste believes there may be significant
opportunities in these contracts, subject to a fair sharing
of risk between councils and contractors and is pursuing
them in a selective manner. During the year, the company
commenced its first such contract with West Sussex
County Council and it has performed well.

Viridor Waste is also exploring a range of new
technologies with Government financial assistance
(DEFRA/London Recycling Fund), in partnership with its
council customers. It has opened in-vessel composting
plants at Heathfield (Devon) and Beddington (Surrey)
whilst others are under construction at Lackford (Suffolk)
and Broadpath (Devon). The company has also gained
planning permission and financial assistance from the
London Recycling Fund for a mechanical/biological
treatment plant at its Beddington landfill. Such
technologies are likely to become more important as
councils strive to meet their diversion targets.

Viridor Waste sees sustainability as key to its overall
business and sets great store by its environmental and
social policies. These will be covered more fully in
Pennon’s annual corporate responsibility report. Viridor
Waste is pleased to report that it gained ISO 14001
accreditation at a further two centres during the year,
bringing the site accreditation total to 35 centres
covering 100 operational sites.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

THE PENNON BOARD’S PRIORITY IS THE CREATION OF SHAREHOLDER
VALUE THROUGH ITS STRATEGIC FOCUS ON WATER AND SEWERAGE
SERVICES AND WASTE MANAGEMENT.

CONTENTS

Introduction

Overview and strategy

Dividend policy

South West Water regulatory & competitive environment

Viridor Waste regulatory & competitive environment

Customer/supplier relationships

Technological changes

Key performance indicators (KPIs)

Corporate responsibility

Current performance and future development

Resources

Risks and uncertainties

Relationships

Financial position

Interpretation

Glossary

Pennon Group Plc

INTRODUCTION

For financial years beginning on or after 1 April 2005,
directors of quoted companies are required to provide an
Operating and Financial Review (OFR) in their Annual
Reports in accordance with the requirements of the
Companies Act 1985 (Operating and Financial Review and
Directors’ Report etc.) Regulations 2005. Whilst Pennon
Group is not required to provide an OFR in this Annual
Report, it has decided to provide further information about
the Group and its businesses in an OFR format with a view
to achieving the principal objectives of the OFR which are
to assist investors to assess the strategies adopted by the
Company and the potential for those strategies to succeed.

The Accounting Standards Board (ASB) is the body
appointed by the Secretary of State to provide a
statement of standard reporting practice which relates to
OFRs. The ASB has only recently produced a reporting
standard in relation to OFRs and, whilst the Company has
sought to take into account the requirements of the
reporting standard, the Directors have not drafted this
OFR with a view to it being compliant with the reporting
standard. The Company will produce an OFR in its 2006
Annual Report which is compliant with the requirements
of the reporting standard.

Certain terms used throughout this OFR are explained/
defined in the Interpretation section on page 35 and in the
Glossary section on page 36.

Forward looking statements

This OFR contains forward looking statements regarding
the financial position, results of operations, cash flows,
dividends,
financing plans, business strategies,
operating efficiencies, capital and other expenditures,
competitive positions, growth opportunities, plans and
objectives of management and other matters. These
including, without
forward

looking statements,

limitation, those relating to the future business
prospects, revenues, working capital, liquidity, capital
needs, interest costs and income in relation to the
Pennon Group and its subsidiaries, wherever they occur in
this OFR, are necessarily based on assumptions reflecting
the views of Pennon Group and its subsidiary companies,
as appropriate. They involve a number of risks and
uncertainties that could cause actual results to differ
materially from those suggested by the forward looking
statements. Such forward looking statements should,
therefore, be considered in light of relevant factors,
including those set out in the section entitled ‘Risks and
uncertainties’ on page 23.

OVERVIEW AND STRATEGY

Pennon Group

Pennon Group Plc (Pennon Group) operates and invests in
the areas of water and sewerage services and waste
management. It has assets of £2.7 billion and employs
around 2,600 people. It has two main subsidiaries –
South West Water Limited (South West Water) and Viridor
Waste Limited (Viridor Waste).

The Board’s priority, as set out in its Mission Statement, is
the creation of shareholder value through its strategic
focus on water and sewerage services and waste
management. It aims to be a pre-eminent operator in
these business areas to ensure the hallmarks of quality,
efficiency and reliability which will help to meet the three
key goals of:

– Satisfying Customers

– Enhancing the Environment

– Adding value for Shareholders, Employees

and the Regional Community.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

South West Water

South West Water is the licensed water and sewerage
service provider for Devon, Cornwall and parts of Dorset
and Somerset. It serves a region of nearly 10,300 square
kilometres with 1.6 million residents and around eight
million annual visitors. It supplies over 455 million litres
of treated water per day through 15,000 kilometres of
water mains and then disposes of around 265 million
litres of waste water each day via 9,000 kilometres of
public sewers.

The asset base of South West Water comprises:

Additional value may be created where South West Water
outperforms Ofwat’s assumptions by, for example,
delivering services at lower operating and/or capital
costs than Ofwat assumed, and/or financing the
investment programme at lower costs than Ofwat
assumed.

The successful delivery of a restructuring and continuous
improvement programme over the K3 regulatory period
(2000 – 2005) to significantly reduce overhead and
operating costs, ensured that South West Water
outperformed the demanding operational and capital
efficiency targets imposed by Ofwat. In K3, the company
also grew its regulatory asset value ahead of the increase
in net debt.

15,000 kms

9,000 kms

Viridor Waste

Distribution mains

Sewers

Impounding reservoirs

Water treatment works

Waste water treatment works
– including works with ultra
violet treatment

614

Viridor Waste is a leading provider of essential waste
treatment, recycling and disposal services in the UK. It
has core competencies in landfill disposal and generation
of electricity from landfill gas. It has a waste collection
fleet focusing primarily on the industrial and commercial
market and a clinical waste incinerator. It also operates
materials recycling facilities, waste transfer stations,
civic amenity sites and composting facilities in a number
of regions in the UK.

The asset base of Viridor Waste comprises:

Landfill sites – operational

Landfill sites – non-operational

with planning

Power generation plants

Transport depots

Collection vehicles

Waste transfer stations

Incineration plant

Materials recycling facilities (MRF)

Glass recycling plants

Glass recycling depots

Waste treatment plants

Composting sites

Civic amenity sites

270

Combined sewer overflows

1,061

The company has successfully delivered the largest capital
programme per capita of any of the privatised water and
sewerage companies with a particular focus on improving
coastal waste water treatment and disposal. The region
currently has 143 EU designated bathing waters, almost
one third of the total in England and Wales.

South West Water expects to create value through
delivering the regulatory contract agreed with Ofwat, the
water regulator, the size and content of which is reviewed
at five-yearly intervals. As well as determining outputs,
inter-alia, to enable efficient
Ofwat sets prices,
companies to earn a reasonable rate of return on their
assets. In the K4 Determination, which covers the period
from April 2005 to March 2010, Ofwat assumed that the
equity cost of capital for all companies is 7.7% real after
tax with an overall weighted average cost of capital of
5.1% real after tax. Ofwat’s Determination allows for
further investment by South West Water to improve the
quality of water and sewerage services. This is expected
to result in the company’s regulatory asset value
increasing from around £1.95 billion in March 2005 to
circa £2.6 billion in March 2010, thereby enlarging the
base on which the return to shareholders is calculated.

Pennon Group Plc

Viridor Waste’s main UK operations

Landfill sites – operational
Landfill sites – with planning
Transport depots
Waste transfer stations
Incineration plant
Power generation plants
MRF plants
Glass recycling plants
Glass recycling depots
Waste treatment plants
Composting sites

Viridor Waste’s strategy is to add value by:

– capitalising on its strong position in landfill
waste disposal

– exploiting opportunities in landfill gas power
generation in line with the Government‘s target of
increasing the proportion of electricity generated
from renewable sources

– pursuing profitable opportunities arising from the
Government‘s developing waste strategy.

Viridor Waste’s landfill market consists of municipal,
commercial and industrial wastes along with contami-
nated soils and certain other special types of waste.
Landfill is currently the major final disposal route for
these wastes.

As a result of the measures taken by the Government to
encourage recycling and comply with the requirements of
the EU Landfill Directive, the amount of bio-degradable
municipal waste in the UK as a whole going to landfill can
be expected to decline gradually. Municipal waste is
around one third of Viridor Waste’s landfill market.
However, although there are regional variations,
according to the Environment Agency’s (EA) most recent
estimates, there remains the equivalent of only around
six years’ overall consented landfill capacity in the UK as
a whole and new planning permissions are difficult to
achieve, particularly for green-field sites. In view of the
above, the Directors believe that consented landfill void
will remain an increasingly valuable resource.

Viridor Waste is one of the largest landfill site operators
in the UK with a total consented landfill capacity of
approximately 80 million cubic metres. The company is at
present filling this at a rate of approximately 5 million
cubic metres per annum which results in an average
remaining life of 16 years at current rates of fill –
significantly longer than the industry as a whole. This
capacity is located as shown on the map opposite.

Gas produced from decomposing waste on landfilled sites
(landfill gas) is increasingly used to generate electricity.
It is a form of renewable energy and now represents over
25% of the UK’s total renewable energy generation. The
Government’s strategy is to increase the percentage of
electricity generated from renewable sources from the
current figure of under 4% to a target of 10% in 2010 and
15% in 2015 with an aspiration of 20% in 2020. To meet
this target, the Government has introduced premium
pricing regimes, most recently renewable obligation
certificates (ROCs), to encourage all eligible forms of
renewable energy including landfill gas. This has
facilitated Viridor Waste in increasing its total generation
capacity to a current 52MW, compared with 28MW in
March 2002 prior to the introduction of ROCs.

To take advantage of opportunities presented by the
Government’s developing waste strategy, Viridor Waste is
pursuing composting, civic amenity or household waste
recycling sites (HWRS) and other recycling opportu-
nities. These may be combined in integrated waste
management contracts.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

In pursuing its strategy, Viridor Waste seeks to grow its
waste management business, both organically and
through acquisition. It has continued to be an active
participant in the consolidation of the UK waste market to
date and, since October 2001, has made seven
acquisitions in the waste sector for an aggregate
consideration of approximately £104 million. They have
been integrated into the Viridor Waste group. The most
recent acquisition was Thames Waste Management
Limited from RWE Umwelt AG, details of which are set out
in the Chief Executive’s Business review.

As a result of this focused strategy, Viridor Waste’s
turnover (including landfill tax) has grown from £106.1
million to £248.3 million over the period 2001 to 2005.
Its operating profit (before amortisation of goodwill) has
increased from £13.1 million to £29.8 million, a
compound annual growth rate of 22.8%. This has been
the result of organic growth of the underlying business of
around 12% per annum and the beneficial impact of
recent acquisitions.

DIVIDEND POLICY

The Group is committed to a progressive dividend policy
under which it expects to increase the dividend payable
to shareholders in real terms each year, barring
unforeseen circumstances, at least up to the end of the
K4 period in 2010.

A scrip dividend alternative is available to shareholders
enabling them to acquire new shares issued by the
Company without incurring dealing costs. The scrip take-
up has resulted in 876,879 new shares being issued in
April 2004 in respect of the 2003/04 interim dividend
and 2,274,426 shares being issued in October 2004, in
respect of the 2003/04 final dividend. The total value of
the scrip take-up during the year was £22.8 million.

SOUTH WEST WATER REGULATORY &
COMPETITIVE ENVIRONMENT

Licences

In 1989, the UK Government appointed companies
(appointees) to provide water and waste water services
(the Appointments). Economic regulation pursuant to the
Appointments is the responsibility of the water
regulator Ofwat.

Pennon Group Plc

The Appointments impose conditions which Ofwat
enforces, along with the appointees’ principal duties
under the Water Industry Act. An Appointment may be
terminated on 25 years notice by the Secretary of State,
with more immediate revocation in certain specified
circumstances (including, for example, failure to comply
with an enforcement order made by Ofwat).

The water industry is also subject to Government
direction and legislation in relation to investment
requirements and social policy (for example the
protection of vulnerable customers). From a customer
interest perspective, water industry activities are also
reviewed by WaterVoice, part of Ofwat, which is being
replaced by a separate statutory body, the Consumer
Council for Water.

Price cap regulation

Ofwat regulates water and waste water charges by
determining the maximum increase in charges which a
company can impose in any year. The water regulator
conducts a Periodic Review and sets price limits every five
years. Prices are set by reference to inflation as measured
by the index of retail prices (RPI) plus an adjustment
factor known as ‘K’ which is specific for each company and
which can vary for each year of the Review period. The size
of a company’s ‘K’ factor (which can be positive, negative
or zero) reflects the scale of its capital investment
programme, the cost of capital determined by the water
regulator and
its operational and environmental
obligations offset by assumed efficiency improvements
required of the company. Ofwat has instituted a system of
‘comparative competition’ and compares South West
Water’s performance on a wide range of parameters,
including efficiency, customer service, and environmental
performance. Operating cost comparisons are used by
Ofwat to determine the level of efficiency improvement
which might be achieved at each Periodic Review. Other
parameters enable Ofwat to compare and publish details
on South West Water’s customer service performance
compared to other water companies.

savings

Companies are incentivised to be efficient both in terms
of their operating costs and in the implementation of
their capital expenditure programme. The benefit of any
effective
achieved
efficiency
management in excess of those assumed by the water
regulator is retained by the companies for a period
generally of five years, after which time the benefit is
passed to customers. The cost of any underperformance
due to poor management is borne by the companies.

through

Companies are also incentivised to provide a high quality
service and penalised if they provide a poor quality
service by means of an adjustment to the ‘K’ factor at the
subsequent Periodic Review.

Unexpected costs or savings arising from changes in
certain regulatory assumptions or legal requirements
during a Periodic Review period are recorded by South
West Water and may be in certain circumstances agreed
by Ofwat. This process, known as ‘logging up and down’,
allows prices to be adjusted up or down at the next
Periodic Review to compensate for the unexpected
change. In addition, in certain circumstances, where the
change is material, the company can request, and Ofwat
can instigate, a re-setting of its price limits (K factors)
during the five-year period, known as an ‘ interim
determination of ‘K’’ (IDoK).

The K factors for the period 2005 – 2010 for South West
Water were determined by Ofwat in its Final K4
Determination of December 2004 as set out below:

Year

Ofwat Final
Determination
K factor %

............................................................................................................

2005/06

2006/07

2007/08

2008/09

2009/10

12.5

9.8

1.7

1.4

............................................................................................................

Average

6.9

The K4 Determination provides for total capital
expenditure of £762 million (2002/03 prices) over the
five year period. The price limits are intended to enable
South West Water to:

– Continue to maintain a safe, reliable water supply to
customers and effective treatment and disposal of
sewage, including increasing activity to maintain its
pipes, sewers and sewage treatment works

– Implement new odour control measures at priority

sites

– Meet the demands of new and existing customers for a

reliable water supply and sewerage service

– Install 113,000 optional domestic customer water

meters by 2009/10

– Deliver required drinking water and environmental

quality improvements including:

– renovation of more than 3,200 kms of

water distribution mains

– improvements at 14 water treatment works to

improve treated tap water

– phosphorous removal at nine sewage treatment

works

– work to address 49 unsatisfactory intermittent

discharges

– Resolve or mitigate problems identified in the

company’s plan where overloaded sewers cause
flooding inside properties

– Maintain access to capital markets to finance delivery

of these outputs at a reasonable cost.

In setting price limits for South West Water, Ofwat
assumed the following efficiency improvements:

– Average annual operating efficiency improvements of

2.5% (water) and 2.0% (sewerage)

– Capital maintenance efficiency improvements of 5.0%

(water) and 8.7% (sewerage)

– Capital enhancement efficiency improvements of 5.0%

(water) and 16.4% (sewerage).

Environment/quality regulation

The water industry in the UK is subject to substantial
domestic and EU regulation, placing significant statutory
obligations on South West Water with regard to amongst
other things, the quality of treated water. Examples of
relevant EU directives include the Drinking Water
Directive, the Bathing Water Directive and the Urban
Waste Water Treatment Directive. The Water Framework
Directive was incorporated in 2003 into UK law and is
intended to rationalise EU water legislation providing a
framework for the protection of and improvement in the
quality of water resources together with the promotion of
sustainable water consumption. To comply with the Water
Framework Directive, member states will have to achieve
the challenging target of ‘good’ status for ground water,
river water, as well as estuarine and coastal water by the
end of 2015.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

Environmental regulation for water and waste water in
England is primarily the responsibility of the Secretary of
State for Environment, Food and Rural Affairs, together
with, among others:

– the Environment Agency (EA) which is responsible for
the licensing of water abstraction and the regulation
of discharges to controlled waters, including
discharges from waste water treatment works

– the Drinking Water Inspectorate (DWI) which sets and

enforces drinking water quality standards.

Competition

South West Water is the licensed appointee for the provision
of water and sewerage services primarily in Devon, Cornwall
and small parts of Dorset and Somerset. As the licensed
undertaker, it has no direct competition for the provision of
these services to the vast majority of its customers. The
Government is introducing a new regime whereby customers
using more than 50Ml per year can contract with alternative
suppliers for water supply. South West Water has only 42
customers in this category, whose aggregate water charges
account for less than 2% of its total turnover.

VIRIDOR WASTE REGULATORY &
COMPETITIVE ENVIRONMENT

The UK is required under the EU Landfill Directive to
reduce the amount of biodegradable municipal waste
going to landfill sites as follows:

– to 75% of 1995 level by 2010
– to 50% of 1995 level by 2013
– to 35% of 1995 level by 2020

Municipal waste accounts for only around one third of
waste going to landfill in the UK.

The alternatives to landfill sites for final waste disposal in
the UK are currently limited. In order to meet the
requirements of the Landfill Directive, local authorities
have been set statutory targets by the Government for the
recycling of household waste and must also implement
strategies for the diversion of biodegradable municipal
waste from landfill.

Each waste disposal authority has been allocated an
allowance of the amount of biodegradable waste it may
dispose of to landfill for the years 2005 to 2020. These
allowances are designed to ensure that the UK as a whole

Pennon Group Plc

achieves the requirements of the EU Landfill Directive.
Subject to some constraints, local authorities can carry
forward or trade under the Landfill Allowance Trading
Scheme (LATS) allowances. Any authority exceeding its
allocation without such an allowance faces a penalty of £150
per tonne in addition to the cost of disposing of the waste.
This is expected to result in the introduction of alternative
disposal processes at higher cost than current routes.

The Government introduced landfill tax as a further
incentive to divert waste from landfill sites. Landfill tax
applies to all waste disposed at a licensed landfill site,
unless the waste is specifically exempt, such as soil from
historically contaminated sites. Landfill tax is chargeable
by weight. For inert waste, landfill tax is chargeable at £2
per tonne. A standard rate of £18 per tonne currently
applies to all other taxable waste which is due to rise by
at least £3 per tonne per annum in the next few years, to
reach a medium to long term rate of £35 per tonne.

Planning for landfill sites

facilities

including

All waste management
the
development of new landfill sites and expansion of
existing landfill sites are subject to planning permission
from the relevant local authority. Landfill (and hazardous
waste facilities) also require a Pollution, Prevention and
Control (PPC) permit from the EA.

Viridor Waste believes that good environmental
management is important in winning future planning
consent. It has achieved ISO 14001 (Environmental
Management Systems) accreditation at all of its key sites.

Planning applications are subject to a rigorous
assessment by the local authority who will consider them
against the backdrop of the
local waste policy
development plans that it has compiled for its area.
Applications have to address a wide range of issues, and
the EA is a statutory consultee in this process.

Landfill gas power generation

Landfill gas power generation is a form of renewable
energy and it is Government policy to increase the
proportion of electricity generated from renewable
sources from just over 4% currently to 10% by 2010 and
to 15% by 2015. Historically, renewable energy projects
were supported by the Government through the Non
Fossil Fuel Obligation (NFFO) scheme. Fixed price RPI
indexed contracts with terms of up to 15 years were
awarded to the most competitive renewable projects in

five tranches of bidding. Since April 2002, no new
contracts have been awarded under the NFFO regime
which has been replaced by the ROCs regime.

operator to undertake upgrades to ensure future
compliance and, where a pollution incident has occurred,
require clean-up action to be undertaken.

The overall price for electricity supplied under ROCs is
currently higher than that achieved under the most
recent NFFO scheme to encourage new generation.

Integrated waste management contracts and
the role of Private Finance Initiatives (PFIs)
in the waste management industry

In order to assist in meeting their landfill diversion
targets, local authorities are seeking to let integrated
waste management contracts covering a range of
activities often including HWRS, composting, recycling,
waste transfer and bulk transport and final disposal (both
incineration and landfill). In a number of instances,
these will be financed under the PFI regime.

Under this regime, local authorities apply to the
Government for funding for capital projects which fall
within the eligibility criteria. Successful applicants
receive cash funds (known as PFI credits), which do not
have to be repaid and can be used by the local authority
to fund a proportion of the capital and operating
expenditures needed for the project.

Considerable investment (potentially as high as £30
billion by 2020 as estimated by the Institution of Civil
Engineers) is required by the UK to meet municipal landfill
diversion targets.

Viridor Waste secured and began servicing a 25-year
Recycling and Waste Transfer PFI contract for West Sussex
County Council in April 2004. The contract, designed to
deliver a 45% recycling rate by 2015, involves the provision
of 14 new or improved recycling and waste handling
facilities and is supported by £25 million of PFI credits.

Viridor Waste recognises that there is a range of risks
associated with entering into such contracts, which are
often for a 25-year term. However, subject to a careful
assessment of the risks on a contract by contract basis,
the company will seek to secure such contracts.

Waste facilities are also subject to the same regulations
as other industries, including health and safety, control
of goods hazardous to health and the Working Time
Directive. In addition, the transport of waste is subject to
specific controls.

CUSTOMER /SUPPLIER RELATIONSHIPS

The Group recognises that maintaining long-term
relationships with customers and suppliers is key to
achieving its strategic objectives. Further details of
supplier relationships are set out in the supplier and
contractors section of this OFR on page 28.

South West Water

No single customer accounts for more than 1.0% of
turnover. No supplier (revenue) accounts for more than
2.8% of turnover and South West Water sources all its
purchases from competitive markets.

Viridor Waste

Local authorities are the largest single customer group
accounting in total for 30% of turnover. No individual
authority accounts for more than 4%. Viridor Waste’s ROC
contracts account for 5% of turnover.

No supplier accounts for more than 1% of Viridor Waste’s
turnover. The company sources from competitive
markets.

TECHNOLOGICAL CHANGES

South West Water

South West Water uses a wide range of proven
technologies with research work being progressed within
UK Water Industry Research Ltd (UKWIR) and other
service providers.

Waste regulation environment

Viridor Waste

EU directives and related UK legislation, as well as
planning and licensing, are referred to above.

The EA and Scottish Environment Protection Agency
(SEPA) monitor performance against permit conditions
and general environmental law. Breaches are subject to
prosecutions. The EA and SEPA can also require the

The waste industry has not been characterised by rapid
technological change. However, landfill diversion targets
are encouraging the search for alternative waste
treatment technologies. Viridor Waste is actively
pursuing new composting and treatment technologies
with Government financial assistance as noted in the
Business review section.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

KEY PERFORMANCE INDICATORS (KPIs)

Key Performance Indicators (KPIs) used by the Directors to assess performance against their stated objectives are as follows:

South West Water

Overall Performance Assessment

Growth in Regulatory Asset Value

Regulatory Asset Value (RAV) is the financial base on which Ofwat
allows a rate of return and sets prices. The opening RAV is adjusted
for projected capital and infrastructure renewals expenditure,
grants and contributions, infrastructure renewals charge and
current cost depreciation together with the efficiency allowance
from the previous regulatory period. Each component is projected
for each year by Ofwat at the Periodic Review. The RAV is adjusted
annually for Retail Price Index movements. At each Determination,
RAV is restated for outputs under-delivered, the logging-up of new
obligations and the effect of construction price inflation on capital
and infrastructure expenditure. A full explanation is given in the
Ofwat letter to Regulatory Directors RD07/05, which is available on
the Ofwat website – www.ofwat.gov.uk

The RAV at 31 March 2005, as published in RD07/05, amounted to
£1.95 billion, indexed to 2004/05 year end prices. The previously
reported RAV for 31 March 2004 was £1.71 billion at 2002/03 year
end prices. The movements include the incorporation of changes in
construction prices in the K3 period, £81 million, and RPI
indexation estimated at around £87 million.

REGULATORY ASSET VALUE

2000

1800

1600

1400

1200

n
o
i
l
l
i

m
£

Overall Performance Assessment (OPA) has been devised by Ofwat
as a comparative tool to measure companies’ performance. The OPA
assigns scores to performance in areas such as customer service and
complaint handling, billing, debt collection, asset serviceability,
environmental compliance and quality of drinking water delivered.

The data is collated for 12 month periods, part calendar year and
part financial year and other than assessed customer service, which
is produced by Ofwat and WaterVoice South West, incorporated in
the June Return to Ofwat. The final OPA assessment is published as
part of Ofwat’s Annual Report on ‘Levels of Service for the Water
Industry in England and Wales’, usually in the autumn.

South West Water scored 374 OPA points out of a maximum of 438
in 2003/04 and was tenth out of the 10 water and sewerage
companies. However, only 20 points in total separated the bottom
five companies and South West Water achieved one of the largest
performance improvements of any of the water companies during
the year. This was because capital expenditure, previously
constrained whilst the coastal clean-up was delivered, has now
been directed to address other areas. A further significant
performance improvement has been achieved in 2004/05.

OVERALL PERFORMANCE ASSESSMENT SCORES

400

350

300

250

200

s
t
n
i
o
p
A
P
O

2001

2002

2003

2004

2005

Financial year ending 31 March

Drinking water compliance

2001

2002

2003

2004

The RAVs up to 2003/04 are based upon South West Water’s
estimation of using COPI indexation. The 2004/05 RAV is the Ofwat
opening position for K4 at 1 April 2005.

During 2004, South West Water improved its overall compliance
with the drinking water quality regulations with 99.95% of its
regulatory tests meeting the required standards.

Operating profit

OVERALL WATER QUALITY COMPLIANCE

Operating profit is used as a key measure of the performance of
South West Water. The company achieved an operating profit of
£121.7 million in 2004/05, up £2.8 million on 2003/04. For the five
year period 2001 to 2005, operating profit was as follows:

Year ended 31 March
2001
£m

2002
£m

2003
£m

2004
£m

2005
£m

107.3

107.0

111.5

118.9

121.7

100

99.5

98.5

e
c
n
a
i
l
p
m
o
c
%

2000

2001

2002

2003

2004

Calendar years

Pennon Group Plc

Viridor Waste

Operating profit and profit before taxation (PBT)

Return on equity investment

Operating profit and PBT are used as key measures of the
performance of Viridor Waste. Data on these is set out in the
Financial position section of the OFR on pages 28 and 29 and set
out in the table below for the five year period 2001 to 2005.

The table also sets out the Compound Annual Growth Rate (CAGR)
(22.8% for operating profit and 11.4% for PBT) being the rate of
growth between 2001 and 2005 expressed as a single average
figure over the period.

Return on equity investment is also used as a key measure of the
performance of Viridor Waste and represents profit before taxation
expressed as a percentage on the amount of Pennon Group’s equity
investment in Viridor Waste, which amounted to £195.2 million at
31 March 2005. This is also set out in the table below.

Year ended 31 March

Operating profit before goodwill amortisation

Profit before taxation

Return on equity investment
after corporate overheads

2001

£m

13.1

11.7

2002

£m

15.2

13.5

2003

£m

19.1

14.2

2004

£m

22.7

14.7

2005

£m

29.8

18.0

CAGR

2001 – 05

22.8%

11.4%

6.1%

7.1%

7.4%

7.5%

9.2%

–

Consented landfill void

Landfill gas electricity generation capacity

As at 31 March 2005, Viridor Waste had a consented void capacity
of 80 million cubic metres. This can be reconciled to the disclosed
consented void capacity in last year’s Annual Report, as follows:

million cubic metres
79

As at 31 March 2004
............................................................................................................
Planning gains (net)
............................................................................................................
Acquisition
............................................................................................................
Used in the period
............................................................................................................
As at 31 March 2005

(5)

CONSENTED LANDFILL VOID

s
r
e
t
e
m
c
i
b
u
c
n
o
i
l
l
i

65m

Electricity generated is sold to electricity suppliers, usually under
NFFO contracts or under short-term contracts with ROCs.

As at 31 March 2005, Viridor Waste had 52MW of generating
capacity, an increase of 7MW over the 45MW disclosed in the
Annual Report last year.

POWER GENERATION CAPACITY

W
10M

2001

2002

2003

2004

2005

Financial year ending 31 March

2001

2002

2003

2004

2005

Financial year ending 31 March

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

CORPORATE RESPONSIBILITY

South West Water

Pennon Group strives to achieve the appropriate balance
between all its stakeholders, the environment and the
needs of the Group.

One of the Group’s key objectives is to maintain its
reputation for integrity and fair dealing, which it
considers is fundamental to the long-term well-being of
the Group and its key stakeholders. The Group has a social
and ethical policy which covers the key areas of finance,
employees, customers and suppliers, community,
management responsibility and communications.

The Group also has a ‘Whistleblowing’ policy which is
reviewed regularly and supports its approach to ethical
employment practices by encouraging employees to
raise, in accordance with a formalised procedure,
concerns which relate to potential unlawful conduct,
financial malpractice, dangers to the public or damage to
the environment.

To benchmark its performance, the Group participates in
the Dow Jones Sustainability Indexes, the Business in the
Communities Environmental Index and is listed in the
FTSE4Good Index. Further details are set out in the
Group’s annual corporate responsibility report.

FTSE4Good

Employees

The Directors believe that the strategies set out at the
beginning of this OFR depend inter alia on the
businesses’ ability to attract and retain appropriately
qualified and motivated employees, provide them with a
safe working environment and the necessary training
and development to fulfil their roles.

In preparation for the challenges of the K4 period 2005 –
2010, South West Water has undertaken a major internal
reorganisation including the establishment of a new
asset management function, which it is anticipated will
produce a more efficient approach to its asset investment
and provide improved performance information about
the company’s assets. A major programme of
familiarisation and training has been undertaken for
those directly or indirectly affected by the changes. The
reorganisation also enables the company to release a
number of employees on early retirement or voluntary
severance terms to assist with meeting the demanding
efficiency targets arising from the K4 Determination. This
process will continue throughout K4, with a directly
employed labour force target of 1,300 by 2010.

Occupational health and safety remain key elements of
South West Water’s assessment of risk management.
Following privatisation, the company set out to build an
occupational health and safety culture in partnership
with a number of stakeholders including trade unions,
regulators, other water companies and construction
partners, which has been introduced into all parts of the
supply chain. South West Water’s reportable accident rate
of 12.5 accidents per 1,000 employees in 2004/05
compared with 17.5 per 1,000 employees in 2003/04, is a
significant improvement, particularly as over the past two
years better reporting systems have given rise to more
accurate reporting of accidents arising from greater
awareness amongst supervisors and managers. Training
in skills acquisition and health and safety continues to
ensure that employees have the knowledge and expertise
to undertake their jobs to the best of their ability. In
partnership with other water companies, South West
Water leads ‘Clear Water 2010’, a national 10 year
occupational health programme which has already
demonstrated a significant reduction in work related ill
health not reflected in other industrial sectors.

Viridor Waste

Viridor Waste is pursuing a number of occupational health
and safety initiatives. Its reportable accident rate per
1,000 employees of 13.2 in 2004/05 (14.3 in 2003/04)
continues to fall and has done so for two consecutive
years, comparing favourably with industry averages. The
company has recruited additional health and safety
professionals during the year and is also raising the level
of training and support available to its staff.

Pennon Group Plc

A significant challenge to Viridor Waste is the Road
Transport (Working Time) Directive (RTD) which will limit
Light Goods Vehicle (LGV) drivers’ hours. Consequently, it
will be necessary to employ more drivers despite a UK-
wide shortage. The company is in discussions with the
trade unions to mitigate the impact of the RTD on both
the drivers and the company. Viridor Waste is also
piloting training programmes with a view to aiding driver
retention.

The environment

The Directors believe that sound environmental
performance is critical to the success of both South West
Water and Viridor Waste. The Group has a long
established environmental policy, as set out in its annual
corporate responsibility report.

Both subsidiaries are subject to significant regulation
and must comply with the high standards set by the EA to
minimise their impact on the environment. Both are
responsible for the treatment and disposal of society’s
waste in a carefully controlled and highly engineered
manner. The companies acknowledge the importance of
environmental sustainability and have taken measures to
ensure that their operations are undertaken to enhance
the environment whenever possible and minimise any
adverse impact.

The Group is a major generator of renewable energy which
supports
reduce
the Government’s objective
greenhouse gas emissions. In 2004/05, the Group
generated 365 GWh, which was the equivalent of 133% of
the Group’s total energy consumption.

South West Water

Water resources

In 2004/05, South West Water abstracted 177,279 Ml of
raw water from its 81 licensed abstraction locations
which have a total licensed volume of 384,466 Ml. The
abstraction locations are either reservoirs, rivers or
groundwater sources known as aquifers. This raw water is
treated to a high standard before being put into supply
for customers’ use.

The company continues to invest in its distribution
network and has consistently met its Ofwat leakage
reduction target of 84Ml/d (84 Ml/d in 2003/04). During
2004/05, it rehabilitated almost 570 kms of water mains,
a major increase on the previous year.

Waste water disposal

In 2004, the company improved its compliance with the
standards set by the EA. The percentage population
served by compliant waste water treatment works
improved to 99.0% (98.7% in 2003).

For future years the company aims to maintain 99.0% as
a minimum.

This high level of compliance is a major contributor to the
region having a significant proportion of the finest
bathing waters, beaches and rivers in the UK. In 2004,
98% of the region’s 143 bathing waters achieved EU
mandatory standards and 81% the more stringent
guideline standards.

South West Water’s region also has the highest
percentage length of high quality rivers in England.

Viridor Waste

The most significant positive environmental impacts of
Viridor Waste’s operations arise from the safe and
efficient disposal of society’s waste materials, increased
resource and energy efficiency from its recycling and
recovery operations, the generation of renewable energy
from non-fossil fuels and the restoration of despoiled
landscapes such as disused mineral workings through the
controlled deposit of waste materials. Significant
negative impacts include transportation and associated
emissions, methane production (where not harnessed),
leachate production and potential local impacts such as
dust, noise, litter and odour.

Viridor Waste operates an environmental management
system (EMS) across all of its operational centres. 35 of
these (covering 100 operational facilities) are accredited
to the formal ISO 14001 standard. Viridor Waste
developed and introduced its own EMS in the early 1990s
recognising the growing importance of measuring and
monitoring the environmental impact of its operations.
This has allowed targets to be set and met to maximise
positive environmental impacts and reduce negative
impacts, thus resulting in continuous improvement in
environmental performance.

Viridor Waste was the first UK waste company to achieve
ISO 14001 accreditation across all major operational
sites. It has also played a leading role in developing and
adopting the environmental performance indicators for
the waste industry as promoted by the Green Alliance.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

The amount of waste recycled by the company increased
over the year to 780,129 tonnes (454,786 tonnes in
2003/04).

Incidents and prosecutions

Whilst from time to time incidents do occur at operational
sites, both South West Water and Viridor Waste endeavour
to manage their operational activities to minimise the
occurrence and impact of such incidents.

South West Water

The number of incidents classified by the EA as ‘Category
Two’ (significant pollution incidents) in 2004/05 was
reduced to four compared with 18 in 2003/04.

During the year, the company was convicted on 12
occasions for environmental offences and fined a total of
£51,200, compared with 14 convictions and £49,000 in
fines in 2003/04. The company has strategies in place to
reduce incidents which lead to prosecutions. This process
has been shared with the EA.

Viridor Waste

Viridor Waste had no EA ‘Category Two’ pollution
incidents during the year but was convicted for seven
offences at one site and fined £42,500. The company has
put in place an action plan to address the issues which
gave rise to the prosecutions. These convictions followed
several years without any pollution incident convictions.

Social and community issues

The Group believes in supporting the communities in
which it operates. This is achieved through carefully
targeted sponsorship and charitable donations to social
and community groups, channelled primarily through the
following initiatives:

– Pennon Charitable Donations – £50,000 was given
during the year primarily to charities operating in
Devon and Cornwall. The average size of donation
was £500 which can make a significant impact on
services provided by organisations. In addition,
a further £50,000 was donated to the Tsunami
appeal.

– South West Water Community Sponsorship –

£73,000 was given during the year to a wide
range of local groups and organisations including
employee charity fund raising teams.

– Landfill Tax Credit Scheme (LTCS) – enables Viridor

Waste to provide significant funding in areas within 10
miles of a landfill, thereby providing long-term social
and environmental benefits to local communities.
During the year, £3.9 million of funds were awarded.

Since the inception of the Scheme in 1996, over £42
million has been distributed to environmental bodies,
providing essential funding for more than 1,250
projects ranging from village hall repairs to protecting
vital habitats. Following the recent Government
changes to the LTCS, which created a new biodiversity
category qualifying for funding, several showcase
projects have been funded including the Avon Wildlife
Trust’s purchase of Prior’s Wood, North Somerset and
founding sponsorship of Manchester’s ‘Green Streets’
campaign.

– Pennon Environmental Fund Committee – the

Committee was established with the aim of advising
Viridor Waste on the application of some landfill tax
credits within primarily Devon and Cornwall. Whilst
the recent changes to the LTCS have significantly
reduced the amount of funding available £63,000 was
allocated during the year based upon the
recommendations of the Committee.

– The South West Water Special Assistance Fund – the
Fund was established to provide help to customers
endeavouring to pay their water and sewerage bills
but who, for reasons of severe financial or personal
difficulties, were having problems paying the full
amount. Although South West Water provides
administrative support to the Fund, the decisions
for applications for help are made by an
independent panel.

Pennon Group Plc

CURRENT PERFORMANCE AND
FUTURE DEVELOPMENT

Group overview

In 2004/05 Group turnover rose 17.6% to £554.2 million
(2003/04 £471.3 million). Before net exceptional items
of £0.1 million comprising £5.0 million now received from
a business disposal in 1998 (2003/04 nil) less abortive
acquisition costs of £1.5 million (2003/04 £6.5 million)
and £3.4 million restructuring costs in South West Water
(2003/04 nil), Group operating profit before goodwill
was up by 9.1% to £151.5 million (2003/04 £138.8
million), Group profit before tax was up 10.9% to £87.4
million (2003/04 £78.8 million) and earnings per share
before deferred tax rose 9.4% to 63.1p (2003/04 57.7p).
Group capital expenditure was £188.4 million (2003/04
£170.0 million).

South West Water

South West Water turnover rose by £18.0 million to £309.8
million. Approved tariff increases amounted to £21.2
million. Customers switching from unmeasured to metered
charging caused a reduction of £6.3 million in turnover.
Other factors contributed a net total of £3.1 million,
including 7,300 new customer connections and increased
commercial sales offset by an estimated £2.4 million
reduction in measured demand, as the summer of 2004 did
not match the high temperatures of the previous year.

South West Water’s operating profit rose 2.4% to £121.7
million before the exceptional item of £3.4 million.
Operating costs, including depreciation, increased by
£15.2 million to £188.1 million. Additional costs from
new capital schemes of £5.7 million, inflation of £4.4
million and other cost increases of £9.2 million (mainly
pensions, direct cost of sales and bad debts), were offset
by £4.1 million of efficiency savings. Some six years ago,
South West Water established a restructuring and
continuous
reduce
improvement programme
significantly overhead and operating costs. Its successful
delivery ensured that it outperformed the demanding
operational and capital efficiency targets imposed by
Ofwat for the K3 regulatory period (2000 – 2005). South
West Water has announced plans for further restructuring
to contribute towards the additional efficiencies required
over the K4 period (2005 – 2010), including a £13
million per annum reduction in base operating costs by
2010. An exceptional charge of £3.4 million has been
made in respect of the associated restructuring costs.

Capital expenditure increased by 1.9% to £141.9 million.
£66.1 million was invested in water supply improvements
including water mains renovation, water treatment works
enhancement and leakage control. Ofwat’s latest report
on leakage notes that South West Water continues to be
one of the leading companies in managing water leakage
and is delivering results in line with Ofwat’s leakage
target. Over 600 kms of water mains were laid, replaced or
refurbished during the year, a major increase on
2003/04. Drinking water quality is at an all time high and
the region features the highest proportion of high quality
rivers in England.

Waste water investment expenditure totalled £75.8
million. Commissioning of the Ilsham Valley pumping
station in Torbay commenced in April 2004 and its
operation signalled the completion of the final major
project in the company’s 15 year original ‘Clean Sweep’
coastal sewage treatment programme. ‘Clean Sweep’ has
transformed the coastal environment around the South
West. 98% of bathing waters conform with EU mandatory
standards and 81% of the region’s bathing waters now
meet the tougher EU guideline standards. This compares
with only 47% of the region’s bathing waters achieving
the guideline standards six years ago.

Viridor Waste

Viridor Waste has continued to trade strongly, building on
the growth achieved over the past several years. Turnover
rose by 35.6% (£65.2 million) to £248.3 million in
2004/05. Acquisitions accounted for £40.2 million of the
increase and underlying business £25.0 million. Landfill
tax within turnover increased by £8.2 million.

Viridor Waste’s operating profit before goodwill
amortisation rose by 31.3% to £29.8 million (£26.3
million after goodwill amortisation), compared with
£22.7 million (£20.2 million after goodwill amortisation)
in 2003/04. The increase was driven by good performance
from landfill, power generation and collection businesses
and the positive impact of the West Sussex integrated
waste contract together with the Thames Waste
Management acquisition. Since 2000/01, operating
profit before goodwill has grown at a compound rate of
22.8% per annum, of which around 12% has been organic
with the rest being achieved through acquisitions.
Earnings before
interest, tax, depreciation and
amortisation (EBITDA) grew from £43.2 million to £56.0
million. Capital expenditure for the year was £45.8
million (2003/04 £30.5 million).

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

Total landfill disposal volumes increased by 10% to 4.0
million tonnes, due mainly to the Thames Waste
acquisition. Volumes on a like for like basis rose by 2%.
Total gate fees per tonne rose by 10%.

Viridor Waste’s total power generation capacity has
increased by a further 16% in the year, most of which has
been introduced under ROCs and underpins the strong
profit growth achieved. 56% of Viridor Waste’s output
benefits from ROCs.

Future prospects for the landfill gas generation business
depend significantly on Government policy for renewable
energy generation. The ROCs system is the Government’s
main policy measure to encourage the development of
electricity generation using renewable energy sources
such as landfill gas. During 2005, the Government is
carrying out a review of the ROCs system. It has stated
that this review will not affect existing accredited
schemes.

Trends and factors likely to impact
future prospects

South West Water

The key factor affecting South West Water’s performance
over the next few years is the K4 Determination
concluded in December 2004. As noted on page 12, this
sets price limits for the next five years and determines the
investment outputs to be delivered by South West Water
over this period.

South West Water is confident that it can deliver the
efficiency improvements assumed over this period and
deliver the required investment programme.

Prospects beyond 2010 depend primarily on the next
Periodic Review and subsequent price Determination.
This is expected to take account of further investment
requirements flowing from EU directives and other
legislation and the continuing need to maintain the
serviceability of the existing asset base and set further
regulatory driven efficiency targets.

Viridor Waste

Consented landfill capacity is expected to continue to rise
in value due to rising costs caused by planning restrictions,
tightening regulation and the demand for higher
standards. The availability of permitted landfill void is
limited. According to the EA’s most recent estimate, there
is around six years consented capacity in the UK.

At the same time the implementation of the Landfill
Directive (via LATS and other regulations), the continued
roll-out of the Pollution Prevention and Control (PPC)
permitting regime, the Government’s National Waste
Strategy (currently under review) and landfill tax increases
are all likely to encourage diversion of waste streams away
from landfill towards treatment and recycling, where
available. This will mostly affect municipal waste, which is
approximately one third of the current landfill market.

RESOURCES

South West Water

Human resources

South West Water has an experienced management team
and utilises remuneration and incentive policies focusing
on financial and operational targets. The company has
invested significant sums over many years to ensure that
its staff have the skills and competencies to undertake
their roles. NVQ training for operators and craftsmen is
carried out to ensure that basic skills are in place and
health and safety requirements are met. Office-based
staff are offered a range of training including assistance
to obtain professional qualifications. Managers are
encouraged to extend their knowledge and skills through
participation in company-wide programmes as well as
bespoke external courses. All training activity is
undertaken under the ‘Investor in People’ standard and is
closely aligned with business requirements.

The company uses financial incentivisation arrangements
as appropriate to each group of workers and job
satisfaction is supported by encouraging role changes
wherever possible around the company to help
employees gain broad experience of business activities.

Staff turnover is well below the national average. The
company as a ‘good employer’ has been introducing a
number of ‘Family Friendly’ policies, which exceed
statutory requirements. External recruitment is proving
to be more difficult in a national climate of high
employment and increased competition for staff locally
from new organisations
in the region. Regular
benchmarking of salary levels is carried out and the
additional benefits of working for the company compared
to others are emphasised. Work is also to be undertaken
to further facilitate recruitment through the company’s
website.

Pennon Group Plc

Water resource position

RISKS AND UNCERTAINTIES

South West Water on a five year basis prepares a Water
Resources Plan for a range of climate change and demand
scenarios. The Plan indicates that no new reservoirs are
required before 2030 but investment is needed to
develop the overall trunk main infrastructure, to expand
treatment capacity and to enhance certain pumped
storage facilities.

At 27 March 2005, reservoir storage levels were 80.8%
compared to 83.4% at 27 March 2004.

Systems

South West Water relies on a range of sophisticated
financial, asset management and operational systems.
They are upgraded and renewed as necessary to ensure
reliability, efficiency and operational effectiveness.
Back-up and standby arrangements are in place in the
event of damage, failure or other disruption.

Viridor Waste

Human resources

The company employs a comprehensive range of
technical and professional managerial personnel,
supervisory, administrative and clerical, semi-skilled and
unskilled. Many are vocationally trained and have
extensive operational experience. Membership of
relevant trade and professional bodies is widespread and
is encouraged.

Industry reputation/expertise

Viridor Waste is an active member of the Environmental
Services Association, the leading trade body and senior
staff are involved in leading positions on industry
committees providing Government departments with
economic and technical information.

The company has a good track record in gaining planning
consents and PPC permits for landfill capacity and waste
management facilities.

As one of the fastest growing and strongest performing
businesses in the waste industry in recent years, Viridor
Waste’s
record of business and environmental
performance, service delivery and regulatory compliance
is strong.

Risk factors relating to the Group

It may not be possible to continue to sustain the
same level of earnings and growth of the Group as in
the past

There is a risk to shareholder value if the Group is not able
to continue to grow its key businesses and continue to
produce sustainable earnings growth. Successfully
achieving these objectives is dependent upon the correct
strategy being pursued by strong and able management
within the Group as well as on external factors. The Group
has maintained earnings and has successfully grown both
South West Water and Viridor Waste and intends to
continue to create shareholder value through its
strategic focus on water and sewerage services and waste
management. In particular, the Board has confidence
that South West Water will successfully deliver the new K4
regulatory contract and significantly grow its regulatory
asset value to 2010, whilst Viridor Waste’s successful
strategy of creating long-term sustainable profit growth
is expected to continue through capitalising on its
landfill asset base, exploiting its landfill gas power
generation potential and pursuing profitable
opportunities in line with the Government’s developing
waste strategy.

Risk factors relating to the Group’s water
and waste water business

Price controls over the turnover of the Group’s
regulated business could adversely affect profitability

Ofwat’s price Determination may adversely affect South
West Water for a number of reasons including an
inadequate cost of capital allowance. There is also a risk
that regulatory assumptions concerning operating
expenses, required capital expenditure and revenue
forecasts may prove to be unrealistic. However, South
West Water has a track record of meeting Ofwat’s
expectations in the last two Periodic Review periods (K2
and K3) and expects to be able to meet the expectations of
the latest Determination for the K4 period (2005 – 2010).

The outcome of future Periodic Review processes (post
2010) will affect the Group’s turnover and profitability.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

Failure to deliver the capital investment programme
could adversely affect profitability

South West Water requires significant capital expenditure
for additions to and replacement of plant and equipment
for its water distribution and waste water facilities and
networks. The price limits set by Ofwat for the K4 period
take into account the level of capital expenditure expected
to be incurred and the associated funding costs. In the
event of under-performance, the water regulator could
intervene to re-set price limits at lower levels.

The company may be unable to raise sufficient funds
to finance its functions

Historically, the Group has financed expenditure from cash
flows from operations and from debt financing. In setting
price limits, the water regulator has a duty to ensure that a
company can finance its functions. Whilst there can be no
assurance that cash flows from operations will not decline
or that additional debt financing or other sources of capital
would be available to meet these requirements, the
Group’s policy is to ensure that it has committed facilities
available for at least 12 months anticipated net cash
requirement.

If South West Water is unable to secure the anticipated
capital efficiencies associated with the capital programme,
or the programme falls behind schedule for other reasons,
the profitability of the Group may suffer. The water
regulator may factor such failure into future price reviews.
In addition, the Group’s ability to meet regulatory and
environmental performance standards could be adversely
affected by the failure to deliver the capital programme on
time. This could result in the potential for fines or other
sanctions imposed by either the water regulator or the
courts including loss of South West Water’s Licence. The
company has a track record of delivering its capital
programme in accordance with regulatory requirements.

Failure to deliver operating cost savings implicit
in the regulatory review could adversely affect
profitability

Operating cost savings to be achieved during the current
K4 period are implicit in the regulatory review. In line with
South West Water’s track record, the Board remains
confident of delivering the assumed operating cost
savings. However, should operational performance
deteriorate, the Group’s profitability could suffer and the
water regulator could seek to impose higher efficiency
targets as part of future price reviews.

Environmental regulations and quality standards
could increase the Group’s costs and adversely affect
profitability

Various environmental and consumer protection, health
and safety laws and regulations govern the company’s
waste water and water distribution businesses. These laws
and regulations establish, amongst other things, quality
standards for drinking water, effluent treatment (including
sewage sludge disposal) and discharges into the environ-
ment which affect South West Water’s operations. In
addition, South West Water is required to obtain various
environmental permissions from regulatory agencies for its
operations. South West Water endeavours to comply with all
regulatory standards but cannot guarantee that it will be in
total compliance at all times with these laws and regulations.

Environmental laws and regulations are complex and
change frequently. These laws, and their enforcement,
have tended to become more stringent over time. Whilst
South West Water has budgeted for future capital and
operating expenditures to achieve compliance with current
and known future changes in law and regulations, it is
possible that new or stricter standards could be imposed
that will raise South West Water’s capital and operating
expenditures by requiring modifications to its assets. It is
also possible that future legislation will impose constraints
on existing water abstractions requiring South West Water
to source alternative water supplies. These costs are
recoverable in part or in whole through the regulatory
process of setting appropriate future price limits. In the
event of these being significant, South West Water could
apply to Ofwat for a revision of its price limits through an
Interim Determination of K (IDoK).

Contamination to water supplies could adversely
affect profitability

Water supplies may be subject to contamination, including
contamination from naturally occurring compounds and
pollution resulting from man-made sources. In the event
that one or more of the company’s water supplies is
contaminated and it is unable to substitute a water supply
from an uncontaminated water source, or to adequately
treat the contaminated water source in a cost-effective
manner, there may be an adverse effect on its reputation,
operating results and financial position. Some or all of
these costs may be recoverable through future price
reviews. South West Water could also be held liable for
human exposure to hazardous substances in its water
supplies or other environmental damage. The Group
maintains insurance policies in relation to these risks,
although there can be no assurance that all or any of the
costs associated with these risks would be covered or that
coverage will continue to be available in the future.

Pennon Group Plc

Non-recovery of customer debt could adversely
affect profitability

The company is responsible for the billing, cash collection
and debt management activities for around 760,000
domestic and business water and waste water customers.
The Water Industry Act 1997 prohibits the disconnection of
a domestic water supply for non-payment. Non-recovery of
debt is therefore a risk to the Group and may cause the
Group’s profitability to suffer, although allowance is made
by the water regulator in the Determination for his estimate
of debt deemed to be irrecoverable. In addition to existing
strategies, South West Water is implementing new
initiatives to improve and secure cash collection, including
the use of charging orders. However, there can be no
assurance that the the amount allowed by the water
regulator is adequate. Provision was made in the last
Periodic Review for companies to make an application for an
Interim Determination of prices in the event of a significant
shortfall.

Other potential liabilities/risks

A failure of the equipment operated by South West Water
could lead to the escape of water or waste water including
sewage effluent and result in damage to third party
property or personal injury. In such circumstances, South
West Water may incur liability to those third parties. South
West Water could also be prosecuted by the EA and/or be
required to undertake costly upgrades.

A water shortage due to a severe drought could reduce the
water supply available to customers, which could have a
material impact on the profitability of South West Water.
The company does have in place a number of schemes to
maintain water resources (such as pumped storage for
certain reservoirs) and has a number of water conservation
measures which are applied on an ongoing basis.

Meter option take-up

Higher than national average water charges within the
South West Water area have encouraged many customers to
change from an unmeasured rateable value based charging
system to a payment based on volume of water used as
measured by a meter. Properties constructed since 1989 do
not have a rateable value assessment and are therefore only
charged by the volume of water used. Most customers in
properties built prior to 1989 can choose to opt for meter
charges. In doing so they have an option to switch back to
rateable value payment within 12 months of meter
installation. The rate at which customers elect to switch to
volume payment is estimated at each Periodic Review.

Current rates of customers opting to change, align with the
estimates made at the last Review which allows for some
65% of customers to pay by measured charges by 2010,
compared with around 48% of such customers with meters
at 31 March 2005. However, it is possible that a higher
proportion of customers could switch to a measured supply
than allowed for and this could have an adverse impact on
the company’s revenues. As referred to in the price cap
regulation section on page 12, an IDoK may be used to at
least partially recover any revenue losses if they exceed the
prescribed materiality threshold.

Risk factors relating to the waste
management business

Increases in landfill costs may not be recovered
through price increases

The raising of environmental standards is leading to a
gradual increase in landfill costs in general. Particular areas
of cost increases include site engineering (which results in
increased depreciation), leachate management, landfill gas
management and general site management. Companies
such as Viridor Waste with landfills engineered to modern
standards and who have good environmental control
systems, should incur lower than average increases in costs.
However, there remains a risk that rising standards may
generate higher treatment and disposal costs than
currently assumed.

Municipal waste contracts typically last for a number of
years; they usually have price increases under formulae
related to inflation as measured by the retail price index in
the UK (RPI) and in some cases take into account specific
legislative or technical changes. Prices for other types of
waste depend more on local markets and competitive
conditions. Viridor Waste’s experience over several years is
that prices in general have risen at least fast enough to
cover cost increases in the areas where it operates. There is
a risk that landfill prices may not rise sufficiently in all
locations to recover recent and projected cost increases.

Not all landfills may meet the standards of the
Integrated Pollution Prevention and Control (IPPC)
Directive and the Landfill Directive, or requirements
may be imposed which would impact on the
economics of landfill

Landfills (and other industrial processes) in the UK are
subject to a new permitting regime pursuant to the
Pollution Prevention and Control (England and Wales)
Regulations 2000 (PPC Regulations). Existing landfills

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

opened before July 2001 operate under waste
management licences. In the future, they (and landfills
opened since July 2001) will require a PPC permit granted
under the PPC regulations. The replacement of waste
management licences with PPC permits is occurring in a
series of application tranches due to run through to
2007. PPC permits are expected to impose higher
standards and costs in general. At the same time, it is
possible that some current landfills may fail to obtain a
PPC permit and will therefore have to seek to agree a
closure plan with the EA or SEPA.

The net result of this is that after a transitional period, it
is expected that the average technical and operational
standards of landfill in the UK will improve and it is
possible that the number of landfills may decrease.

Viridor Waste believes that its own key landfills are
generally well placed to obtain PPC permits. However, it is
not possible to prejudge the EA’s or SEPA’s decision on
this and it is possible that some sites may not achieve
permits or that more onerous conditions may be imposed
by those permits. Were a landfill not to achieve the
necessary permits it would have to cease operation with
consequent loss in profits.

Under both waste management licences and PPC Permits,
landfills require expenditure on restoration when the site
is closed and subsequently on aftercare (maintenance,
supervision, monitoring and management of gas and
leachate levels) long after the landfilling activities have
ceased. The EA or SEPA will only grant a full or partial PPC
permit or waste management licence surrender once it is
satisfied that the landfill is inert and no longer poses any
environmental risk. There may still be a risk of liability
arising from any residual contamination following the
surrender of the PPC permit. Landfill licences or permits
cannot be surrendered during the aftercare period.

The UK Government’s waste strategy (including
municipal landfill diversion targets and increases
in landfill tax) stemming from the Landfill Directive,
may lead to a reduction in volumes of waste being
disposed of via landfill

Viridor Waste focuses on the disposal of municipal,
industrial and commercial, construction and demolition
waste. Of this, around one third (26 million tonnes) of the
UK total for these waste streams is municipal (of which
approximately two thirds is biodegradable municipal
waste (BMW)). These figures are based on estimates from
DEFRA, the EA, SEPA and HM Revenue & Customs.

Assuming the EU Landfill Directive targets are met, the
total amount of BMW permitted to be landfilled from
2020 will be around 10 million tonnes per annum
(depending on the precise interpretation of the
Directive). If there is no change in other waste streams,
this would still leave a substantial landfill market in
2020. This should be seen in the context of an EA
estimate of a current consented landfill capacity UK-wide
of around six years.

Whilst to date Viridor Waste has seen its landfill volumes
slowly increasing, the combined effect of the various
Government measures may reduce waste to landfill in the
future.

Pricing and other risks relating to renewable energy

Without a pricing mechanism such as ROCs as identified
on page 14, further investment in renewables would not
generally be economic. The Government has made a
strong commitment to renewables which are key to
meeting the long-term carbon reduction strategy set out
in the energy white paper and the UK’s 2010 targets for
carbon dioxide reductions under the Kyoto Protocol.
Renewables are also important in minimising the UK’s
increasing reliance on imported energy. Nevertheless,
there remains a risk that the Government may change the
current regime. The Government is currently undertaking
a review of the ROCs. It has stated that current schemes
which benefit from ROCs will not cease to be eligible. It is
recognised that the recent expansion in landfill gas
generation would not have taken place without such
subsidy. However, it is consulting on whether new landfill
gas schemes, after a transitional period, should have
reduced eligibility.

The value of ROCs is increased by the sharing of the buy-
out price monies among holders of ROCs and is therefore
dependent on the financial strength of those suppliers
who opt to pay the buy-out price. There is a risk that the
insolvency of a licensed electricity supplier could lead to
a drop in the value of the ROCs which Viridor Waste sells
to licensed suppliers.

A landfill gas project must be able to collect and burn
sufficient gas to produce electricity. Ultimately, the
volume of gas generated will depend on the amount and
composition of the waste landfilled. For example, if the
amount of BMW diverted away from landfill is increased in
the future in accordance with the EU Landfill Directive
obligations, the total biodegradable component of the
waste going to landfill will affect volumes of landfill gas

Pennon Group Plc

produced. It is therefore possible that the gas obtained
will not be available either in the amounts or of the
calorific value required to make a project cost effective.

The future costs of defined benefit schemes are subject to
a number of factors including:

The current planning regime may restrict the
availability of future waste treatment facilities

Achievement of the Government’s targets for waste
management is critically dependent on the planning
system delivering sufficient waste treatment facilities.
Obtaining planning permission for any type of waste
treatment facility is difficult and will represent a major
challenge for the waste management industry.

Viridor Waste may be unable to recruit/retain
adequate numbers of staff with the necessary skills

Good quality staff with the required technical skills and
certification are essential in the waste industry. Viridor
Waste recognises that there is a risk of losing staff to
competitors and seeks to address this by its employment
policies.

Other Group risks

Pensions costs may increase due to factors outside
the Group’s control

The Group has a defined benefit pension scheme for
existing staff of, and new entrants to, Pennon and South
West Water and for certain employees of Viridor Waste.
Pennon Group set up a defined contribution scheme in
July 2003 for new entrants to Viridor Waste and
employees from certain acquired waste companies.

The triennial actuarial valuation of the Group defined
benefit schemes at 1 April 2004 indicated a scheme
deficit which resulted in additional annual costs of
around £5.5 million under the SSAP 24 accounting policy.

Under Financial Reporting Standard 17 ‘Retirement
Benefits’, the Group pension schemes had net liabilities
at 31 March 2005 of £55.7 million, a similar level to that
reported under FRS 17 at 31 March 2004. A sound
investment performance has been offset by an increase in
liabilities as reflected in the recent actuarial valuation.
The net liabilities represent circa 4.5% of the Group’s
total market capitalisation as at 31 March 2005.

– The returns achieved on pension fund investments

– Movements in interest rates and inflation

– Pensioner longevity.

Insurance

The Group manages property and third party risks by the
purchase of insurance policies from the insurance
market. The Group’s insurance brokers assist in sourcing
appropriate insurance cover from insurance companies
that have good credit ratings. Main insurance policies
cover property, business interruption, public liability,
environmental pollution and employers’ liability. There
are three tiers of insurance for most policies. The first tier
is self-insurance in the form of a moderate deductible.
The second tier is covered by the Group’s subsidiary,
Peninsula Insurance Limited (PIL). PIL insures the layer
of risk between the deductible and the cover provided by
external insurers. The third tier of risk is placed with the
external insurance market.

RELATIONSHIPS

South West Water

Regulatory relationships

South West Water views relationships with regulators,
Government, customer representative bodies and its
customers as central to its operations.

South West Water maintains a continuing dialogue with
Ofwat, the EA and DWI in addition to making the
prescribed reports of data and activity. It also inputs into
national dialogue on developing issues through its
representation at Water UK, the industry trade body.

South West Water works with WaterVoice South West and
will work with its successor, the Consumer Council for
Water, to ensure that customer issues and concerns are
addressed and a full understanding of the company’s
activities is maintained. South West Water adopts a
proactive policy of informing its customers through its
customer newspaper, ‘Waterlevel’, and through regular
press releases and media briefings.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

David Dupont – Group Director of Finance – Pennon Group Plc

Suppliers and contractors

Viridor Waste

South West Water’s procurement strategy is focused on the
pro-active management of around 50 key and strategic
suppliers who account for the large majority of expenditure.
Regular meetings are held to manage performance and to
identify and deliver ‘continuous improvement’ oppor-
tunities for further reducing cost while
improving
performance and service levels. This includes some eight
‘strategic partners’ responsible for significant areas of
outsourced services including capital delivery, water
distribution, sewer management and customer service.
Management of these strategic partners is co-ordinated by
the Contract Strategy Group including key members of South
West Water’s Executive Management Team.

South West Water has robust pre-qualification and tender
procedures included within the Company’s ISO 9001
Quality Management system delivering best practice and
ensuring compliance with EU procurement regulations.
Qualification and tender processes take full account of
environmental, social and ethical factors providing a
comprehensive approach to the management of
corporate responsibility through the supply chain.

All waste management facilities require planning
permission, whilst landfill (and certain other facilities)
also require a waste management licence or a PPC permit,
issued and enforced by the EA. Viridor Waste maintains a
positive working relationship with the EA, proactively
liaising on and managing issues at both a site-specific
and strategic level. Likewise, with regard to obtaining
planning consents for new or extended facilities, Viridor
Waste proactively consults and openly communicates
with local communities and other key stakeholders
throughout the planning application process in order to
respond to concerns and to maximise the chances of
gaining consent.

A ‘good neighbour’ attitude exists at all facilities
managed by Viridor Waste with local liaison groups
consisting of locally elected representatives of the
community meeting regularly to be consulted about the
company’s plans and operating procedures. Liaison
groups also include representatives of the EA and the
relevant planning authority.

Supplier forums

FINANCIAL POSITION

Engagement of suppliers is the challenge faced by South
West Water, arising from the Periodic Review process. It is
reinforced through supplier forums where repre-
sentatives of supplier organisations are invited to a
sharing of details related to the size, shape and nature of
the future capital investment programme.

Financiers

South West Water is financed from a number of sources.
These include relationship banks who have provided
long-term finance lease facilities and also provide
shorter-term facilities for periods of up to five years. A
further important source of low cost medium to long-term
funding is the European Investment Bank (EIB). The EIB
is able to lend proportionately more to South West Water
because Cornwall is regarded by the EIB (and EU) as
having particular economic difficulties due to high
unemployment and low income. The EIB has recently
agreed to extend a further £70 million of funding for the
K4 period.

Analysis of the Group’s financial position

The Group’s financial results showed growth in both
turnover and profit before tax from continuing operations.

Turnover and operating profit

Turnover rose by 17.6% to £554.2 million. South West
Water turnover was £309.8 million, up 6.2% on 2003/04,
principally resulting from the additional increase in
tariffs approved by the water regulator. Turnover for
Viridor Waste at £248.3 million was 35.6% up on
2003/04. The acquisitions accounted for £40.2 million of
the increase and underlying business £25.0 million.
Landfill tax within turnover increased by £8.2 million.

Group operating profit before the exceptional items
increased by £11.7 million. South West Water achieved a
£121.7 million operating profit, up £2.8 million on
2003/04. Viridor Waste contributed £26.3 million (after
goodwill amortisation of £3.5 million), up £6.1 million on
2003/04 and representing 18.4% of the operating profit
of the Group in 2004/05 (2003/04 15.6%).

Pennon Group Plc

There were three exceptional items during the year:

Finance costs

– Costs of £1.5 million (2003/04 £6.5 million) relating
to the abortive acquisition of the UK landfill and
landfill gas operations of Shanks Group Plc where
discussions were terminated on 25 May 2004.

– Restructuring costs in South West Water of

£3.4 million (2003/04 nil).

– Profit of £5.0 million (2003/04 nil) relating to the

balance of proceeds due from the 1998 disposal of the
Group’s interest in Societa Italo Britannica dell’Acqua
Srl (SIBA).

Group earnings before interest, taxation, depreciation
and goodwill amortisation (EBITDA) amounted to £243.9
million before the exceptional items (2003/04 £222.0
million) including South West Water £187.8 million
(2003/04 £181.7 million) and Viridor Waste £56.0
million (2003/04 £43.2 million).

Total Group operating costs were £406.2 million
excluding the exceptional items, (2003/04 £335.0
million) and included the following major categories of
expenditure:

Depreciation and goodwill amortisation

Manpower

Landfill tax

Raw materials and consumables

Property costs

Transport

Power

Abstraction and discharge consent costs

Statutory operating licences and royalties

Lease rentals – plant and machinery

£m

98.6

73.1

56.7

18.6

17.1

15.7

10.3

7.4

6.9

4.8

Offsetting the above power costs was revenue from power
generation of £17.6 million.

Net interest payable was £60.7 million (2003/04 £57.2
million), which was 2.4 times covered by Group operating
profits in both years.

Gross interest payable was £74.0 million. Gross interest
receivable of £13.3 million was derived from the
investment of temporarily surplus funds.

Net interest payable represents a rate of 5.5% when
measured against average net debt (2003/04 5.5%).

Profit before tax

Profit before tax was £87.4 million before the exceptional
items, £8.6 million up on 2003/04, an increase of 10.9%.

Viridor Waste achieved a pre-tax return on investment in
2004/05 of 9.2% (2003/04 7.5%).

Taxation

The corporation taxation charge for the year was £18.7
million (2003/04 £10.8 million). The deferred tax charge
for the year was £10.8 million (2003/04 £3.3 million).

Earnings per share

Earnings per share before deferred tax and the
exceptional items increased by 9.4% to 63.1p. Basic
earnings per share increased 9.6% to 54.6p.

Dividends and retained earnings

The Directors recommend the payment of a final dividend
of 29.2p per share for the year ended 31 March 2005.
Together with the interim dividend of 13.8p per share
paid on 7 April 2005, this makes a total dividend for the
year of 43.0p per share, an increase of 4.9% on the
dividend for 2003/04.

The dividend of 43.0p per share results in a dividend
cover of 1.4 times.

The total cost of the interim dividend and recommended
final dividend of the Company is £55.1 million. The
retained surplus of £13.7 million has been transferred to
reserves.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

International Financial Reporting Standards

Payments to suppliers

Preparation for the adoption of International Financial
Reporting Standards (IFRS) in 2005/06 is under way. The
principal differences between current UK and
International Accounting Standards likely to impact on
the Group are detailed on pages 86 to 88. The overall net
impact will be to reduce Group reported net assets. The
adoption of IFRS and the reduction in reported net assets
do not affect current dividend policy, compliance with
debt covenants, or underlying cash flow.

It is the Group’s payment policy for the year ending 31
March 2006 to follow the Code of The Better Payment
Practice Group on supplier payments. Information about
the Code can be obtained from www.payontime.co.uk
The Company will agree payment terms with individual
suppliers in advance and abide by such terms. The ratio,
expressed in days, between the amount invoiced to the
Company by its suppliers during 2004/05 and the amount
owed to its trade creditors at 31 March 2005, was 30 days.

Investment

Share capital

Capital expenditure by the Group on tangible fixed assets
was £188.4 million (2003/04 £170.0 million). The major
categories of expenditure comprised:

South West Water

Water mains renovation

Water supply leakage control

Water treatment works

Sewage treatment works

Sewerage

Sewage sludge treatment

Viridor Waste

Landfill

Power generation

Collection

£m

34.8

7.9

3.7

42.8

25.0

2.2

£m

21.7

3.8

2.8

Other expenditure included investment in information
systems, metering and transport.

During the year, the nominal value of the Company’s
issued ordinary share capital increased from £137.9
million to £142.0 million. The weighted average number
of shares in issue during the year was 126.0 million
(2003/04 123.5 million).

The value of net assets per share at book value at 31
March 2005 was 733p.

Permission was obtained from shareholders at the Annual
General Meeting in July 2004 to purchase up to 10% of
the Company’s ordinary share capital. Renewal of the
authority will be sought at the July 2005 Annual General
Meeting.

Accounting policies critical to understanding
the performance and financial position

Pennon Group’s Principal Accounting Policies are set out
on pages 54 to 56. To apply certain of these policies,
management
is required to make estimates and
assumptions that affect reported profit, assets and
liabilities. Actual outcomes could differ from those
calculated based on estimates or assumptions.

Pennon Group believes that the accounting policies
outlined below are the critical policies where changes in
the estimates and assumptions made could have a
impact on the consolidated financial
significant
statements.

In the opinion of the Directors, the current market value
of land and buildings is not significantly different from
the holding cost shown in the financial statements.

Landfill costs

The estimation of landfill reserves is of particular
importance in assessing landfill costs, since the cost of a
landfill site is depreciated over its estimated operational
life taking into account the usage of void space. The

Pennon Group Plc

Group’s estimates of landfill reserves are regularly
reviewed and updated during the financial year for usage
and other events (for example site extensions). Estimates
are also subject to physical review by external advisors. A
number of factors impact on the value of landfill reserves,
including the available landfill space, future capital
expenditure and operating costs. The valuation is subject
to revision as these factors change.

Carrying value of long-life assets

The Group’s accounting policy for tangible fixed assets is
detailed in note 1(f) of the consolidated financial
statements. The carrying value of tangible fixed assets as
at 31 March 2005 was £2,248 million. In the year ended
31 March 2005, additions to tangible fixed assets totalled
£188 million and the depreciation charge was £96
million. The estimated useful economic lives of fixed
assets are based on management’s judgement and
experience. When management identifies that actual
useful lives differ materially from the estimates used to
is adjusted
calculate depreciation,
prospectively. Due to the significance of fixed asset
investment to the Group, variations between actual and
estimated useful lives could impact operating results
both positively and negatively. Historically, few changes
to estimated useful lives have been required.

that charge

Revenue recognition

The Group recognises revenue generally at the time of
delivery. Payments received in advance of revenue
recognition are recorded as deferred revenue.

In South West Water’s case, the Group raises bills and
recognises revenue in accordance with its entitlement to
receive revenue in line with the limits established by the
Periodic Review price setting process. For water and
waste water customers with water meters, income
recognised is dependent upon the volume supplied
including an estimate of the sales value of units supplied
between the date of the last meter reading and the year
end. Estimated usage is based on historic data,
judgement and assumptions; actual results could differ
from these estimates which would result in operating
revenue being adjusted in the period that the revision to
the estimates is determined.

Accounting for provisions and contingencies

The Group is subject to a number of claims incidental to
the normal course of its business, relating to and
including commercial, contractual and employment
matters, which are handled and defended in the ordinary
course of business. The Group routinely assesses the
likelihood of any adverse judgments or outcomes to these
matters as well as ranges of probable estimated losses.
Reasonable estimates involve judgments made by
management after considering information including
notifications, settlements, estimates performed by
independent parties and outside counsel, available facts,
identification of other potentially responsible parties and
their ability to contribute and prior experience. A
provision is recognised when it is probable that an
obligation exists for which a reliable estimate can be
made after careful analysis of the individual matter. The
required provision may change in the future due to new
developments and as additional information becomes
available. Matters that are either possible obligations or
do not meet the recognition criteria for a provision are
disclosed, unless the possibility of transferring economic
benefits is remote.

Depreciation

Fixed assets excluding landfill sites are depreciated using
the straight-line method. The cost of a landfill site is
depreciated over its estimated operational life taking
into account the usage of void space.

Renewals accounting

The depreciation charge for infrastructure assets is the
estimated level of annual expenditure to maintain the
operating capability of the network which is based on
South West Water’s Asset Management Plan which has
been certified by W S Atkins Limited, an independent
infrastructure management consultant approved by
Ofwat. Variations between actual infrastructure spend
and estimated spend are included in the balance sheet,
with the principle being to ‘equalise’ the effect of annual
spend variations on the charge to the profit and loss
account. Changes in the plan assumptions (including
judgements relating to the condition and performance of
infrastructure assets) could give rise to a different
operating profit.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

Restoration and aftercare

Restoration and aftercare provisions are recognised in
the financial statements at the net present value of the
future expenditure required to settle the Group’s
restoration and aftercare obligations. The discount
implicit in recognising the restoration and aftercare
liability is unwound over the life of the provision and is
included in the profit and loss account as a financial item
within the net interest charge. Where a provision gives
access to future economic benefits, an asset is recognised
and depreciated in accordance with the Group’s
depreciation policy.

The measurement of restoration and aftercare provisions
involves the use of estimates and assumptions such as the
discount rate used to determine the net present value of
the liability. The estimated cost of restoration and
aftercare is based on engineering estimates and reports
from independent advisors. In addition, the payment
dates of expected restoration and aftercare costs are
uncertain and are based on economic assumptions
surrounding the useful economic lives of the assets
concerned.

Impairments

The Group reviews its assets for impairment if there is an
indication that the carrying amount may not be
recoverable. Impairment reviews compare the carrying
value of an income generating unit with its recoverable
amount. The recoverable amount is the higher of the net
realisable value and the estimated value in use. Value in
use is based on the net present value of expected future
pre-tax cash flows. Impairment reviews may cover all
operating segments.

Long-term assumptions are used to determine the net
present value of future cash flows for use in impairment
reviews. Particular assumptions which impact the
calculations are discount rates and the terminal value of
assets and income streams.

Deferred tax

maturity dates to those of the deferred tax assets and
liabilities. The Group uses long-term UK gilt rates to
reflect the long-life nature of infrastructure and
operational assets. A deferred tax asset is regarded as
recoverable and therefore recognised only when, on the
basis of available evidence, it is regarded as more likely
than not that there will be suitable taxable profits from
which the future reversal of the underlying timing
differences can be deducted. Changes to management’s
view of the recoverability of deferred tax assets could give
rise to different tax charges.

Provision for doubtful debts

At each balance sheet date, each subsidiary evaluates the
collectability of trade debtors and records provisions for
doubtful debts based on experience. For example,
comparisons of the relative age of accounts and
consideration of actual write-off history. The actual level
of debt collected may differ from the estimated levels of
recovery, which could impact operating results positively
or negatively. As at 31 March 2005, the Group’s gross
trade debtors were £88 million.

Goodwill

The Group records all assets and liabilities acquired in
business acquisitions, including goodwill, at fair value.
Goodwill is amortised by equal annual instalments over
the estimated useful life of 20 years. Goodwill is assessed
for impairment whenever events or circumstances might
indicate that it may be impaired. As at 31 March 2005, the
net book value of goodwill was £63.0 million and the
amortisation charge for the year then ended was £3.5
million. The initial goodwill recorded and subsequent
impairment analyses require management to make
subjective judgements concerning the fair value of
reporting units.

Pensions

The Group operates defined benefit schemes plus a
defined contribution section. Actuarial valuations of the
schemes are carried out as determined by the trustees at
intervals of not more than three years.

The Group accounts for deferred tax on a discounted
basis, as permitted by UK GAAP. The deferred tax
provision as at 31 March 2005 was £72.4 million. The
balance sheet provision is discounted using the rate of
interest at the balance sheet date on UK gilts with similar

The pension cost under SSAP 24 is assessed in accordance
with the advice of an independent qualified actuary based
on the latest actuarial valuation and assumptions
determined by the actuary. The assumptions are based on
information supplied to the actuary by the Company,

Pennon Group Plc

supplemented by discussions between the actuary and
management. The assumptions are disclosed in note 33
of the consolidated financial statements.

Capital structure

Overall position

With year end net debt of £1,119 million, the Group year
end debt to equity ratio was 119% (2003/04 119%). The
Directors believe this reflects an appropriate balance
sheet structure for the underlying businesses.

The borrowing powers of the Directors are limited to two
and a half times capital and reserves, as defined in the
Company’s Articles of Association. At 31 March 2005, the
limit was £2.6 billion. The Directors confirm that the
Group can meet its short-term requirements from the
existing borrowing
facilities without breaching
covenants or other borrowing restrictions.

South West Water

South West Water’s debt to regulatory asset value (RAV)
was circa 53% at 31 March 2005, just below Ofwat’s
‘optimum range’ of 55% – 65%. The scale of the
forthcoming K4 investment programme means that this
ratio is expected to progressively increase during the
next five years.

Viridor Waste

Viridor Waste is funded by a combination of Pennon
Group equity and debt (raised by Pennon Group and
direct borrowings by Viridor Waste). At the year end,
Viridor Waste’s net debt stood at £131 million, equivalent
to 2.3 times EBITDA. Viridor Waste’s net debt is expected
to increase substantially in 2005/06 with capital
investment to meet the requirements of its West Sussex
PFI contract and also developments at a number of its
existing operational sites which will facilitate growth in
2006/07 onwards.

The Board believes that South West Water and Viridor
Waste have adequate debt capacity for currently
anticipated
requirements, with an
appropriate margin to provide for currently unforeseen
opportunities/adverse movements.

investment

The Group continues to explore options to optimise
funding for the K4 period. These options could include
additional funding from the sources noted above as well
as other opportunities.

Treasury policies and objectives

The Group’s treasury function seeks to ensure that
sufficient funding is available to meet foreseeable needs,
maintains reasonable headroom for contingencies and
manages interest rate risk. It operates within policies
approved by the Board and does not undertake any
speculative trading activity.

Debt profile

At 31 March 2005, loans and finance lease obligations
were £1,422 million and the Group held current asset
investments and cash of £303 million. Net borrowings
increased by £45 million during the year to £1,119
million, principally as a result of the payment of
dividends, the cost of acquisitions of £29 million and
capital expenditure of £183 million.

A somewhat larger increase in net debt is projected in
2005/06 reflecting a significant increase in the South
West Water capital programme to meet regulatory targets
in December 2005, requirements of Viridor Waste’s West
Sussex PFI contract and investment for growth.

During 2004/05, the Group secured £65 million
additional term loans and £190 million additional
revolving credit facilities. In addition, the Group drew
down £57 million additional financing under existing
finance lease arrangements.

Pennon Group debt has a maturity of 0 – 29 years with an
average maturity of 15 years. The major components of
debt finance are:

– Finance leasing – £824 million
– EIB loans – £181 million
– Bank bilateral debt – £255 million
– 2012 Bond – £150 million

Interest Rate Management

Interest costs of £61 million equated to an average
interest rate of 5.5%.

The Group’s exposure to interest rate movements is
managed by the use of interest rate derivatives. The
Board policy is that in any one year at least 50% of net
debt is fixed. Interest rate swaps are used to manage the
mix of fixed and floating rates. Relatively low interest
rates have resulted in the Group fixing 70% of existing
net debt up to 31 March 2006, and 50% up to 31 March
2010. The notional principal amounts of the interest rate

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

swaps are used to determine settlement under those
swaps and are not, therefore, an exposure for the Group.
These instruments are analysed in more detail in note 30
to the financial statements.

The impact of future interest rate changes is expected to
be mitigated by the proportion of debt held at fixed rates
as noted above.

Overall, the net cash outflow of the Group, before the use
of liquid resources and financing, was £35.8 million
(2003/04 £71.9 million).

Capital expenditure for existing activities is expected to
reduce in 2006/07 onwards but the level of investment is
expected to result in the business being cash negative at
least up to 2010.

Refinancing risk management

Liquidity

Refinancing risk is managed under the Group Policy that
no more than 20% of Group net debt is permitted to
mature in any financial year.

Counterparty risk management

Surplus funds of the Group are usually placed in short-
term fixed interest deposits or the overnight money
markets. All deposits are with counterparties that have
credit ratings that are approved by the Board.

Counterparty risk arises from the investment of surplus
funds and from the use of derivative instruments. The
Board has agreed a policy for managing such risk, which
limits, counterparty
is controlled through credit
approvals, and rigorous monitoring procedures.

It is Group policy to ensure that the Group has committed
loan facilities equivalent to at least one year’s forecast
requirements at all times. This is achieved through the
use of credit facilities which are utilised as required and
re-financed using drawdowns for longer-term facilities.

Payment commitments are expected to be met on the
loan refinancing as required during the coming period.

Internal transfers

For regulatory purposes, South West Water funding is
treated as effectively ring-fenced. Funds raised by or for
South West Water are used in the appointed business
(provision of water and sewerage services) and are not
available as long-term funding for the rest of the Group.

Cashflows

Covenants

Pennon Group and South West Water have entered into
covenants with lenders. Whilst terms vary, these typically
provide for limits on gearing and interest cover.

The net cash inflow from operating activities was £255.3
million (2003/04 £215.1 million). Capital expenditure
cash outflow in 2004/05 was £183.0 million, an increase
of £1.1 million from £181.9 million in 2003/04. The net
cash outflow for acquisitions was £28.6 million (2003/04
outflow of £20.0 million). Equity dividends paid and
servicing of net debt involved a cash outflow of £87.4
million (2003/04 £88.3 million). Group net debt
increased from £1,074 million at 31 March 2004 to
£1,119 million at 31 March 2005. The net cash outflow
reflected continuing investment in South West Water and
Viridor Waste in excess of depreciation, together with the
acquisition of Thames Waste Management for £31 million
at the start of the financial year and the payment of
dividends.

Pennon Group Plc

Modelling future power generation requires consi-
deration of a number of factors including the waste mass
and composition already in place and volumes of gas
currently being extracted. In addition, the model
requires an assessment of how the current position is
expected to change throughout each site's remaining life
as an operational landfill and beyond into the aftercare
period. Any
requires certain
assumptions to be made including in relation to the
amount of waste in the site, its biodegradable content,
the age of the waste and the likelihood of obtaining a grid
connection at an economic cost.

such assessment

INTERPRETATION

Landfill void space and power generation
calculations

The landfill void space figures quoted in this OFR in
relation to Viridor Waste are in respect of consented void
only (void with planning permission for land filling).

The void space figures are based upon Viridor Waste’s
most recent assessment of void available to the company
for waste and daily cover materials. The void figures have
been assessed using pre-settlement levels (based upon
the extent of the planning consent), proposed base levels
(based upon the terms of the site licence/permit) and
existing waste surfaces (determined by survey). These
involve an element of
calculations necessarily
management judgement and are based on certain other
assumptions (such as the waste mix profile of a site).
However, Viridor Waste is of the opinion that its
calculation methodologies are in line with convention
typical in the landfill industry. The void actually available
at any one time may be different from the figures quoted.

Gas/electricity generating capacity of Viridor Waste is
defined by the megawatt capacity of the engines installed
on landfill sites through which the gas passes to generate
electricity.

Pennon Group Plc

OPERATING & FINANCIAL REVIEW

GLOSSARY

The following are descriptions of some of the terms used in this OFR:

DEFRA

Department for Environment, Food and Rural Affairs

Determination

The price limits and expenditure plans determined by Ofwat for South West Water
for a five year period

DWI

GWh

HWRS

IDoK

ISO 14001

June Return

LATS

LTCS

Ml/d

MWh

NFFO

Ofwat

PFI

PPC

Drinking Water Inspectorate

Environment Agency

Gigawatt hours

Household waste recycling sites

Interim Determination of K

International environmental accreditation standard

The annual return to Ofwat made by South West Water of its performance
during the last financial year

The South West Water Periodic Review period 2000 – 2005

The South West Water Periodic Review period 2005 – 2010

Local Authority Trading Scheme

Landfill Tax Credit Scheme

Megalitres

Megalitres per day

Megawatts

Megawatt hours

Non fossil fuel obligation

Office of Water Services

Private finance initiative

Pollution, Prevention and Control Permit

Periodic Review

The process of determining the price limits and expenditure plans of South West Water
for the next five-year regulatory period

RAV

RPI

ROCs

SEPA

SSAP 24

UK GAAP

Regulatory asset value

The UK Government’s Retail Price Index

Renewable obligation certificates

Scottish Environment Protection Agency

Statement of Standard Accounting Practice (Pensions)

UK Generally Accepted Accounting Principles

Water Regulator

The Director General of Water Services

By Order of the Board
KEN WOODIER, Group General Counsel & Company Secretary
23 June 2005

Pennon Group Plc

BOARD OF DIRECTORS

Gerard Dominic Connell MA, FCA (47)
Senior independent Non-executive Director
Was appointed on 1 October 2003. Gerard is
currently Group Finance Director of Wincanton Plc.
Previously he was a director of Hill Samuel and a
managing director of Bankers Trust and has held
other corporate finance and business development
positions in the City and in industry.

Katharine Mary Hope Mortimer MA, BPhil (59)
Non-executive Director
Was appointed on 1 May 2000. Kate is currently a
freelance financial consultant, a member of the
Crown Agents Foundation Council and a director
of Crown Agents Asset Management Limited and
Crown Agents Financial Securities Limited. She
was formerly a director of N M Rothschild & Sons
Limited, Director of Policy at the Securities and
Investments Board, Chief Executive of Walker Books
and was a member of the Competition Commission
between 1995 and 2001.

Dinah Alison Nichols CB, BA Hons (61)
Non-executive Director
Was appointed on 12 June 2003. Dinah was
formerly Director General Environment at the
Department for Environment, Food and Rural Affairs
and previously held various senior appointments
within Government departments including being
Head of the Water Directorate during the period of
water privatisation. She is also a Crown Estate
Commissioner, a non-executive director of Shires
Smaller Companies Plc, chair of the National Forest
Company, a board member of Toynbee Housing
Association and chair of Toynbee Partnership
Housing Association.

Kenneth George Harvey BSc, CEng, FIEE (64)
Non-executive Chairman
Was appointed on 1 March 1997. Ken was formerly
chairman and chief executive of Norweb Plc. He was
chairman of National Grid Holdings in 1995 and was
previously deputy chairman of London Electricity
and earlier its engineering director. He has also
been Chairman of a number of limited and private
equity funded companies. Currently he is a non-
executive director of National Grid Transco Plc.

Robert John Baty OBE, FREng, CEng, FICE, FCIWEM,
CCMI, ACIArb (61)
Chief Executive, South West Water Limited
Was appointed on 1 March 1996. Bob was formerly
engineering and scientific director of South West
Water Services Limited having joined South West
Water Authority in 1988. Previously he held
engineering and operational appointments with
North West Water Authority. He is also currently
a non-executive director of the Royal Devon &
Exeter NHS Foundation Trust.

Colin Irwin John Hamilton Drummond MA, MBA,
LTCL, CCMI (54)
Chief Executive, Viridor Waste Limited
Was appointed on 1 April 1992. Prior to joining the
Company Colin was a divisional chief executive of
Coats Viyella, having previously been corporate
development director of Renold plc, a strategy
consultant with the Boston Consulting Group and
an official of the Bank of England. He is Chairman
of the Government’s Environmental Sector
Advisory Group and was a member of the
Government’s Advisory Committee for Business
in the Environment between 2001 and 2003.

David Jeremy Dupont MA, MBA (51)
Group Director of Finance
Was appointed on 2 March 2002. David was formerly
regulatory and finance director of South West Water
Limited, having joined Pennon Group Plc (then
South West Water Plc) in 1992 as strategic planning
manager. Previously he held business planning and
development roles with Gateway Corporation.

COMMITTEES OF THE BOARD

Audit
Gerard Connell (Chairman)
Kate Mortimer
Dinah Nichols

Environment
Bruce Hewett (Chairman) (co-opted member)
Bob Baty
Colin Drummond

Nomination
Ken Harvey (Chairman)
Gerard Connell
Kate Mortimer
Dinah Nichols

Remuneration
Kate Mortimer (Chairman)
Gerard Connell
Dinah Nichols

Company secretary and registered office
Ken Woodier
Peninsula House, Rydon Lane, Exeter EX2 7HR
Registered in England No 2366640

Auditors
PricewaterhouseCoopers LLP
Chartered Accountants
31 Great George Street, Bristol BS1 5QD

Registrars
Lloyds TSB Registrars
The Causeway, Worthing, West Sussex BN99 6DA

Pennon Group Plc

DIRECTORS’ REMUNERATION REPORT

THE REMUNERATION COMMITTEE

The Remuneration Committee’s terms of reference include
advising the Board on the framework of executive remuneration
for the Group and responsibility
for determining the
remuneration and terms of employment of the Executive Directors
and senior management of the Group. During the year the terms
of reference of the Committee were revised to be in accordance
with corporate governance best practice and they now also
include determining the terms of engagement and remuneration
of the Chairman of the Company. The Committee comprises three
Non-executive Directors, being Kate Mortimer, who chairs the
Committee, Gerard Connell and Dinah Nichols. During the year
the Committee met on seven occasions and received advice, or
services, that materially assisted the Committee in the
consideration of remuneration matters from Ken Harvey
(Chairman of the Company), Ken Woodier (Group General Counsel
& Company Secretary), Deloitte & Touche LLP – remuneration
consultants, (appointed by the Committee) and Hewitt Bacon &
Woodrow Limited – pensions and remuneration consultants
(appointed by the Committee).

Hewitt Bacon & Woodrow also provided actuarial and investment
pensions advice to the Group during the year.

GROUP REMUNERATION POLICY

The policy of the Group, which will be applied by the
Remuneration Committee in 2005/06 and is also currently
intended to be applied in each subsequent year, continues to be
to provide for Executive Directors a remuneration package which
is adequate to attract, retain and motivate good quality
executives and which is commensurate with the remuneration
packages provided by companies of similar size and complexity.
The policy in respect of Non-executive Directors is set out on page
41 in the Non-executive Directors’ remuneration section.

Executive Directors

The remuneration package of the Executive Directors is
summarised below. It comprises salary, annual bonus, long term
incentives, pensions, car benefit and health cover. The total
package was reviewed during the year by Deloitte & Touche at the
request of the Remuneration Committee to ensure that it was
consistent with the overall Group policy. In 2005/06 (subject to
fluctuations in the Company’s share price and not taking account
of the operation in 2004/05 of the Company’s Restricted Share
Plan at a level up to 150% of basic salary as this was a ‘one off’ for
the reason stated in section (iii) on page 39 and is not due to
mature until 2007/08) it is expected that just over 60% of
Directors’ potential direct remuneration (i.e. excluding pensions,
car benefit and health cover) will be performance related (the
same as in 2004/05). It is intended that this balance between
performance related and that which is not related to performance
will continue.

Bob Baty, with the Board’s consent, is a non-executive director of
the Royal Devon & Exeter NHS Trust. For this appointment he
received a fee of £3,300 in 2004/05 from the Trust and the Board
has determined that he may retain such earnings.

(i) Basic salary and benefits – These are set out on page 42 for
each Executive Director and are not related to performance. The
Committee determines revised salaries, usually on an annual
basis, for Executive Directors based upon surveys conducted by
external consultants (being a commissioned survey from Deloitte
& Touche during 2004/05) and the performance of the individual
Executive Directors which the Committee assesses with the advice
of Ken Harvey, Chairman. Other benefits, not mentioned below,
include contributory pension provision (with four times salary life
assurance cover), a fully expensed car (or a cash equivalent
alternative) and health cover.

(ii) Performance related bonus – Annual performance related
bonuses are awarded in accordance with an Incentive Bonus Plan
for Executive Directors and based on the achievement of overall
corporate and individual objectives established by the Committee.
The maximum bonus achievable under the Plan for Executive
Directors is 80% of basic salary with half of any payment being in
the form of shares which must be held for a period of three years
before release. During this period, the Directors, in respect of
these shares, are entitled to receive any dividends declared by the
Company. No additional performance conditions applicable to the
release of these shares, apart from continuous service with the
Company, are considered appropriate by the Committee in view of
the performance conditions applicable to the initial award of the
shares.

The following corporate and individual objectives of the Executive
Directors applicable to the performance related bonus award for
2005/06 were determined by the Committee as appropriate
having regard to the activities of the Group that each individual
Director could most influence and also to the overall performance
of the Group, all of which seek to align the interests of the
Directors with those of shareholders (the references to a
percentage bonus relate to a percentage of the annual basic
salary of each Executive Director in 2005/06):

Bob Baty

– A bonus of up to a maximum of 20% for outperformance of
Group earnings per share against budget and up to 60% bonus
calculated by reference to the average bonus earned by the other
Executive Directors of South West Water (which relate to
outperformance against the operating costs and the profit before
tax budgets of the company; the position the company achieves
in the ‘Overall Performance Assessment’ of water and sewerage
companies established by the Director General of Water Services;
and the achievement of a range of service standards set by the
Director General of Water Services for the company).

Pennon Group Plc

DIRECTORS’ REMUNERATION REPORT

Colin Drummond

– A bonus of up to a maximum of 20% for outperformance of
Group earnings per share against budget and up to 60% bonus
calculated by reference to outperformance of profit before tax of
Viridor Waste against budget; and for personal objectives relating
to key business targets for Viridor Waste.

David Dupont

– A bonus of up to a maximum of 20% for outperformance of
Group earnings per share against budget and up to 60% bonus for
outperformance against budget relating to net debt and net
interest of the Group, profit before tax of South West Water and
Viridor Waste; and for personal objectives relating to Group
financing and Group initiatives.

The achievements of the Executive Directors against their
individual performance objectives are assessed by the Committee
following the financial year end when the audited results of the
Company and performance against parameters set are known.
This enables the Committee to apply largely objective criteria in
determining the level of bonus (if any) that should be awarded,
with the advice of Chairman, Ken Harvey.

(iii) Long Term Incentive Plan – A Restricted Share Plan for
Executive Directors and senior management, as approved by
shareholders at the Annual General Meeting on 29 July 1997, was
operated by the Company during the year. In respect of the
Executive Directors and certain senior management, no award
was made during 2003 because of the existence of unpublished
price sensitive information relating to the Company. Therefore,
following shareholder approval of a change to the rules of the
Restricted Share Plan granted at the Annual General Meeting on
29 July 2004, the Company made in 2004 the usual annual awards
and, in addition, for the Executive Directors and senior
management who did not receive the awards in 2003, a further
award of up to 75% of their basic salary (being an equivalent
percentage to that which they did not receive in 2003). For 2005
and 2006 (being the last year in which an award can be made
pursuant to the shareholder approval granted in 1997) the Plan
reverts to the original award level which provides for Executive
Directors to receive a conditional award of shares in the Company
up to a value of 75% of their basic salary provided they make a
matching investment in shares of the Company (by way of shares
they already hold or which they purchase) in the ratio of one
investment share for every four shares awarded. The eventual
number of shares, if any, which the Directors may receive is
dependent upon the achievement of the performance condition
of the Plan over the restricted period, being not less than three
years. During the restricted period the Directors are entitled to
receive, in respect of the awarded shares, any dividends declared
by the Company. In respect of the awards made to the Directors

for the years 1997, 1998 and 1999, no shares vested at the end of
each successive three year restricted period because the
performance criteria then applicable had not been met on each
occasion. With regard to the years 2000 and 2001 awards, all of
the shares awarded to Directors vested at the end of the restricted
period because the performance condition in respect of each
award had been met in full. It is expected that some (but not all)
of the shares awarded in 2002 to Directors will vest at the end of
the three year restricted period in September 2005 because the
performance condition has been partially met. For each of the
years 2000 to 2004 the performance condition to be satisfied for
at least 50% of the award to vest was:

The total shareholder return (TSR) achieved by the Company in the
performance period must be greater than that of the Company at or
nearest to (but not above) the 50th percentile position of the
comparator group.

A description of what percentage of the award vests by reference
to the position of the Company in the comparator group above the
50th percentile position is given on page 40.

The comparator group applicable for awards during the year to 31
March 2005 was as follows, with the comparator group applicable
to other previous award years being similar in content and size:

awg Plc
Bristol Water Holdings Plc
British Energy Plc
Centrica Plc
Dee Valley Group Plc
East Surrey Holdings Plc
International Energy Group Ltd
International Power Group Plc
Kelda Plc
National Grid Transco Plc
Northumbrian Water Group Plc
Pennon Group Plc
Scottish & Southern Energy Plc
Scottish Power Plc
Severn Trent Plc
South Staffordshire Group Plc (now Homeserve Plc)
United Utilities Plc
Viridian Plc

It is expected that the comparator group applicable to any awards
that may be made by the Committee in the current year will be
similar in content and size to the above group.

Pennon Group Plc

DIRECTORS’ REMUNERATION REPORT

received previously

The TSR performance condition was applied by the Committee
because, based upon advice
from
remuneration consultants, Meis, it believes that this is an
appropriate measure to align the interests of the Executive
Directors with those of shareholders. In addition, the Committee
believes that comparing the total shareholder return of the
Company to the other companies in the comparator group is
appropriate because the other companies operate in sectors similar
to that of the Company and therefore it is possible to demonstrate
superior performance by the Company if its TSR is at least higher
than half of the other companies in the comparator group.

If the performance condition is met then 50% of an award for the
year in question will vest with 100% of an award vesting if the
Company achieves the position equal or closest to but not above
the 75th percentile position or a position above the 75th percentile
position of the comparator group. The achievement of a position
between the 50th percentile position and the 75th percentile
position will result in vesting in steps reflecting the number of
companies within that third quartile of the comparator group.

The TSR of each company in the comparator group is measured by
Hewitt Bacon & Woodrow and is calculated by taking the average
market value of each company’s shares for the whole of March
before the beginning of the three year performance period and
comparing this to the average market value of the same shares for
the whole of March at the end of the three year period. The share
price is averaged for the whole of the month of March to avoid any
distortion of the TSR values from any significant daily share price
movements during the month.

(iv) Sharesave Scheme – Executive Directors are entitled to
participate in this Scheme. It is an all-employee plan to which
performance conditions do not apply.

In addition, following the canvassing of all Group employees to
gauge interest, the Board is proposing to launch a Share
Incentive Plan (SIP) this year which will be an all-employee plan
where performance conditions will not apply.

(vi) Provision for Pension – Executive Directors participate in the
Pennon Group Pension Scheme and the Pennon Group Executive
Pension Scheme. These are funded defined benefit schemes. Through
membership of these schemes, Executive Directors will be provided
with a pension which, dependent on length of service at normal
retirement date (age 60 or 62), will normally amount to two thirds of
final pensionable pay (subject to any restriction in respect of the
Earnings Cap which applies to Colin Drummond and David Dupont).

Colin Drummond and David Dupont (being subject to the Earnings
Cap) are both provided with additional pension benefits under the
unapproved funded Supplementary Scheme of the Company in
order to bring their pension benefits up to a level which would have
been provided under the other schemes if the Earnings Cap had not
applied. Executive Directors included in the unapproved pension
arrangements received payments equivalent to the tax liability
which arises in respect of Company contributions to the
Supplementary Pension Scheme.

The pensionable pay for Executive Directors consists of the highest
basic salary in any consecutive twelve month period of service
within five years of retirement. Bonuses are not included in
pensionable pay.

In determining remuneration arrangements for Executive
Directors, full consideration is given to their impact on the pension
funds and costs of providing individual pension arrangements.

In view of the changes which come into effect as a result of the
Pensions Act 2004 and the Finance Act 2004 involving, in particular,
the simplification of taxation of pensions, the Remuneration
Committee is currently reviewing executive pension provisions.

Total shareholder return graph

The graph shows the value, over the five year period ending in
March 2005, of £100 invested in Pennon Group on 31 March 2000
compared with the value of £100 invested in the FTSE All-Share
Utilities (Other) Index. This Index is considered appropriate as it is
an equity market index of which the Company is a constituent.

(v) Service Agreements – In accordance with Company policy, all
Executive Directors have service agreements which are subject to
one year’s notice and which expire when Directors reach their
normal retirement age. No provision is made for termination
payments under the service agreements. In the event of
termination by the Company of any Executive Director’s service
agreement, the Board would determine what payments, if any,
should be made to the Director depending on the circumstances
of the termination. The dates of the agreements are:

300

250

200

150

100

Pennon Group

FTSE All-Share Utilities - other

Bob Baty
Colin Drummond
David Dupont

26 February 1996
5 March 1992
2 January 2003

Pennon Group Plc

2000

2001

2002
2003
Year ending 31 March

2004

2005

This performance graph has been produced in accordance with
Schedule 7A of the Companies Act 1985 as introduced by the
Directors’ Remuneration Report Regulations 2002.

DIRECTORS’ REMUNERATION REPORT

Non-executive Directors and the Chairman

Non-executive Directors’ remuneration (excluding the Chairman,
Ken Harvey) consisting of fees only set out below, is determined
by the Board of Directors (in the absence of the Non-executive
Directors) and is usually reviewed biennially, although in
2003/04 it was reviewed after one year to take account of market
changes in non-executive directors’ fees arising from the impact
of the Higgs Review on non-executive directors’ duties and
obligations. The level of fees was considered again in January
2005 and it was decided to defer the review until September 2005
to take into account the expected further impact of the Higgs
Review. In reviewing the fees, the Executive Directors take
account of market information on non-executive directors’ fees,
most recently from Deloitte & Touche who undertook a review at

the request of the Board. The policy to be applied in 2005/06
(which is also currently intended to be applied in each
subsequent year) continues to be to set fees around the median
level compared to the market, which the Executive Directors
believe is appropriate to attract and retain suitably experienced
Non-executive Directors on the Board. As referred to earlier, the
Chairman’s remuneration is now set by the Remuneration
Committee. The policy of the Committee to be applied in 2005/06
(which is also currently intended to be applied in each
subsequent year) is the same as that of the Executive Directors in
reviewing the fees of the Non-executive Directors. In addition to
a fee (determined with the advice of and market information from
Deloitte & Touche) the Chairman receives car benefit (fully
expensed) and health cover. No other benefits or remuneration
are received by the Chairman.

The fees of the Non-executive Directors (excluding the Chairman) payable for the full year 2004/05 were made up as follows:

Non-executive Director

Gerard Connell

Kate Mortimer

Dinah Nichols

Audit/Remuneration
Committee
membership fee
(£3,000 per
Committee)
£000

Basic fee
£000

Chairman of
Committee
fee
£000

–

Total
£000

The Non-executive Directors (excluding the Chairman) have contracts for services setting out their terms and conditions of appointment
which are subject to the Articles of Association of the Company and which may be extended by agreement between the Company and the
Non-executive Directors. No provision is made for any termination payment under these contracts.

The dates of their contracts are:

Director

Date of contract

Expiry of contract

Gerard Connell

Kate Mortimer

Dinah Nichols

30 September 2003
19 March 2005

10 June 2003

30 September 2006
30 April 2006
11 June 2006

The Chairman, Ken Harvey, has a contract for services dated 1 April 2005 which is subject to 12 months’ notice. No provision is made for
any termination payments under this contract.

The contracts for services of Ken Harvey and Kate Mortimer were revised during the year to reflect corporate governance best practice. The
contracts for services of Gerard Connell and Dinah Nichols already reflect corporate governance best practice. The contracts of all the Non-
executive Directors (including the Chairman) and those of the Executive Directors are available for inspection at the Company’s registered
office during normal business hours.

Pennon Group Plc
Pennon Group Plc

41
41

DIRECTORS’ REMUNERATION REPORT

The information set out on the remaining pages of this Remuneration Report (pages 42 to 44) has been audited by PricewaterhouseCoopers LLP.

Emoluments of Directors

The emoluments of individual Directors are shown in the table below:

Director

Chairman:

Ken Harvey

Executive Directors:

Bob Baty

Colin Drummond

David Dupont

Non-executive Directors:

Gerard Connell

Kate Mortimer
Dinah Nichols

Total

Performance related
bonus
payable†
£000

Salary/fees
£000

Other
emoluments*
£000

Payments
related to
supplementary
pension
£000

Total 2005
£000

Total 2004
£000

170

200

190

33
31

859

–

–
–

209

–

–
–

–

–
–

190

289

350

322

164

234

300

246

108

1,250

1,015

**Bob Baty has elected to waive this cash element of his performance related bonus.

*Other emoluments are car benefit and health cover.

† In addition to the performance related cash bonus, Executive Directors are due to receive a conditional award of shares as referred to in
a note to (c) ‘Incentive Bonus Plan – Deferred Shares’ on page 44.

No expense allowances chargeable to tax or termination/compensation payments were made during the year.

Directors’ pensions

Defined benefit pensions accrued and payable on retirement for Directors holding office during 2004/05 are shown in the table below:

Director

Bob Baty

Colin Drummond

David Dupont

Increase in
accrued pension
during 2004/05
(net of inflation)
£000
a

Increase in
accrued
pension
during 2004/05
£000
b

Accrued
pension at
31 March 2005
£000
c

Transfer
value at
31 March 2005
£000
d

Transfer
value at
31 March 2004
£000
e

Increase in
transfer value
(net of Directors’
contributions)
£000
f

Transfer value
of Column a
(net of Directors’
contributions)
£000
g

147

2,903

1,030

744

2,316

768

551

577

252

184

396

191

139

During the year, the sum of £83,000 was transferred from a former pension scheme by Colin Drummond into the Pennon Group Pension Scheme.

Column a above is the increase in accrued pension during 2004/05 (net of inflation). It recognises:

i
ii

the accrual rate for the additional period’s service based upon the pensionable pay at the end of the period; and
the effect of pay changes in real terms (net of inflation) upon the accrued pension at the start of the year.

Column b is the actual increase in accrued pension during 2004/05.
Column c is the accrued pension at 31 March 2005 payable at normal retirement age.
Column d is the transfer value of the accrued pension set out in column c as at 31 March 2005.
Column e is the transfer value of the accrued pension at the end of the previous financial year on 31 March 2004.
Column f is the increase in the transfer value during the year (column d minus column e) after deducting Directors’ contributions.
Column g is the transfer value of column a, less Directors’ contributions.
Columns d, e, f and g have been calculated in accordance with Actuarial Guidance Note GN11.

Pennon Group Plc

DIRECTORS’ REMUNERATION REPORT

Directors’ pensions continued

The Supplementary Pension Scheme, which mainly funds pension provision above the Earnings Cap, provides benefits in tax-paid lump
sum form at retirement. Appropriate figures have been included in the accrued pension totals shown on page 42.

Directors have the option to pay additional voluntary contributions; neither the contributions nor the resulting benefits are included in
the table shown on page 42.

Directors’ share interests

(a) Shareholdings

The number of shares of the Company in which Directors held beneficial interests at 31 March 2005 and 31 March 2004 were:

Director

2005

2004

Director

Bob Baty
Colin Drummond
David Dupont

49,959
29,062
25,595

28,722
14,455
15,924

Ken Harvey
Kate Mortimer

2005

2,644
265

2004

2,644
256

Additional shares have been acquired by the Directors since 31 March 2005 as follows as a result of participation in Personal Equity Plans,
Individual Savings Accounts and the scrip dividend alternative on 7 April 2005:

Bob Baty
Colin Drummond

45
34

David Dupont
Kate Mortimer

16
4

There have been no other changes in the beneficial interests or the non-beneficial interests of the Directors in the ordinary shares of the
Company between 1 April 2005 and 30 May 2005.

(b) Restricted Share Plan

In addition to the above beneficial interests, the following Directors have or had a contingent interest in the number of shares shown
below, representing the maximum number of shares to which they would or have become entitled under the Group’s Long Term Incentive
Plan with the relevant criterion being met in full.

Director and date
of award

Bob Baty
12/9/00
11/9/01
16/9/02
16/9/04

Colin Drummond
12/9/00
11/9/01
16/9/02
16/9/04

David Dupont
12/9/00
11/9/01
16/9/02
16/9/04

Conditional
awards
held at
1 April 2004

Conditional
awards
made in
year

Market price
upon award
in year

Vesting in
year
*
**

Value of shares
upon vesting
(before tax)
£

Conditional

Date of end of
awards period for qualifying
condition to be
held at
fulfilled
31 March 2005

16,174
16,294
18,514
–

6,842
7,038
14,694
–

–
–
–
37,059

–
–
–
35,206

598p
622p
638p
809.5p

16,174 *
16,294 **
–
–

6,842 *
7,038 **
–
–

118,070
131,981
–
–

49,947
57,008
–
–

–
–
18,514
37,059

–
–
14,694
35,206

–
–
15/9/05
15/9/07

* The 2000 awards vested on 27 May 2004 at a price of 730p per share because the criterion described in paragraph (iii) on page 39 was met in full.
** The 2001 awards vested on 13 September 2004 at a price of 810p per share because the criterion described in paragraph (iii) on page 39 was met in full.

Pennon Group Plc

DIRECTORS’ REMUNERATION REPORT

Directors’ share interests continued

During the year, the Directors received dividends on the above shares in accordance with the conditions of the Restricted Share Plan, as
follows: Bob Baty £16,406; Colin Drummond £16,406; David Dupont £9,813.

It is anticipated that some (but not all) of the shares will vest under the 2002 awards as the performance criterion has been partially met.

Director and date
of award

Bob Baty
26/7/02
25/7/03
28/6/04

Colin Drummond
26/7/02
3/12/02
25/7/03
28/6/04

David Dupont
26/7/02
25/7/03
28/6/04

Conditional awards
held at
1 April 2004

Conditional awards
made in
year

Market price
upon award
in year

Vesting in
year

Conditional awards
held at
31 March 2005

Date of end of
period for qualifying
condition to be
fulfilled

7,885
6,435
–

5,554
1,161
7,990
–

4,728
6,146
–

–
–
6,262

–
–
–
7,579

–
–
5,834

652p
652p
778.5p

652p
607p
652p
778.5p

652p
652p
778.5p

–
–
–

–
–
–
–

–
–
–

7,885
6,435
6,262

5,554
1,161
7,990
7,579

4,728
6,146
5,834

25/7/05
24/7/06
27/6/07

25/7/05
2/12/05
24/7/06
27/6/07

25/7/05
24/7/06
27/6/07

A further conditional award of shares will be made in 2005/06 to the value of the amount of the performance related cash bonus shown
in the Emoluments of Directors table on page 42. (Paragraph (ii) on page 38 sets out the provisions relating to the conditional award of
shares pursuant to the Incentive Bonus Plan).

During the year, the Directors received dividends on the above shares in accordance with the conditions of the long term incentive
element of the Bonus Plan as follows: Bob Baty £7,612; Colin Drummond £8,136; David Dupont £6,080.

It is anticipated that all of the shares will vest under the 2002 awards in 2005/06 as the criterion is expected to be met.

(d) Sharesave Scheme

Details of options to subscribe for shares of the Company under the all-employee Sharesave Scheme were:

Director and
date of grant

Options held
at 1 April 2004

Granted
in year

Exercised
in year

Market price
on exercising

Options held
at 31 March 2005

Exercise
price

Exercise period/
maturity date

Bob Baty
10/7/01
8/7/03

Colin Drummond
8/7/03

David Dupont
9/7/02

(e) Share price

792
1,047

1,745

2,924

–
–

–

792
–

–

822p
–

–
1,047

489p
530p

1/9/04 – 1/3/05
1/9/06 – 1/3/07

–

1,745

530p

1/9/06 – 1/3/07

2,924

566p

1/9/07 – 1/3/08

The market price of the Company’s shares at 31 March 2005 was 976p (2004 690.5p) and the range during the year was 677p to 1016p
(2004 575p to 697p).

By Order of the Board
KEN WOODIER, Group General Counsel & Company Secretary
23 June 2005

Pennon Group Plc

CORPORATE GOVERNANCE AND INTERNAL CONTROL

COMPLIANCE

The Board is committed to the highest standards of corporate
governance with the aim of continuing to enhance its effectiveness.
The Annual Report is the principal means of reporting to
shareholders on the Board’s governance policies. This section sets
out how the main and supporting principles of good corporate
governance contained in Section 1 of the new Combined Code issued
in July 2003 annexed to the UK Listing Authority Rules have been
applied by the Company in practice. Throughout the year, the
Company has complied with the provisions of the Combined Code.

THE BOARD

The Board of Directors at the end of the year comprised the
Chairman, three Executive Directors and three Non-executive
Directors. All of the Non-executive Directors are considered to be
independent and Gerard Connell is the Senior independent Non-
executive Director. The biographies on page 37 demonstrate a broad
range of business and financial experience and there is a clear
division of responsibilities between the roles of Chairman and the
Chief Executives of South West Water and Viridor Waste as recorded
in the descriptions of the roles approved by the Board. All Directors
are subject to re-election at least every three years.

During the year, the Board met in accordance with its schedule of
meetings on 10 occasions and at each meeting all Directors were
present with the exception of Gerard Connell on one occasion and
Kate Mortimer on two occasions. The Board also held six special
meetings during the year at which all Directors were present with the
exception of Kate Mortimer on two occasions. The Board has adopted
a Group Policy which includes a schedule of matters reserved for its
decision. The Board has delegated more detailed consideration of
certain matters to Board Committees, to the subsidiary boards of
South West Water and Viridor Waste and to the Executive Directors
and Group General Counsel & Company Secretary as appropriate.
Recognising this policy, the matters reserved to the Board include
the approval of financial statements, acquisitions and disposals,
major items of capital expenditure, authority levels for other
expenditure, risk management and approval of the Strategic Plan
and annual operating budgets. The Board operates by receiving
written reports circulated in advance from the Executive Directors
and the Group General Counsel & Company Secretary on matters
within their respective business areas within the Group. Under the
guidance of the Chairman, all matters before the Board are discussed
openly and if necessary, presentations and advice are received on
occasions from other senior executives within the Group or external
advisers.

Directors have access to the advice and services of the Group General
Counsel & Company Secretary and the Board has established a
procedure whereby Directors, in order to fulfil their duties, may seek
independent professional advice at the Company’s expense. The
training needs of Directors are reviewed on a regular basis.

The Board has an internal procedure to evaluate the performance of
the whole Board, each Committee, the Chairman, each individual
Director and the Group General Counsel & Company Secretary. This
evaluation procedure was carried out for the year by the Group General
Counsel & Company Secretary seeking all participants’ views on a
range of prescribed questions designed to ensure objective evaluation
of performance. The participants’ responses were then summarised
and evaluated by the Group General Counsel & Company Secretary for
the Board to consider and determine whether any changes were
necessary for the Board to be more effective. Overall performance was
considered to be satisfactory but a number of minor issues were
identified where changes could be made to improve performance. The
Chairman’s performance was evaluated separately by the Non-
executive Directors, led by the Senior Independent Non-executive
Director.

All Directors are equally accountable for the proper stewardship of the
Group’s affairs with the Non-executive Directors having a particular
responsibility for ensuring strategies proposed for the development of
the business are critically reviewed. The Non-executive Directors also
critically examine the operational and financial performance of the
Group and fulfil a key role in corporate accountability through their
membership of various Committees of the Board. Group Policy
allocates the tasks of giving detailed consideration to specified
matters, to monitoring executive actions and to assessing reward to
the Board Committees as follows:

Audit Committee

The Audit Committee was chaired by Gerard Connell, who has recent
and relevant financial experience, and the other members of the
Committee were Kate Mortimer and Dinah Nichols. During the year,
the Committee met on five occasions and all members were present
except Kate Mortimer on one occasion. In discharging its Terms of
Reference, the Committee receives reports and meets regularly to in
particular:

– monitor the integrity of the financial statements of the Group,
including a review of significant reporting judgements, prior to
approval by the Board;

– keep under review the effectiveness of the Group’s internal
controls, including all material financial, operational and
compliance controls and risk management systems;

– monitor and review the effectiveness of the Group’s internal audit
function and approve the annual internal audit plan; review the
findings of the internal audit function and review and monitor
management’s responsiveness to such findings;

– oversee the relationship with the external auditors including their
remuneration, appointment, reappointment and removal and in
addition monitor their independence and objectivity including the
supply of non-audit services; receive internal control reports from
the external auditors and meet with them in the absence of
management at least once a year to discuss their remit and any
issues arising from the audit.

Pennon Group Plc

CORPORATE GOVERNANCE AND INTERNAL CONTROL

The Committee pays particular attention to the independence and
objectivity of the auditors and has established a policy for the
engagement of the auditors for non-audit work by the Group. This
involves the Group Director of Finance setting out in a report to the
Committee reasons for appointing the auditors for any material work
and obtaining the approval of the Committee to such appointment
which the Committee will only grant if it is satisfied that the
auditors’ independence and objectivity are safeguarded. This is
achieved by reviewing the appointment with the auditors as
considered appropriate and receiving from the auditors at the year
end a letter setting out how the auditors believe their independence
and objectivity have been maintained. In addition, the Company’s
current auditors ensure that the senior partner responsible for the
external audit of the Group remains responsible for such audit for no
more than five years and that there is an independent partner who
is involved in planning and in the reviewing of the final accounts of
the Company and also any critical matters that may be identified in
the audit. Details of audit and non-audit fees are contained in note
3 to the financial statements on page 58. The Executive Directors
attend by invitation and the Company’s auditors have the right of
direct access to the Committee without the presence of any
Executive Director.

Remuneration Committee

The Remuneration Committee was chaired by Kate Mortimer and
Gerard Connell and Dinah Nichols were the other members of the
Committee. The Committee met on seven occasions during the year
and all members were present except Gerard Connell on one
occasion. The Committee is responsible for determining the
remuneration and terms of engagement of the Chairman and the
remuneration and terms of employment of the Executive Directors
and senior management of the Group. Members of the Remuneration
Committee do not participate in decisions concerning their own
remuneration. The Directors’ report on remuneration, which also
provides more information on the activities of the Remuneration
Committee, appears on pages 38 to 44.

Nomination Committee

The Nomination Committee was chaired by Ken Harvey and also
comprised Kate Mortimer, Dinah Nichols and Gerard Connell. It
meets as and when required to select and recommend to the Board
suitable candidates for appointment as Executive and Non-
executive Directors, determine the nomination process and review
succession plans. During the year, it met on two occasions (and all
members were present except for Kate Mortimer on one occasion) to
review succession plans for the Executive Directors of the Board and
senior management and to formally determine the nomination
process for Board appointments.

The Terms of Reference of the Audit, Remuneration and Nomination
Committees are available upon request to the Company Secretary and
are also set out on the Company’s website at www.pennon-group.co.uk

Environment Committee

The Environment Committee was chaired by Bruce Hewett (a co-
opted member and former Non-executive Director of the Company)
and also comprised the Chief Executives of South West Water and
Viridor Waste. The Committee met four times during the year with all
members present except for Bruce Hewett on one occasion. It is
responsible for reviewing and monitoring the environmental
policies of Group companies and their achievement of
environmental objectives and targets and considering the Group’s
annual corporate responsibility report.

INTERNAL CONTROL

Wider aspects of internal control

The Board acknowledges that it is responsible for the Company’s
system of internal control (including financial control) and for
reviewing its effectiveness. The system is designed to manage rather
than eliminate the risk of failure to achieve business objectives and
can only provide reasonable and not absolute assurance against
material misstatement or loss. There is an ongoing process for
identifying, evaluating and managing the significant risks faced by
the Company that has been in place throughout the year 2004/05
and up to the date of the approval of this Annual Report and
Accounts. The Board confirms that it continues to apply procedures
in accordance with the ‘Guidance on Internal Control’ (The Turnbull
Guidance) annexed to the Combined Code. As part of these
procedures, the Board has a formalised risk management policy
which provides for the identification of key risks in relation to the
achievement of the business objectives of the Group. This policy is
applied by all business units within the Group in accordance with an
annual timetable.

Risk identification

A full risk and control assessment is undertaken annually by the
management of each business to identify financial and non-
financial risks and is continuously updated. Each business then
receives as part of its regular management reports an enhanced and
focused assessment of key risks against corporate objectives. The
Board at each meeting receives from Executive Directors details of
any new high level risks identified and how they are to be managed,
together with details of any changes to existing risks and their
management. The subsidiary Boards of South West Water and Viridor
Waste also receive at each meeting similar reports in respect of their
own areas of responsibility. All senior managers are required to
certify on an annual basis that they have established effective
controls to manage risks and to operate in compliance with
legislation and Group procedures. All of these processes serve to
ensure that a culture of effective control and risk management is
embedded within the organisation and that the Group is in a
position to react appropriately to new risks as they arise. Details of
key risks affecting the Group are set out in the Operating and
Financial Review on pages 23 to 27.

Pennon Group Plc

CORPORATE GOVERNANCE AND INTERNAL CONTROL

INTERNAL CONTROL continued

DIRECTORS’ RESPONSIBILITIES STATEMENT

After the end of each financial year, both the Board and the Audit
Committee receive a report from the Group General Counsel &
Company Secretary on overall internal control compliance by the
Group. An evaluation of the effectiveness of internal control is then
undertaken initially by the Audit Committee and then reported to
the Board for final evaluation. For 2004/05, both the Committee
and the Board were satisfied with the effectiveness of the internal
control process and its operation.

Internal control framework

There is an established internal control framework which comprises:

(a)

(b)

(c)

(d)

a clearly defined structure which delegates an appropriate
level of authority, responsibility and accountability,
including responsibility for internal financial control, to
management of operating units;

a comprehensive budgeting and reporting function with an
annual budget approved by the Board of Directors, which
also monitors monthly achieved results and updated
forecasts for the year against budget;

documented financial control procedures. Managers of
operating units are required to confirm annually that they
have adequate financial controls in operation and to report
all material areas of financial risk. Compliance with
procedures is reviewed by the Company’s internal audit
function; and

an investment appraisal process for evaluating proposals for
all major capital expenditure and acquisitions, with defined
levels of approval and a system for monitoring the progress
of capital projects.

The Audit Committee regularly reviews the operation and
effectiveness of this framework and also annually reviews the scope
of work, authority and resources of the Company’s internal audit
function and reports to the Board on such reviews.

GOING CONCERN

The Directors consider, after making appropriate enquiries, that the
Company and the Group have adequate resources to continue in
operational existence for the foreseeable future. For this reason
they continue to adopt the going concern basis in preparing the
financial statements.

The Directors are required by the Companies Act 1985 to prepare
financial statements for each financial year which give a true and
fair view of the state of affairs of the Company and the Group as at
the end of the financial year and of the profit or loss of the Group for
the financial year.

In preparing the financial statements, appropriate accounting
policies have been used and consistently applied and reasonable
and prudent judgements and estimates have been made. All
relevant accounting standards which the Directors consider to be
applicable have been followed.

The Directors have responsibility for ensuring that accounting
records are kept which disclose with reasonable accuracy the
financial position of the Company and the Group and which enable
them to ensure that the financial statements comply with the
Companies Act 1985. They are responsible for safeguarding the
assets of the Group and hence for taking reasonable steps for the
prevention and detection of fraud and other irregularities.

RELATIONS WITH SHAREHOLDERS

The Company maintains a regular dialogue with its institutional
shareholders and has a well developed investor relations
programme. During the year, meetings with
institutional
shareholders were held and were attended by the Group Director of
Finance and the Company’s Investor Relations Manager and on
certain occasions, the Chairman, the Chief Executive of South West
Water and the Chief Executive of Viridor Waste also attended. The
Board encourages the participation of shareholders at the Annual
General Meeting and complies with the provisions of the Combined
Code in respect of relations with shareholders. In particular, Non-
executive Directors are invited to attend meetings with institutional
shareholders and analysts’ and brokers’ briefings. The Group
Director of Finance reports to the Board regularly on major
shareholders’ views about the Company. The Group Director of
Finance also conducts surveys of shareholder opinion, usually on an
annual basis, which are evaluated and reported on to the Board.

By Order of the Board
KEN WOODIER, Group General Counsel & Company Secretary
23 June 2005

Pennon Group Plc

REPORT OF THE DIRECTORS

THE DIRECTORS SUBMIT THEIR REPORT AND AUDITED FINANCIAL
STATEMENTS FOR THE YEAR ENDED 31 MARCH 2005

PRINCIPAL ACTIVITY AND BUSINESS REVIEW

The principal activities of the Company and its subsidiaries (‘the
Group’) continue to be the provision of water and sewerage
services and waste management. Further information regarding
the Group, including important events and its progress during the
year, events since the year end and likely future developments is
contained in the Chairman’s statement, in the Business reviews
and in the Operating and Financial Review on pages 2 to 36.

The principal subsidiaries of the Company are listed in note 32 to
the financial statements on page 78.

FINANCIAL RESULTS AND DIVIDEND

Group profit on ordinary activities after taxation was £68.8
million. The Directors recommend a final dividend of 29.2p per
ordinary share to shareholders on the register on 5 August 2005,
making a total for the year of 43.0p, the cost of which would be
£55.1 million, leaving a retained surplus of £13.7 million to be
transferred to reserves.

The Operating and Financial Review on pages 28 to 34 analyses the
results in more detail and sets out other financial information,
including the Directors’ opinion on asset values (page 30).

DIRECTORS

EMPLOYMENT POLICIES AND EMPLOYEE
INVOLVEMENT

The Group has a culture of continuous improvement through
investment in people at all levels within the Group.

The Company is committed to pursuing equality and diversity in
all its employment activities including recruitment, training,
career development and promotion and ensuring there is no bias
or discrimination in the treatment of people. In particular, the
Company welcomes applications for employment from disabled
persons and makes special arrangements and adjustments as
necessary to ensure that disabled applicants are treated fairly
when attending for interview or for pre-employment aptitude
tests. Wherever possible, the opportunity is taken to retrain
people who become disabled during their employment in order to
maintain their employment within the Group.

Employees are consulted regularly about changes which may
affect them either through their Trade Union appointed
representatives or by means of the elected Staff Council which
operates in South West Water for staff employees. These forums,
together with regular meetings with particular groups of
employees, are used to ensure that employees are kept up to date
with the operating and financial performance of the Company.
The Group also uses a monthly information cascade process to
provide employees with important and up to date information
about key events.

Bob Baty, David Dupont and Kate Mortimer are due to retire at the
Annual General Meeting and offer themselves for re-election.
Resolutions for their re-election will be proposed at the Annual
General Meeting.

The Group encourages share ownership amongst its employees by
operating an Inland Revenue approved sharesave scheme open to
all eligible employees and intends to launch a Share Incentive
Plan (SIP) to further develop this policy.

No Director has, or has had, a material interest, directly or
indirectly, at any time during the year under review in any
contract significant to the Company’s business.

A list of all the Directors during the year is set out in the
emoluments table on page 42. Further details relating to the
Directors and their service contracts or contracts for services are
set out on pages 38 to 44 and details of the Directors’ interests in
shares of the Company are given on pages 43 and 44.

Further information relating to employee matters is set out in the
Operating and Financial Review on page 18.

RESEARCH AND DEVELOPMENT

Research and development activities within the Group involving
water and waste treatment processes amounted to £0.1 million
during the year (2003/04 £0.1 million).

Pennon Group Plc

REPORT OF THE DIRECTORS

DONATIONS

ANNUAL GENERAL MEETING

During the year, charitable donations amounting to £100,000
were made. Details relating to charitable and other donations are
set out in the Operating and Financial Review on page 20. No
political donations were made.

TAX STATUS

The Company is not a close company within the meaning of the
Income and Corporation Taxes Act 1988.

PAYMENTS TO SUPPLIERS

The sixteenth Annual General Meeting will be held at the
Plymouth Pavilions, Millbay Road, Plymouth, Devon PL1 3LF on 28
July 2005 at 11.00am.

In addition to routine business, resolutions will be proposed at
the Annual General Meeting to:

renew the existing authorities to issue a limited number of
shares and to purchase up to 10% of the issued share capital

seek authority to make political donations under the Political
Parties, Elections and Referendums Act 2000

Details are set out in the Operating and Financial Review on
page 30.

re-elect Bob Baty, David Dupont and Kate Mortimer as
Directors of the Company

seek approval to amend the Articles of Association of the
Company by way of separate resolutions to (a) amend the
borrowing powers of the Company, and (b) update the
Articles generally.

Details of the resolutions are set out in the Notice of Annual
General Meeting on pages 90 to 95 of this Annual Report.

By Order of the Board
KEN WOODIER, Group General Counsel & Company Secretary
23 June 2005

SUBSTANTIAL SHAREHOLDINGS

Details are set out in the Shareholder information section on
page 96.

AUDITORS

PricewaterhouseCoopers LLP were appointed auditors until the
conclusion of the sixteenth Annual General Meeting. A resolution
for their re-appointment upon the recommendation of the Audit
Committee of the Board will be proposed at the Annual General
Meeting and the auditors have indicated their willingness to
continue in office.

APPOINTED BUSINESS

South West Water Limited is required to publish additional
financial information relating to the ‘appointed business’ as
water and sewerage undertaker in accordance with the
Instrument of Appointment from the Secretary of State for the
Environment. A copy of this information will be available from 15
July 2005 upon application to the Company Secretary at
Peninsula House, Rydon Lane, Exeter EX2 7HR.

Pennon Group Plc

INDEPENDENT AUDITORS’ REPORT

INDEPENDENT AUDITORS’ REPORT TO THE
MEMBERS OF PENNON GROUP PLC

We have audited the financial statements which comprise the
Group profit and loss account, the Group balance sheet, the
Company balance sheet, the Group cash flow statement, the
accounting policies and the related notes. We have also audited
the disclosures required by Part 3 of Schedule 7A to the
Companies Act 1985 contained in the Directors’ remuneration
report (‘the auditable part’).

RESPECTIVE RESPONSIBILITIES OF
DIRECTORS AND AUDITORS

The Directors’ responsibilities for preparing the Annual Report
and the financial statements in accordance with applicable
United Kingdom law and accounting standards are set out in the
Directors’ responsibilities statement. The Directors are also
responsible for preparing the Directors’ remuneration report.

Our responsibility is to audit the financial statements and the
auditable part of the Directors’ remuneration report in
accordance with relevant legal and regulatory requirements and
United Kingdom Auditing Standards issued by the Auditing
Practices Board. This report, including the opinion, has been
prepared for and only for the Company’s members as a body in
accordance with Section 235 of the Companies Act 1985 and for
no other purpose. We do not, in giving this opinion, accept or
assume responsibility for any other purpose or to any other
person to whom this report is shown or into whose hands it may
come, save where expressly agreed by our prior consent in writing.

We report to you our opinion as to whether the financial
statements give a true and fair view and whether the financial
statements and the auditable part of the Directors’ remuneration
report have been properly prepared in accordance with the
Companies Act 1985. We also report to you if, in our opinion, the
Directors’ report is not consistent with the financial statements,
if the Company has not kept proper accounting records, if we have
not received all the information and explanations we require for
our audit, or if information specified by law regarding Directors’
remuneration and transactions is not disclosed.

We read the other information contained in the Annual Report
and consider the implications for our report if we become aware
of any apparent misstatements or material inconsistencies with
the financial statements. The other information comprises only
the Chairman’s statement, the Business review, the Operating
and Financial Review, the unaudited part of the Directors’
remuneration report, the statements of compliance on corporate
governance and internal control and the Report of the Directors.

Pennon Group Plc

We review whether the corporate governance statement reflects
the Company’s compliance with the nine provisions of the 2003
Financial Reporting Council (FRC) Combined Code specified for
our review by the Listing Rules of the Financial Services Authority
and we report if it does not. We are not required to consider
whether the Board’s statements on internal control cover all risks
and controls, or to form an opinion on the effectiveness of the
Company’s or Group’s corporate governance procedures or its risk
and control procedures.

BASIS OF AUDIT OPINION

We conducted our audit in accordance with Auditing Standards
issued by the Auditing Practices Board. An audit includes
examination, on a test basis, of evidence relevant to the amounts
and disclosures in the financial statements and the auditable part
of the Directors’ remuneration report. It also includes an
assessment of the significant estimates and judgements made by
the Directors in the preparation of the financial statements and of
whether the accounting policies are appropriate to the Company’s
circumstances, consistently applied and adequately disclosed.

We planned and performed our audit so as to obtain all the
information and explanations which we considered necessary in
order to provide us with sufficient evidence to give reasonable
assurance that the financial statements and the auditable part of
the Directors’ remuneration report are free from material
misstatement, whether caused by fraud or other irregularity or
error. In forming our opinion, we also evaluated the overall
adequacy of the presentation of information in the financial
statements.

OPINION

In our opinion, the financial statements give a true and fair view
of the state of affairs of the Company and the Group at 31 March
2005 and of the profit and cash flows of the Group for the year
then ended, have been properly prepared in accordance with the
Companies Act 1985 and those parts of the Directors’
remuneration report required by Part 3 of Schedule 7A to the
Companies Act 1985 have been properly prepared in accordance
with the Companies Act 1985.

PRICEWATERHOUSECOOPERS LLP
Chartered Accountants and Registered Auditors
23 June 2005

GROUP PROFIT AND LOSS ACCOUNT
for the year ended 31 March 2005

Turnover
Continuing operations

Acquisitions

Total turnover

Operating costs

Group operating profit
Continuing operations

Acquisitions

Total Group operating profit

Share of operating profit/(loss) in joint venture

Total operating profit

Business disposal profit
Net interest payable

Profit on ordinary activities before taxation
Tax on profit on ordinary activities

Profit on ordinary activities after taxation
Dividends

Retained surplus transferred to reserves

Earnings per share
Before exceptional items and deferred tax:

Adjusted basic

Adjusted diluted

After exceptional items and deferred tax:

Basic

Diluted

Dividend per share

5
6

Before
exceptional
items
2005
£m

Exceptional
items
2005
£m

Notes

Before
exceptional
item
2004
£m

Exceptional
item
2004
£m

0.1

–

0.1

(0.3)

–

(0.3)

Total
2005
£m

514.0

40.2

554.2

–

(4.9)

(411.1)

(4.9)

–

139.6

3.5

(4.9)

143.1

514.0

40.2

554.2

(406.2)

144.5

3.5

148.0

148.1

–

(60.7)

87.4

(4.9)

5.0

–

0.1

143.2

5.0

(60.7)

87.5

(18.7)

68.8

(55.1)

13.7

63.1p

62.6p

54.6p

54.2p

43.0p

471.3

–

471.3

(335.0)

136.3

–

136.3

136.0

–

(57.2)

–

(6.5)

(341.5)

(6.5)

–

(6.5)

129.8

–

129.8

(6.5)

129.5

78.8

(6.5)

Total
2004
£m

471.3

–

471.3

–

(57.2)

72.3

(10.8)

61.5

(51.1)

10.4

57.7p

57.3p

49.8p

49.5p

41.0p

All operating activities are continuing operations, except the business disposal profit which relates to a discontinued operation.

There were no recognised gains or losses, other than the profit for the year, in 2005 and 2004.

There is no difference between the profits as reported and those profits on a historical basis.

The notes on pages 54 to 85 form part of these financial statements.

Pennon Group Plc

BALANCE SHEETS
at 31 March 2005

Fixed assets
Intangible assets

Tangible assets

Investments

Current assets
Stocks

Debtors: amounts falling due
after more than one year

Debtors: amounts falling due

within one year

Investments

Cash at bank and in hand

Current liabilities
Creditors: amounts falling due

within one year

Group Company

Notes

19
20

2005

£m

63.2

2,248.1

2.6

2,313.9

4.7

1.3

99.6

298.4

4.4

408.4

2004

Restated

(note 13)

£m

47.6

2,141.1

2.6

2,191.3

4.5

5.0

92.3

253.7

14.0

369.5

2004

Restated

(note 13)

£m

–

0.2

931.8

932.0

2005

£m

–

0.2

931.8

932.0

–

239.6

230.8

32.9

57.5

–

25.8

–

330.0

256.6

(270.9)

(293.6)

(358.1)

(476.1)

Net current assets/(liabilities)

137.5

75.9

(28.1)

(219.5)

Total assets less current liabilities
Creditors: amounts falling due
after more than one year

Provisions for liabilities and charges

Deferred income

Net assets

Capital and reserves
Called-up share capital

Share premium account

Profit and loss account

Shareholders’ funds

2,451.4

2,267.2

903.9

712.5

(1,366.8)

(1,234.9)

(293.6)

(108.7)

(37.8)

(94.0)

(38.7)

–

(158.7)

(0.1)

–

938.1

899.6

610.3

553.7

142.0

153.7

642.4

938.1

137.9

154.2

607.5

899.6

142.0

153.7

314.6

610.3

137.9

154.2

261.6

553.7

22
24

27
27

The notes on pages 54 to 85 form part of these financial statements.

Approved by the Board on 23 June 2005 and signed on its behalf by:

KEN HARVEY, Chairman

Pennon Group Plc

GROUP CASH FLOW STATEMENT
for the year ended 31 March 2005

2004
Restated
(note 13)
£m

2005
£m

255.3

215.1

(59.1)

(41.3)

(0.4)

(0.1)

(174.7)

(178.6)

(28.6)

(28.3)

(35.8)

(8.1)

72.5

(20.0)

(47.0)

(71.9)

(62.1)

155.7

Notes

35(a)

35(b)

Net cash inflow from operating activities

Returns on investments and servicing of finance

Taxation

Capital expenditure and financial investment

Acquisitions

Equity dividends paid

Net cash outflow before use of liquid resources and financing

Management of liquid resources

Financing

Increase in cash in year

35(c)

28.6

21.7

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

1. ACCOUNTING POLICIES

The main policies are:

(a) Accounting convention

The financial statements have been prepared under the historical cost convention and in compliance with all applicable accounting
standards, the requirements of the Financial Services Authority and, except for the treatment of grants and contributions on
infrastructure assets, with the Companies Act 1985. An explanation of this departure from the requirements of the Companies Act 1985 is
given in note 1(h) below.

(b) Basis of consolidation

The Group financial statements include the results of the Company and its subsidiary undertakings, each made up to 31 March 2005,
together with the attributable share of results and reserves of joint ventures on the basis of their latest financial statements. The results
of any undertakings acquired or disposed of during the year are included for the periods of ownership.

Turnover, excluding Value Added Tax, represents the income receivable in the ordinary course of business for goods and services provided.

(d) Landfill tax

Landfill tax is included within both turnover and operating costs.

(e) Intangible fixed assets and amortisation

From 1 April 1998, goodwill arising from the acquisition of subsidiary, joint venture and associated undertakings, representing the excess
of the purchase consideration over the fair value of net assets acquired, is capitalised and classified as an asset on the balance sheet.
Where goodwill has a finite economic life, it is amortised evenly over that period. For acquisitions before 1 April 1988 goodwill arising on
acquisitions was written-off directly to Group reserves.

When a subsidiary, joint venture or associated undertaking is sold, the profit or loss on disposal is determined after including the
attributable amount of unamortised goodwill or the goodwill previously written-off to Group reserves.

(f) Tangible fixed assets and depreciation

i Infrastructure assets (being mains and sewers, impounding and pumped raw water storage reservoirs, dams, pipelines and sea outfalls)

Infrastructure assets comprise a network that, as a whole, is intended to be maintained in perpetuity at a specified level of service by the
continuing replacement and refurbishment of its components.

Expenditure on infrastructure assets relating to increases in capacity or enhancement of the network, in accordance with defined
standards of service and to the maintenance of the operating capacity of the network, is treated as an addition and included at cost after
deducting grants and contributions.

The depreciation charge on infrastructure assets represents the level of annual expenditure required to maintain the operating capacity
of the network and is calculated from an independently certified Asset Management Plan.

ii Landfill sites

Landfill sites are included at cost less accumulated depreciation. The cost of a landfill site is depreciated over its estimated operational
life taking account of the usage of void space. Cost includes acquisition and development expenses.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

1. ACCOUNTING POLICIES continued

(f) Tangible fixed assets and depreciation continued

iii Other assets (including properties, overground plant and equipment)

Other assets are stated at cost less accumulated depreciation.

Freehold land is not depreciated. Other assets are depreciated evenly over their estimated economic lives, which are principally as follows:

Leasehold buildings
Freehold buildings
Operational structures
Fixed plant
Vehicles, mobile plant and computers

Over the period of the lease
30 – 60 years
40 – 80 years
20 – 40 years
3 – 10 years

Assets in the course of construction are not depreciated until commissioned.

The cost of assets includes directly attributable labour and overhead costs that are incremental to the Group.

(g) Leased assets

Assets held under finance leases are included in the balance sheet as tangible fixed assets at their equivalent capital value and are
depreciated over their estimated economic lives or the finance lease period, whichever is the shorter. The corresponding liability is
recorded as a creditor. The interest element of the rental costs is charged against profits, using the actuarial method, over the period of
the lease.

Rental costs arising under operating leases are charged against profits in the year they are incurred.

(h) Grants and contributions

Grants and contributions receivable in respect of capital expenditure on non-infrastructure assets are included in the balance sheet as
deferred income and are released to profits over the depreciable lives of the assets to which they relate.

Grants and contributions receivable relating to infrastructure assets have been deducted from the cost of tangible fixed assets. This is not
in accordance with the Companies Act 1985 which requires tangible fixed assets to be shown at cost and hence grants and contributions
as deferred income. This departure from the requirements of the Companies Act 1985 is, in the opinion of the Directors, necessary for the
financial statements to show a true and fair view as, while a provision is made for depreciation of infrastructure assets, it is calculated
from an independently certified Asset Management Plan and not determinable finite lives. Therefore, no basis exists on which to recognise
grants and contributions as deferred income. The effect of this treatment on the value of tangible fixed assets is disclosed in note 15.

Grants and contributions receivable in respect of expenditure charged against profits in the year have been included in the profit and loss
account.

(i) Investments

Listed investments held as current assets are stated at the lower of cost and net realisable value.

Short-dated unlisted securities held as current assets are stated at cost plus accrued income.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

1. ACCOUNTING POLICIES continued

(j) Employee Share Ownership Plan

The cost of shares acquired under the Employee Share Ownership Plan is recognised in the profit and loss account on a straight-line basis
over the period to which the performance criteria relate and is based on an assessment of the expectations of the extent to which those
performance criteria will be met. To meet the award, shares are held in a discretionary trust. Until such time as the shares vest
unconditionally with the employees, the consideration paid for the shares is deducted in arriving at shareholders’ funds.

The application of the Urgent Issues Task Force Abstract 17 (revised 2003) ‘Employee Shares Schemes’ and Urgent Issues Task Force
Abstract 38 ‘Accounting for ESOP Trusts’ has resulted in a change in the method of accounting for shares acquired under the Employee
Share Ownership Plan. The effect of this change is disclosed in note 13.

(k) Stocks

Stocks are stated at the lower of cost and net realisable value. Cost includes labour, materials and an element of overheads.

(l) Pension costs

The expected cost of pensions in respect of the Group’s defined benefit pension schemes is charged against profits so as to spread the cost
of pensions over the service lives of employees in the schemes. A pension surplus (or deficit) is released (or charged) to profits using the
straight-line method, over the remaining service lives of employees in the scheme.

Pension costs for the Group’s defined contribution schemes are charged against profits in the year in which they are incurred.

The financial statements reflect, as set out in note 33, only the disclosure requirements of Financial Reporting Standard 17 ‘Retirement
Benefits’.

(m) Research and development expenditure

Research and development expenditure is charged against profits in the year in which it is incurred.

(n) Taxation

Tax payable on profits for the year is provided at current rates. Tax deferred or accelerated as a result of timing differences between the
treatment of certain items for taxation and for accounting purposes is provided in full. Where the effect of the time value of money is
material the current amount of the reversals of tax deferred is discounted to its present value. The unwinding of the discount to present
value is included in the tax charge.

Deferred tax assets are recognised to the extent that it is regarded as more likely than not that there will be suitable taxable profits against
which the deferred tax asset can be recovered in future periods.

(o) Environmental and landfill restoration costs

Provisions for restoration, aftercare and environmental control costs are made when an obligation arises. Where the obligation
recognised as a provision gives access to future economic benefits, a tangible fixed asset is recognised. Provisions are otherwise charged
against profits.

Where the effect of the time value of money is material, the current amount of the provision is the present value of the expenditures
expected to be required to settle obligations. The unwinding of the discount to present value is included as a financial item within net
interest payable.

(p) Financial instruments

Derivative financial instruments are used to hedge interest rate risks. All such hedging instruments, including interest differentials which
arise, are matched with their underlying hedged item.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

2. SEGMENTAL ANALYSIS

Turnover
Continuing operations

Water and sewerage

Waste management
Other
Less intra-group trading

Group total

Group operating profit
Continuing operations before exceptional items and goodwill amortisation

Water and sewerage

Waste management

Other

Total continuing operations before exceptional items and goodwill amortisation

Group operating profit
Continuing operations after exceptional items and goodwill amortisation

Water and sewerage

Waste management

Other

Group total

Profit on ordinary activities before taxation
Continuing operations after net exceptional items and goodwill amortisation

Water and sewerage

Waste management

Other

Group total

2005
£m

2004
£m

309.8

248.3
6.9

(10.8)

291.8

183.1
7.3

(10.9)

554.2

471.3

121.7

29.8

–

151.5

118.3

26.3

(1.5)

118.9

22.7

(2.8)

138.8

118.9

20.2

(9.3)

143.1

129.8

67.1

18.0

2.4

87.5

70.1

14.7

(12.5)

72.3

Net assets/(liabilities)

Employees
(average number)

Continuing operations

Water and sewerage

Waste management

Other, including intra-group trading

2005

£m

871.4

99.1

(32.4)

2004
Restated
(note 13)

£m

2005

2004

896.0

97.9

(94.3)

1,336

1,169

1,341

895

2,275

Group totals

938.1

899.6

2,544

Water and sewerage business comprises the regulated water and sewerage services undertaken by South West Water Limited.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

2. SEGMENTAL ANALYSIS continued

Net liabilities of other continuing operations include parent company financing of business acquisitions. Profit before tax of other
continuing operations is shown after interest arising thereon.

Separate disclosure by geographical origin and destination is not shown since the operations of the Group are substantially located in the
United Kingdom.

There are no employees working outside the United Kingdom (2004 none).

3. OPERATING COSTS

Continuing

operations

£m

69.4
28.5

3.2

3.7

0.1

87.5

2.6

69.8

21.3

(1.4)

(1.3)

91.0

374.4

Acquisitions

£m

6.7
4.3

1.6

0.1

–

12.7

0.9

3.9

0.1

–

6.4

36.7

Manpower costs (note 11)
Raw materials and consumables

Rentals under operating leases:

Hire of plant and machinery

Other operating leases

Research and development expenditure

Other external charges

Amortisation of intangible fixed assets

Depreciation:

On owned assets

On assets held under finance leases

Profit on disposal of tangible fixed assets

Deferred income released to profits

Other operating charges

Operating costs include the exceptional items set out in note 4.

Fees payable to the Group’s auditors

Audit services

Statutory audit

Regulatory audit and reporting

Other assurance services

Tax services

Compliance services

Advisory services

Other services

Total

2005

£m

76.1
32.8

4.8

3.8

0.1

100.2

3.5

73.7

21.4

(1.4)

(1.3)

97.4

Total

2004

£m

57.9
35.8

3.5

3.2

0.1

70.4

2.5

66.8

19.3

(1.7)

(1.2)

84.9

411.1

341.5

2005

£000

308

220

105

2004

£000

250

116

740

219

385

Included within the statutory audit fee above is an amount of £46,000 (2004 £46,000) for the Company’s audit.

Regulatory audit and reporting is lower in 2005 than in 2004 as during 2004 the auditors were engaged in the audit of South West Water
Limited’s Periodic Review submission to Ofwat.

Other assurance services and tax advisory services in both years include costs relating to the abortive acquisition of the UK landfill
operations of Shanks Group Plc.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

3. OPERATING COSTS continued

Other services in 2004 represent fees for consulting services in relation to Viridor Waste Limited’s successful bid for a Private Finance Initiative
(PFI) contract with West Sussex County Council.

4. EXCEPTIONAL ITEMS

The exceptional items are:

Abortive acquisition costs

Other external charges

Water and sewerage business restructuring

Manpower costs

Other external charges

2005
£m

2004
£m

1.5

3.0

0.4

4.9

6.5

–

6.5

The abortive acquisition costs arise from negotiations to acquire the UK landfill and landfill gas operations of Shanks Group Plc where
discussions were terminated on 25 May 2004.

5. BUSINESS DISPOSAL PROFIT

Societa Italo Britannica dell’Acqua Srl

2005
£m

5.0

2004
£m

–

The business disposal profit relates to the balance of proceeds due from the 1998 arrangement to dispose of the Group’s interest in Societa
Italo Britannica dell’Acqua Srl.

The tax charge was not affected by the business disposal profit.

6. NET INTEREST PAYABLE

Interest payable:

Bank loans and overdrafts

Other loans

Interest element of finance lease rentals

Other finance costs

Interest receivable:

Listed redeemable securities

Other investments (as defined in note 20)

Unwinding of discount in provisions

Net interest payable

2005
£m

2004
£m

(23.5)

(16.2)

(32.7)

(0.6)

(73.0)

0.3

13.0

13.3

(1.0)

(60.7)

(18.8)

(16.7)

(29.6)

(0.5)

(65.6)

0.2

9.2

9.4

(1.0)

(57.2)

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

7. TAX ON PROFIT ON ORDINARY ACTIVITIES

(a) Analysis of charge for the year

Current tax:

UK corporation tax at 30%:

Current year
Prior year

Total current tax (note 7(b))

Deferred tax:

Origination and reversal of timing differences
Increase in discount

Total deferred tax (note 24)

Tax on profit on ordinary activities

(b) Factors affecting tax charge for the year

2005
£m

2004
£m

13.1
(5.2)

7.9

18.4
(7.6)

10.8

18.7

12.8
(5.3)

7.5

16.2
(12.9)

3.3

10.8

The tax assessed for the period is lower than the standard rate of corporation tax in the UK (30%). The differences are explained below:

Profit on ordinary activities before tax

Profit on ordinary activities multiplied by standard rate of corporation tax in the UK (30%)

Effects of:

Income not taxable/expenses not deductible for tax purposes

Capital allowances for year in excess of depreciation

Other timing differences

Adjustments to tax charge in respect of prior year

Current tax charge for year (note 7(a))

8. PROFIT OF PARENT COMPANY

Profit on ordinary activities after taxation dealt with in the accounts of the parent company

2005
£m

87.5

26.3

1.3

(14.8)

0.3

(5.2)

7.9

2004
£m

72.3

21.7

5.9

(15.3)

0.5

(5.3)

7.5

2005
£m

85.7

2004
£m

74.6

As permitted by section 230 of the Companies Act 1985, no profit and loss account is presented for the Company.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

9. DIVIDENDS

Interim dividend of 13.8p (2004 13.2p) per share paid 7 April 2005
Proposed final dividend of 29.2p (2004 27.8p) per share payable 5 October 2005

10. EARNINGS PER SHARE

Adjusted earnings:

Profit on ordinary activities

after taxation

Net exceptional items
Deferred tax

Profit
after tax
£m

2005

Earnings per share

Basic
p

Diluted
p

68.8
(0.1)
10.8

54.6
(0.1)
8.6

54.2
(0.1)
8.5

Adjusted earnings before exceptional

items and deferred tax

79.5

63.1

62.6

Profit
after tax
£m

61.5
6.5
3.3

71.3

2005
£m

17.7
37.4

55.1

2004

Basic
p

49.8
5.3
2.6

57.7

2004
£m

16.4
34.7

51.1

Earnings per share

Diluted
p

49.5
5.2
2.6

57.3

Adjusted earnings per share have been calculated to exclude the impact of net exceptional items and deferred tax on the results, as these
items can have a distorting effect on earnings from year to year and therefore warrant separate consideration.

The calculation of earnings per share is based on the profit on ordinary activities after taxation divided by the weighted average number
of ordinary shares in issue during the year of 126.0 million (2004 123.5 million).

All share options with an exercise price lower than the average market price of the Company’s shares during the year have been included
in the calculation of diluted earnings per share. The weighted average number of shares in issue during the year, taking account of the
dilutive effect of share options, was 126.9 million (2004 124.3 million).

11. EMPLOYEES AND EMPLOYMENT COSTS

The average number of persons (including Directors) employed by the Group was 2,544 (2004 2,275).

Employment costs comprise:

Wages and salaries
Social security costs
Pension costs

Total employment costs

Charged as follows:

Manpower costs (note 3):
Before exceptional costs
Exceptional costs (note 4)

Capital schemes
Restructuring provision

Continuing

operations

£m

Acquisitions

£m

59.3
5.1
14.8

79.2

66.4
3.0

69.4
9.8
–

79.2

6.1
0.5
0.1

6.7

6.7
–

6.7
–
–

6.7

Total
2005

£m

65.4
5.6
14.9

85.9

73.1
3.0

76.1
9.8
–

85.9

Total

2004

£m

55.2
4.4
7.1

66.7

57.9
–

57.9
8.5
0.3

66.7

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

12. DIRECTORS’ EMOLUMENTS

Executive Directors:

Salary

Performance related bonus payable

Vesting of Restricted Share Plan awards

Other emoluments

Payments in respect of tax liability from supplementary pension arrangements

Non-executive Directors

Total emoluments

2005
£000

590

209

607

108

289

2004
£000

490

153

–

262

1,857

1,042

The above performance related bonus payable represents the cash element. In addition, Directors receive a conditional award of shares
for a matching amount which is subject to a future service criterion as described in the Directors’ remuneration report on pages 41 to 44.

Conditional awards made to Directors in 2000 and 2001 vested during the year, as described in the Directors’ remuneration report on
page 43.

The emoluments of the highest paid Director were £600,000, which includes £250,000 from the vesting of two awards (one deferred from
the previous year) under the Company’s Restricted Share Plan (2004 £300,000).

Total gains made by Directors on the exercise of share options were £3,000 (2004 £4,000).

Total emoluments above include £911,000 (2004 £427,000) payable to Directors in respect of services performed as directors of
subsidiary undertakings. This sum also includes a total of £400,000 in respect of the vesting of the Restricted Share Plan awards described
above.

At 31 March 2005 and 31 March 2004, retirement benefits were accruing to three Directors under defined benefit pension schemes. The
accrued pension entitlement at 31 March 2005 under defined benefit schemes of the highest paid Director was £73,000 (2004 £57,000).
No pension contributions were payable to defined contribution schemes in 2005 or 2004.

More detailed information concerning Directors’ emoluments, shareholdings and share options is shown in the Directors’ remuneration
report on pages 38 to 44.

13. PRIOR YEAR ADJUSTMENTS

The Group’s accounting policy on the treatment of shares acquired under the Employee Share Ownership Plan has been changed following
adoption of Urgent Issues Task Force Abstract 17 (revised 2003) ‘Employee Share Schemes’ (UITF17 revised 2003) and Urgent Issues Task
Force Abstract 38 ‘Accounting for Employee Share Option Plan (ESOP) Trusts’ (UITF38).

The policy adopted by the Group for the treatment of shares acquired under the Employee Share Ownership Plan recognises in the profit
and loss account the cost of an award on a straight-line basis over the period to which the performance criteria relate and is based on an
assessment of the expectations of the extent to which those performance criteria will be met. To meet the award, shares are held in a
discretionary trust. Until such time as the shares vest unconditionally with the employees, the consideration paid for the shares is
deducted in arriving at shareholders’ funds. Previously, the shares acquired by the trust were recognised on the balance sheet at cost of
acquisition less impairment, being the charge to profits over the period to which the employees’ performance related. Any gain or loss on
transactions in own shares will be reported through the statement of movements in shareholders’ funds.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

13. PRIOR YEAR ADJUSTMENTS continued

As a result of these changes in accounting policy, the comparative year has been restated as follows:

Group and Company balance sheets

Previously reported

Application of UITF17 (revised 2003)

Application of UITF38

Restated now reported

Fixed asset

investments

2004

£m

3.6

3.7

(4.7)

2.6

Group

Profit and loss

reserve

2004

£m

608.5

3.7

(4.7)

Fixed asset

investments

2004

£m

932.0

1.3

(1.5)

Company

Profit and loss

reserve

2004

£m

261.8

1.3

(1.5)

607.5

931.8

261.6

The restatement of the Group’s profit and loss reserve at 31 March 2004 includes a prior period adjustment of £1.3 million at 31 March
2003. There has been no change to the amount recognised as the cost of the awards in the profit and loss account for the year.

Group cash flow statement

Previously reported

Application of UITF38

Restated now reported

14. INTANGIBLE FIXED ASSETS

Cost:

At 1 April 2004

Additions

At 31 March 2005

Amortisation:

At 1 April 2004

Charge for year

At 31 March 2005

Net book value:

At 31 March 2005

At 31 March 2004

Capital

expenditure and

financial investment

Financing

2004

£m

(179.2)

0.6

2004

£m

156.3

(0.6)

(178.6)

155.7

Goodwill
£m

Patents
£m

51.7
18.9

70.6

4.1

3.5

7.6

63.0

47.6

–
0.2

0.2

–
–

–

0.2

–

Total
2005
£m

51.7

19.1

70.8

4.1

3.5

7.6

63.2

47.6

All goodwill is amortised evenly over the Directors’ estimate of useful economic life, which is 20 years.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

15. TANGIBLE FIXED ASSETS

Land and
buildings
£m

Infrastructure
assets
£m

Operational
properties
£m

Fixed and
mobile plant,
vehicles and
computers
£m

Construction
in progress
£m

Group
Total
2005
£m

Company
Total
2005
£m

Cost:

At 1 April 2004

Arising on acquisitions

Additions

Grants and contributions

Disposals

Transfers/reclassifications

206.0

1,103.5

557.7

9.0

23.9

–

(2.1)

(3.8)

–

46.6

(2.8)

(0.7)

16.5

–

0.6

–

(0.9)

2.6

At 31 March 2005

233.0

1,163.1

560.0

Depreciation:

At 1 April 2004

Charge for year

Disposals

Transfers/reclassifications

At 31 March 2005

Net book value:

At 31 March 2005

At 31 March 2004

Assets held under finance leases

included above:

Cost: At 31 March 2005

Depreciation: Charge for year

Depreciation: At 31 March 2005

80.4

15.1

(2.1)

(0.2)

93.2

127.2

14.9

(0.7)

–

141.4

139.8

125.6

1,021.7

976.3

111.6

9.9

(0.9)

(0.5)

120.1

439.9

446.1

–

155.8

315.0

2.0

10.7

5.5

49.0

857.0

9.8

54.1

–

(12.2)

52.4

961.1

340.4

56.6

(11.4)

0.7

386.3

574.8

516.6

246.0

13.9

111.7

76.5

–

63.2

–

(0.1)

(67.7)

2,800.7

18.8

188.4

(2.8)

(16.0)

–

71.9

2,989.1

–

71.9

76.5

59.0

–

659.6

96.5

(15.1)

–

741.0

2,248.1

2,141.1

775.8

21.4

171.4

0.3

–

0.1

–

(0.1)

–

0.3

0.1

(0.1)

–

0.1

0.2

–

Tangible fixed assets of the Company comprise fixed and mobile plant, vehicles and computers.

The cost of land and buildings and of operational properties includes non-depreciable land of £5.1 million (2004 restated £4.7
million) and £9.3 million (2004 £9.3 million) respectively.

The net book value of land and buildings comprises:

Freehold

Long leasehold

Short leasehold

Long leasehold land and buildings have an unexpired term of not less than 50 years.

2005
£m

83.4

35.0

21.4

2004
£m

78.1

34.1

13.4

139.8

125.6

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

15. TANGIBLE FIXED ASSETS continued

The net book value of infrastructure assets is stated after deducting £49.8 million (2004 £47.0 million) grants and contributions.

The net book value of infrastructure assets includes £13.8 million (2004 £13.8 million) for the accumulated difference between
expenditure on maintaining operating capacity and depreciation charges. Expenditure in the year was £14.9 million (2004 £16.4 million).

Out of the total depreciation charge for the Group of £96.5 million (2004 £87.7 million), £1.4 million (2004 £1.6 million) has been
charged to capital projects and £95.1 million (2004 £86.1 million) against profits.

16. FIXED ASSET INVESTMENTS

Group

At 1 April 2004

Prior year adjustment (note 13)

At 1 April 2004 (restated)

At 31 March 2005

Company

At 1 April 2004

Prior year adjustment (note 13)

At 1 April 2004 (restated)

At 31 March 2005

Subsidiary

undertakings

£m

–

931.8

–

931.8

Own

£m

1.0

(1.0)

–

0.2

(0.2)

–

Other

investments

Total

investments

£m

2.6

–

2.6

–

2005

£m

3.6

(1.0)

2.6

932.0

(0.2)

931.8

All investments are in shares except other investments for the Group which includes £2.6 million loans (2004 £2.6 million).

Details of principal subsidiary, joint venture and associated undertakings of the Group are set out in note 32.

The Group’s share of the turnover of £4.5 million (2004 £4.2 million) and net liabilities of £0.3 million (2004 £0.4 million) of the joint
venture is not considered material for disclosure on the face of the Group Profit and Loss Account and Balance Sheet.

17. STOCKS

Raw materials and consumables

Work in progress

Group

Company

2005

£m

4.6

0.1

4.7

2004

£m

4.1

0.4

4.5

2005

£m

–

2004

£m

–

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

18. DEBTORS: AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR

Amounts owed by subsidiary undertakings

Amounts owed by joint venture

Other debtors

Prepayments for pension costs

Deferred tax (note 24)

19. DEBTORS: AMOUNTS FALLING DUE WITHIN ONE YEAR

Trade debtors

Amounts owed by subsidiary undertakings

Amounts owed by joint venture

Other debtors

Prepayments for pension costs

Other prepayments and accrued income

20. CURRENT ASSET INVESTMENTS

Listed investments

Other investments:

Overnight deposits

Other

Group

2004

£m

–

1.1

3.9

–

5.0

Company

2005

£m

2004

£m

238.4

229.4

–

1.1

–

0.1

–

1.0

0.2

239.6

230.8

Group

Company

2004

£m

61.5

–

1.4

5.6

0.7

23.1

92.3

2005

£m

–

32.6

–

0.1

0.2

–

32.9

Group

Company

2004

£m

4.2

13.5

236.0

249.5

253.7

2005

£m

–

29.4

28.1

57.5

2004

£m

–

24.5

–

1.0

0.3

–

25.8

2004

£m

–

2005

£m

–

0.2

1.1

–

1.3

2005

£m

63.9

–

1.1

10.1

–

24.5

99.6

2005

£m

–

49.8

248.6

298.4

At 31 March 2005 the market value of listed investments was nil (2004 £4.2 million).

Other investments include deposits of £177.1 million (2004 £173.6 million) made to counter-indemnify letters of credit by financial
institutions to lessors in order to secure rental obligations (note 29). The Group’s access to these funds is restricted during the period of
the counter-indemnity.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

21. CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR

Loans:

Bank loans and overdrafts

Short-term loans

European Investment Bank loans

Unsecured loan stock notes

Obligations under finance leases

Trade creditors

Amounts owed to subsidiary undertakings

Amounts owed to joint venture

Other creditors

Corporation tax

Other taxation and social security

Accruals and deferred income

Interim dividend

Proposed final dividend

Group

Company

2004

£m

7.0

53.0

14.5

12.2

86.7

20.3

53.4

–

0.5

21.1

15.7

17.0

27.8

16.4

34.7

2005

£m

1.6

–

5.6

7.2

–

0.1

2004

£m

7.3

53.0

–

12.2

72.5

–

0.8

288.7

342.9

–

6.4

–

0.2

0.4

17.7

37.4

–

5.2

–

0.3

3.3

16.4

34.7

2005

£m

5.1

0.1

14.7

5.6

25.5

29.3

61.2

–

0.4

15.9

23.6

19.2

40.7

17.7

37.4

270.9

293.6

358.1

476.1

22. CREDITORS: AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR

Loans:

Sterling bond (repayable February 2012)

European Investment Bank loans

Other bank loans

Obligations under finance leases

Amounts owed to subsidiary undertakings

Other creditors

23. RELATED PARTY TRANSACTIONS

Group

Company

2004

£m

150.0

181.1

160.4

491.5

743.3

–

0.1

2005

£m

150.0

–

134.9

284.9

–

8.7

–

2004

£m

150.0

–

150.0

–

8.7

–

2005

£m

150.0

166.4

255.3

571.7

795.1

–

1,366.8

1,234.9

293.6

158.7

During the year, the Group purchased services in the ordinary course of business from Echo South West Limited, a joint venture
undertaking, at a cost of £8.0 million (2004 £7.8 million) and sold services to Echo South West Limited at a value of £2.5 million (2004
£2.5 million). Amounts owed by and to joint venture undertakings are disclosed in notes 18, 19 and 21. These amounts relate to trading
balances except for loans of £0.2 million included in debtors falling due after more than one year, note 18 (2004 £0.1 million included in
debtors falling due within one year, note 19).

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

24. PROVISIONS FOR LIABILITIES AND CHARGES

At 1 April 2004

Arising on acquisitions

Charged against/(released) to profits

Utilised during year

At 31 March 2005

Deferred

tax

£m

63.3

(1.7)

10.8

–

72.4

Environmental

and landfill

restoration

£m

28.0

7.0

2.4

(3.9)

33.5

Restructuring

Other

provisions

£m

0.4

–

3.7

(1.5)

2.6

£m

2.3

–

(1.0)

(1.1)

0.2

Group

Total

2005

£m

94.0

5.3

15.9

(6.5)

108.7

Company

Restructuring

2005

£m

0.1

–

(0.1)

–

Environmental and landfill restoration provisions will be utilised over the period from 2006 to beyond 2050. The provisions have been
established assuming current waste management technology based upon estimated costs at future prices which have been discounted to
present value. The restructuring provision principally relates to severance costs which are expected to be incurred by September 2006.

Deferred taxation

Accelerated capital allowances

Other timing differences

Undiscounted provision/(asset) for deferred tax

Discount

Discounted provision/(asset) for deferred tax

Provision at 1 April 2004

Arising on acquisitions

Deferred tax charge in profit and loss account for year

Provision/(asset) at 31 March 2005

Group

Company

2004

£m

275.4

(6.2)

269.2

(205.9)

63.3

2005

£m

293.4

(7.5)

285.9

(213.5)

72.4

63.3

(1.7)

10.8

72.4

2005

£m

–

(0.1)

–

(0.1)

(0.2)

–
0.1

(0.1)

2004

£m

–

(0.2)

–

(0.2)

The Company deferred tax asset is included within debtors falling due after more than one year (note 18).

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

25. DEFERRED INCOME

At 1 April 2004:

Amount to be released:

After more than one year

Within one year

(Settlements)/additions

Released to profits

At 31 March 2005:

Amount to be released:

Within one year

After more than one year

26. CALLED-UP SHARE CAPITAL

Authorised

157,657,600 Ordinary shares of £1.11 each

Allotted, called-up and fully paid

Forward
interest rate
swaps
(note 30)
£m

Grants and
contributions
£m

Group
Total
2005
£m

Forward
interest rate
swaps
(note 30)
£m

Grants and
contributions
£m

18.2

–

18.2

(3.4)

–

14.8

–

14.8

20.5

1.3

21.8

4.1

(1.3)

24.6

(1.6)

23.0

38.7

1.3

40.0

0.7

(1.3)

39.4

(1.6)

37.8

18.2

–

18.2

–

18.2

–

18.2

21.2

1.3

22.5

0.5

(1.2)

21.8

(1.3)

20.5

Group
Total
2004
£m

39.4

1.3

40.7

0.5

(1.2)

40.0

(1.3)

38.7

2005
£m

2004
£m

175.0

127,944,340 Ordinary shares of £1.11 each (2004 124,284,779)

142.0

137.9

Ordinary shares allotted during the year

In lieu of £22.8 million cash (2004 £1.3 million) under scrip dividend alternative

3,151,305

202,015

For consideration of £0.8 million under the Company’s Sharesave Scheme (2004 £2.1 million)

163,276

453,391

Own shares issued in respect of share options granted

344,980

–

3,659,561

655,406

2005
number

2004
number

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

26. CALLED-UP SHARE CAPITAL continued

Share options

Outstanding options to subscribe for shares of £1.11 each under the Company’s share option schemes are:

Nature of scheme

Sharesave

Executive

Date granted and
subscription price fully paid

8 July 1997 556p

7 July 1998 775p

6 July 1999 825p

5 July 2000 461p

4 July 2001 489p

9 July 2002 566p
8 July 2003 530p

6 July 2004 601p

6 Jan 1995 503p

Period when

options normally
exercisable

2000 – 2004

2001 – 2005

2002 – 2006

2003 – 2007

2004 – 2008

2005 – 2009
2006 – 2010

2007 – 2011

1998 – 2005

Thousands of shares

in respect of which options
outstanding at 31 March

2005

2004

–

258

198

441

308

–

262

172

215

476

–

1,282

1,214

At 31 March 2005 there were 1,133 participants in the Sharesave Scheme (2004 1,084) and none in the Executive Scheme (2004 one).

Options granted to Directors, included above, are shown in the Directors’ remuneration report on pages 38 to 44.

27. RESERVES

At 1 April 2004

Prior year adjustment (note 13)

At 1 April 2004 (restated)
Retained surplus for year

Adjustment for shares issued under the scrip dividend alternative

Purchase of own shares
Own shares issued to the Pennon Employee Share Trust in respect of share options granted

Adjustment for shares issued in respect of the Incentive Bonus Plan – deferred shares

Adjustment in respect of employee share schemes
Premium on shares issued under the Sharesave Scheme

Goodwill arising on previously acquired business (note 31)

Group and
Company share
premium account
£m

Profit and loss account

Group
Restated
(note 13)
£m

Company
Restated
(note 13)
£m

154.2
–

154.2

–

ª(3.5)

–

–
–

3.0

–

608.5
(1.0)

607.5

13.7

22.8
–

(2.8)

0.5
0.9

–

(0.2)

261.8
(0.2)

261.6

30.6

22.8
–

(0.8)

0.2
0.2

–

At 31 March 2005

153.7

642.4

314.6

The cumulative value of goodwill at 31 March 2005 resulting from acquisitions, which has been written-off to reserves, is £126.8 million
(2004 £126.6 million).

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

27. RESERVES continued

A Long-Term Incentive Plan is operated for senior management of the Group. Awards under the Plan, involving the release of ordinary
shares in the Company to participants, are dependent upon performance conditions being met. Shares are also held as part of an Incentive
Bonus Plan operated for senior management of the Group. Awards under the Plan involve the release of ordinary shares in the Company
to participants, usually conditional upon continuous service with the Company for a period of three years from the award. The shares
described above are released out of an Employee Share Ownership Plan, a discretionary trust, established to facilitate the operation of the
incentive plans. Shares held by the discretionary trust, which is controlled by the Company, are deducted at cost in arriving at
shareholders’ funds. The cost of an award is recognised in the profit and loss account as employment costs on a straight-line basis over
the period to which the performance criteria relate and is based on an assessment of the expectation of the extent that those performance
criteria will be met. This is a change of accounting policy and the prior year adjustment is set out in note 13. More information on the
operation of the incentive plans is included in the Directors’ remuneration report on pages 38 to 44.

During the year, 345,000 of the Company’s ordinary shares were issued to the trustees of the Employee Share Ownership Plan, financed
through non-interest bearing advances made by sponsoring Group companies (2004 nil). During 2004, the trustees of the Employee Share
Ownership Plan purchased 101,000 of the Company’s ordinary shares, financed through non-interest bearing advances made by
sponsoring Group companies.

The market value of the 690,000 ordinary shares (2004 531,000) held by the trust at 31 March 2005 was £6.7 million (2004 £3.7 million).
200,000 of those shares (2004 153,000) held for the Company had a market value of £1.9 million at 31 March 2005 (2004 £1.1 million).

The Group and the Company have taken advantage of the exemption provided in Urgent Issues Task Force Abstract 17(revised 2003)
‘Employee Share Schemes’ not to recognise a cost arising from the award of discounted Company shares to employees under the Sharesave
Scheme.

28. STATEMENT OF MOVEMENTS IN SHAREHOLDERS’ FUNDS

Profit on ordinary activities after taxation

Dividends

Adjustment for shares issued under the scrip dividend alternative

Shares issued for cash consideration

Purchase of own shares

Disposal of own shares

Adjustment for shares issued in respect of the

Incentive Bonus Plan – deferred shares

Adjustment in respect of employee share schemes

Goodwill arising on previously acquired business (note 31)

Shareholders’ funds (equity interest):

Addition for year

At 1 April

As previously reported

Prior year adjustment (note 13)

At 1 April (restated)

At 31 March

Group

Company

2004

Restated

(note 13)

£m

61.5

(51.1)

10.4

1.3

2.1

(0.6)

–

0.9

(3.3)

2005

£m

68.8

(55.1)

13.7

22.8

0.8

–

0.5

0.9

(0.2)

2004

Restated

(note 13)

£m

74.6

(51.1)

23.5

1.3

2.1

(0.2)

0.1

–

0.5

–

2005

£m

85.7

(55.1)

30.6

22.8

2.8

–

0.2

–

38.5

10.8

56.6

27.3

900.6

(1.0)

899.6

938.1

890.1

(1.3)

888.8

899.6

553.9

(0.2)

553.7

610.3

527.0

(0.6)

526.4

553.7

The restatement of Group shareholders’ funds at 1 April 2003 is £1.3 million (Company £0.6 million). No restatement of the profit for the
year 2003 was required (Company nil).

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

29. LOANS AND OTHER BORROWINGS

Loans

Repayable:

Over five years

Over two and up to five years

Over one and up to two years

Falling due after more than one year (note 22)

Falling due within one year (note 21)

Group

Company

2004

£m

281.9

194.8

14.8

491.5

86.7

578.2

2005

£m

150.0

114.9

20.0

284.9

7.2

292.1

2004

£m

150.0

–

150.0

72.5

222.5

2005

£m

267.7

239.7

64.3

571.7

25.5

597.2

£1.1 million floating rate unsecured loan stock notes were issued in the year. £0.9 million, repayable at par in 2006 or on notice being
given by the noteholder, was to satisfy consideration payable in connection with the November 2004 acquisition of Mac-Glass Recycling
Limited (note 31) and £0.2 million, repayable at par in 2009 or on notice being given by the noteholders, was to satisfy contingent
consideration payable in connection with the December 1997 acquisition of Terry Adams Limited (note 31).

Obligations under finance leases

Repayable:

Over five years

Over two and up to five years

Over one and up to two years

Falling due after more than one year (note 22)

Falling due within one year (note 21)

Group

2004

£m

663.5

55.6

24.2

743.3

20.3

763.6

2005

£m

709.2

58.2

27.7

795.1

29.3

824.4

Company

2005

£m

2004

£m

–

Included above are accrued finance charges arising on obligations under finance leases totalling £104.6 million (2004 £96.0 million), of
which £22.7 million (2004 £15.6 million) is repayable within one year.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

29. LOANS AND OTHER BORROWINGS continued

Loans and obligations under finance leases

Included above are instalment debts, of which any part falls due for repayment after five years and non-instalment debts due after five
years:

Loans

Obligations under finance leases

Group

Company

2005

£m

310.0

824.4

2004

£m

310.0

763.6

1,134.4

1,073.6

2005

£m

150.0

–

150.0

2004

£m

150.0

–

150.0

The rates of interest payable on loans and other borrowings, any part of which is due after five years, range between 3.7% and 10.6%
(2004 3.4% and 10.6%) and are repayable over the period 2006 to 2035.

Within obligations under finance leases South West Water Limited has:

(a) utilised finance lease facilities of £180.0 million at 31 March 2005 (2004 £180.0 million) for certain water and sewerage business

tangible fixed assets;

(b) deposited amounts, equal to the present value of rental obligations arising from those finance leases, with United Kingdom

financial institutions, to counter-indemnify the letters of credit issued by those financial institutions to the lessors in order to
secure those rental obligations.

These deposited funds, which totalled £144.9 million at 31 March 2005 (2004 £144.9 million), together with interest earned thereon, may
be used to settle the rental obligations under those finance leases. If the finance leases terminate due to the insolvency of the financial
institutions which have issued the letters of credit, no liability will fall on South West Water or any Pennon Group company.

The rentals payable under the finance leases will vary if interest rates, or effective tax rates, change.

Borrowing facilities

Undrawn committed borrowing facilities of £240.0 million were available to the Group at 31 March 2005 which expire as follows:

Between one and two years

Over two years

In addition, the Group has short-term uncommitted bank facilities of £115.0 million.

2005

£m

20.0

220.0

240.0

2004

£m

–

80.0

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

30. FINANCIAL INSTRUMENTS

Disclosures on financial and treasury policies are also included in the Corporate governance and internal control section on pages 45 to 47.

Interest rate and currency profile of financial assets and liabilities

After taking into account interest rate swaps entered into by the Group, the interest rate profile of the Group’s financial assets and
liabilities was:

Floating rate

Fixed rate

On which no interest is paid

Which is included in:

Net debt

Provisions for liabilities and charges

Deferred income

Other long-term monetary assets/(liabilities)

Fixed rate financial assets and liabilities:

Weighted average interest rate

Weighted average period for which rate is fixed

Range of interest rates

Financial assets Financial liabilities

2005

£m

302.1

2.1
2.5

306.7

2004

£m

262.6

6.1
2.7

2005

£m

(650.6)

(771.0)
(0.2)

2004

£m

(668.5)

(673.3)
(19.6)

271.4

(1,421.8)

(1,361.4)

302.8

267.7

(1,421.6)

(1,341.8)

–

3.9

–

3.7

(0.2)

–

(1.3)

(18.2)

(0.1)

306.7

271.4

(1,421.8)

(1,361.4)

6.8%

3.6 years

3.5% to
8.0%

6.1%

2.6 years

4.2% to
8.0%

6.4%

4.0 years

4.0% to

11.3%

6.5%

2.8 years

4.3% to
11.3%

Financial assets and liabilities on which no interest is paid:

Weighted average period until maturity

–

1.0 years

14.2 years

All financial assets and liabilities are denominated in sterling.

The floating rate financial assets earn interest, in some cases fixed in advance for periods up to twelve months, based on short-term money
market rates.

The floating rate financial liabilities bear interest at rates, in some cases fixed in advance for periods up to twelve months, related to the
London Inter Bank Offer Rate (LIBOR) or equivalent. The range of interest rates applying at 31 March 2005 was 3.7% to 5.7% (2004 3.4%
to 5.0%).

The maturity profile of floating rate and fixed rate financial liabilities is shown in note 29. Other financial liabilities fall due for payment
principally after five years.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

30. FINANCIAL INSTRUMENTS continued

Interest rate swaps are used to manage the mix of fixed and floating rates to ensure at least 50% of net debt is at fixed rate:

at 31 March 2005 69% of net debt was at fixed rate (2004 62%);

at 31 March 2005 interest rate swaps to hedge financial liabilities with a notional principal value of £365.0 million existed, with
a weighted average maturity of 2.4 years (2004 £490.0 million, with 1.3 years) to swap from floating to fixed rate.

At 31 March 2004 floating rate interest rate swaps, to hedge financial liabilities with a notional principal value of £200.0 million, existed
to swap LIBOR to European Inter Bank Offer Rate (EURIBOR) with commencement dates between 1 April 2006 and 1 April 2010 and
maturing on 31 March 2030. A settlement of £18.2 million, which was received when these swaps were entered into during December
1999, was deferred (note 25). In May 2004 these interest rate swaps were terminated through the payment of £3.4 million. The net
balance of £14.8 million received remains deferred and will be matched with interest charges on the underlying hedged debt over the
period of the original swaps.

The notional principal amounts of the interest rate swaps are used to determine settlement under those swaps and are not, therefore, an
exposure for the Group.

Financial assets and liabilities exclude short-term debtors and creditors (other than loans and obligations under finance leases falling due
within one year).

Fair values of financial assets and liabilities

Fair values are established at a specific point in time, based on relevant market information and the character of the financial instrument,
using estimates that are subjective in nature.

The fair values of the Group’s financial assets and liabilities are as follows:

Financial assets:

Current asset investments

Cash at bank

Other

Financial liabilities:

Short-term debt

Long-term debt

Other

Derivative financial instruments

(used to manage interest rate profile):

Interest rate swaps

2005

2004

Book value
£m

Fair value
£m

Book value
£m

Fair value
£m

298.4

4.4

3.9

306.7

298.4

4.4
4.0

306.8

253.7

14.0

3.7

271.4

253.8

14.0
3.8

271.6

(54.8)

(54.4)

(107.0)

(107.4)

(1,366.8)

(1,363.8)

(1,234.8)

(1,226.3)

(0.2)

(1.4)

(1,421.8)

(1,418.4)

(1,343.2)

(1,335.1)

–

(0.9)

(18.2)

(6.1)

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

30. FINANCIAL INSTRUMENTS continued

Market values, where available, have been used to determine fair values. The fair values of floating rate loans and obligations under finance
leases have been estimated by discounting cash flows at prevailing interest rates. Other floating rate liabilities, floating rate current asset
investments and cash at bank are assumed to have a fair value equal to book value.

Hedging interest rate exposures

The Group uses derivative financial instruments to manage certain interest rate risks. The unrecognised gains and losses on such
instruments are:

Unrecognised gains and losses

on hedges:

At 1 April

Of which recognised in

current year

Arising in previous years on swaps

terminated in current year

Arising and not recognised

in current year

At 31 March

Expected to be recognised:

In next year
Thereafter

Gains

£m

13.7

1.0

12.7

2005

Total

net gains

£m

12.1

(0.4)

12.5

Losses

£m

(1.6)

(1.4)

(0.2)

(12.3)

–

(12.3)

0.2

0.6

–

0.6

(1.3)

(1.5)

(0.4)

(1.1)

(1.5)

(1.1)

(0.9)

0.2

(1.1)

(0.9)

Gains

£m

12.4

0.4

12.0

–

1.7

13.7

1.0

12.7

13.7

2004

Total

net gains

£m

1.6

(5.4)

7.0

–

5.1

12.1

(0.4)

12.5

12.1

Losses

£m

(10.8)

(5.8)

(5.0)

–

3.4

(1.6)

(1.4)

(0.2)

(1.6)

Gains and losses on hedging instruments are matched with their underlying hedged item.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

31. ACQUISITIONS

On 5 April 2004, the entire issued share capital of Thames Waste Management Limited, (now renamed Viridor Waste (Thames) Limited),
was purchased by Viridor Waste Management Limited for a cash consideration of £30.8 million, including costs of £0.3 million. The
acquisition was accounted for using the acquisition method and goodwill arising on the acquisition, amounting to £18.0 million, has been
capitalised and will be amortised evenly over the Directors’ estimate of useful economic life, which is 20 years.

The profit after tax of Thames Waste Management Limited amounted to £0.4 million for the period from 1 January 2004 to 4 April 2004.
Profit after tax for the year ended 31 December 2003 was £3.7 million.

The operating assets and liabilities of the acquisition were:

Tangible fixed assets

Debtors: amounts falling due after more than one year

Debtors: amounts falling due within one year

Cash at bank

Creditors: amounts falling due within one year

Provisions for liabilities and charges

Accounting

policy
harmonisation

£m

Book value

£m

16.7

1.7

6.4

2.2

(8.4)

(8.2)

10.4

(3.7)

–

1.2

(2.5)

Revaluation

adjustment

£m

5.4

–

Other

adjustments

£m

Fair value
to the

Group

£m

–

(0.5)

–

18.4

1.7

6.4

2.2

(8.9)

(7.0)

5.4

(0.5)

12.8

Accounting policy harmonisation in respect of tangible fixed assets related to a change from the accounting policy of Thames Waste
Management Limited which recognised the full cost of aftercare of landfill sites as an asset within tangible fixed assets matched by an
equivalent liability. The policy of the Group is to recognise a provision for aftercare by taking account of the usage of void space. The other
accounting policy harmonisation for provisions for liabilities and charges related to the recognition of environmental and licence
obligations. The revaluation adjustment recognises the value to the Group of the landfill acquired, based on projected discounted cash
flows. Other adjustments include additional creditors for taxation following a reassessment of the taxation affairs of the company for pre-
acquisition periods.

On 19 November 2004, the entire issued share capital of Mac-Glass Recycling Limited was purchased by Viridor Waste Management Limited
through the issue of loan notes by Pennon Group Plc of £0.9 million (note 29). The acquisition was accounted for using the acquisition
method and provisional goodwill arising on the acquisition, amounting to £0.9 million, has been capitalised and will be amortised evenly
over the Directors’ estimate of useful economic life, which is 20 years.

The profit after tax of Mac-Glass Recycling Limited amounted to £0.1 million for the period from 1 December 2003 to 18 November 2004.
The company incurred a loss of £0.1 million for the year ended 30 November 2003.

The acquisition of Terry Adams Limited on 12 December 1997 provided for contingent consideration with a maximum of £28.0 million,
linked to planning approval of landfill sites, which was not included in the acquisition cost. At 31 March 2004, £10.7 million remained as
contingently payable. During the year, £0.2 million of that contingent consideration was settled through the issue of loan stock notes
(note 29) and goodwill arising amounting to £0.2 million has been written-off to reserves. At 31 March 2005, £6.9 million remained as
contingently payable.

During the year, £3.0 million fair value acquisition accruals and provisions were established (2004 £1.2 million), £1.5 million were utilised
(2004 £0.7 million), £1.4 million were released (2004 £1.4 million) and at 31 March 2005 £12.9 million (2004 £12.8 million) were carried
forward.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

32. PRINCIPAL SUBSIDIARY AND JOINT VENTURE UNDERTAKINGS

Subsidiary undertakings

Country of incorporation, registration and principal operations

Water and sewerage

South West Water Limited*

Peninsula Leasing Limited

Peninsula Properties (Exeter) Limited

Waste management

Viridor Waste Limited*

Viridor Waste Disposal Limited

Viridor Waste Exeter Limited

Dragon Waste Limited

Viridor Waste Hampshire Limited

Viridor Waste Management Limited

Mac-Glass Recycling Limited

Viridor EnviroScot Limited

Viridor Parkwood Holdings Limited

Parkwood Group Limited

Viridor Glass Recyling Limited

Viridor Waste (Bristol Holdings) Limited

Viridor Waste (Bristol) Limited

Viridor Waste (Thames) Limited

Viridor Waste Suffolk Limited

Other

Peninsula Insurance Limited*

Peninsula Water Limited*

England

Scotland

British Virgin Islands†

England

Guernsey

England

* Indicates the shares are held directly by the Company. † Operations are carried out in England.

All shares in issue are ordinary shares. The subsidiary undertakings are wholly-owned, except Dragon Waste Limited where 81% of the
ordinary shares are held by Viridor Waste Exeter Limited.

Joint venture

Share capital in issue Percentage held Activity

Echo South West Limited

100,000 A ordinary shares

100,000 B ordinary shares

100%

–

Customer contact management

Shares in Echo South West Limited are held by South West Water Limited.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

33. PENSIONS

The Group operates a number of pension schemes including a defined contribution section within the main scheme. The assets of the
Group’s pension schemes are held in separate trustee administered funds.

The latest actuarial valuation of the main scheme was as at 1 April 2004. At that date, the market value of the scheme’s assets was £196.4
million and this covered 77% of the value of benefits that had accrued to members, after allowing for assumed future increases in
earnings. The assumptions which have the most significant effect on the results of the valuation are those relating to the rate of return
on investments, the rates of increase in earnings and pensions, current life expectancy of pensioners and future improvements in life
expectancy. The valuation assumes that the investment return would be 6.7% per annum before retirement and 5.5% per annum after
retirement, pensionable pay increases would average 3.7% per annum and that present and future pensions would both increase at a rate
of 2.7% per annum.

The pension cost of the main defined benefit scheme has been determined on the advice of the independent qualified actuary using the
projected unit method. The employers’ regular pension cost for the year was 11.5% of pensionable earnings (2004 11.5%). The pension
charge for the year ended 31 March 2005 for the main scheme was £12.3 million (2004 £5.6 million) reflecting the recovery of the pension
deficit identified in the 1 April 2004 actuarial valuation over the average remaining service lives of employees in the scheme.

Accrued pension costs included as creditors of the Group amount to £4.0 million (2004 prepayment £4.6 million), representing the
accumulated difference between the Group pension charge and employer contributions paid.

The Group accounts for pension benefits in accordance with Statement of Standard Accounting Practice 24 ‘Accounting for Pension Costs’.
Financial Reporting Standard 17 ‘Retirement Benefits’ (FRS 17) was originally intended to change the basis of accounting for pension
benefits from 2003/04 but full implementation has been deferred until 2005/06. Under transitional arrangements applying to FRS 17,
certain additional disclosures are still required and these are given below.

The full actuarial valuation at 1 April 2004 was updated at 31 March 2005 by the independent qualified actuary using the projected unit
method, as required by FRS 17. The value of the schemes’ assets has been updated to market value as at 31 March 2005. The demographic
assumptions used in calculating the scheme liabilities under FRS 17 remain unchanged from those used in the 1 April 2004 actuarial
valuation. The financial assumptions at each year end under FRS 17 were as follows:

Rate of increase in pensionable pay

Rate of increase for present and future pensions

Rate used to discount scheme liabilities

Inflation

2005

3.7

2.7

5.5

2.7

2004

3.7

2.7

5.5

2.7

2003

3.5

2.5

5.5

2.5

The assets in the schemes and the expected long term rate of return at the year end were:

Equities

Bonds
Other

Total market value of assets

Present value of schemes’ liabilities

Deficit in schemes

Related deferred tax asset

Net pension liabilities

2005

2004

2003

Return

7.8

4.8

Value

£m

172.3
42.7

9.1

224.1

(303.6)

(79.5)

23.8

(55.7)

Return

7.7

4.7

4.3

Value

£m

154.6
38.2

8.4

201.2

(278.4)

(77.2)

23.2

(54.0)

Return

7.0
4.5

3.5

Value

£m

119.0
31.9
8.4

159.3

(244.2)

(84.9)
25.5

(59.4)

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

33. PENSIONS continued

Had FRS 17 been adopted in the financial statements, the Group’s net assets and profit and loss account reserve at 31 March would have
been as follows:

Net assets including prepayments for pension costs and excluding

net pension liabilities

Prepayments for pension costs

Creditor for pension costs

Net pension liabilities

Net assets including net pension liabilities

Profit and loss account reserve including prepayments for pension costs

and excluding net pension liabilities

Prepayments for pension costs

Creditor for pension costs

Net pension liabilities

Profit and loss account including net pension liabilities

2005

£m

938.1

–

4.0

(55.7)

886.4

642.4

–

4.0

(55.7)

590.7

2004

Restated

(note 13)

£m

899.6

(4.6)

–

(54.0)

841.0

607.5

(4.6)

–

(54.0)

548.9

The following amounts would have been recognised in the financial statements for the year ended 31 March 2005:

2005

£m

8.3

0.6

8.9

14.0

(15.3)

(1.3)

9.8

(7.9)

–

1.9

2004

£m

6.3

0.2

6.5

10.0

(13.4)

(3.4)

33.1

4.3

(25.1)

12.3

Operating profit

Current service cost

Past service cost

Total operating charge

Other finance income

Expected return on pension schemes’ assets

Interest on pension schemes’ liabilities

Net cost

Statement of total recognised gains and losses (STRGL)

Actual return less expected return on pension schemes’ assets

Experience (losses) and gains arising on schemes’ liabilities
Changes in assumptions underlying the present value of schemes’ liabilities

Actuarial gain to be recognised in STRGL

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

33. PENSIONS continued

Movement in deficit in scheme during the year

Deficit at 1 April

Movement in year:

Current service cost

Contributions

Past service cost

Other finance income

Actuarial gain

Deficit at 31 March

History of experience gains and losses

Difference between the expected and actual return in schemes’ assets:

Amount (£m)

Percentage of schemes’ assets

Experience gains and losses on schemes’ liabilities:

Amount (£m)
Percentage of the present value of schemes’ liabilities

Total amount recognised in statement of total recognised gains and losses:

Amount (£m)

Percentage of the present value of schemes’ liabilities

2005

£m

2004

£m

(77.2)

(84.9)

(8.3)

6.0

(0.6)

(1.3)

1.9

(6.3)

5.3

(0.2)

(3.4)

12.3

(79.5)

(77.2)

2005

2004

2003

9.8

4.4%

(7.9)

(2.6)%

1.9

0.6%

33.1

16.5%

4.3

1.5%

12.3

4.4%

(61.0)

(38.3)%

(1.4)

(0.6)%

(75.0)

(30.7)%

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

34. COMMITMENTS AND CONTINGENT LIABILITIES

Capital commitments
Contracted but not provided

Commitments under operating leases
Rentals during the year following the balance sheet date:

Land and buildings leases expiring:

Within one year
Between one and five years
After five years
Other leases expiring:

Within one year

Between one and five years

Contingent liabilities
Contractors’ claims on capital schemes

Guarantees

Other

Group

2005

£m

2004

£m

Company

2005

£m

2004

£m

46.1

56.3

0.2
0.5
2.2

0.2

0.5

3.6

–

60.2

6.9

67.1

0.1
0.3
3.4

0.1

0.4

4.3

0.3

41.5

10.8

52.6

–

623.8

6.9

630.7

594.4

10.8

605.2

Guarantees by the Company are principally in respect of borrowing facilities of subsidiary undertakings. Guarantees by the Group are
principally in respect of performance bonds entered into in the normal course of business. No liability is expected to arise in respect of the
guarantees. Other contingent liabilities relate to a possible obligation to pay further consideration in respect of a previously acquired
business when the outcome of planning applications is known.

35. NOTES TO THE GROUP CASH FLOW STATEMENT

(a) Reconciliation of Group operating profit to net cash inflow from operating activities

Group operating profit

Depreciation charge

Amortisation of intangible fixed assets

Deferred income released to profits

Decrease in provisions for liabilities and charges

Increase in stocks

Decrease/(increase) in debtors (amounts falling due within and over one year)

Increase in creditors (amounts falling due within and over one year)

Profit on disposal of tangible fixed assets

Other non-cash changes

Net cash inflow from operating activities

Pennon Group Plc

2004

Restated

(note 13)

£m

129.8

86.1

2.5

(1.2)

(2.0)

(0.5)

(4.2)

5.4

(1.7)

0.9

2005

£m

143.1

95.1

3.5

(1.3)

(2.4)

(0.2)

7.9

10.1

(1.4)

0.9

255.3

215.1

NOTES TO THE FINANCIAL STATEMENTS

35. NOTES TO THE GROUP CASH FLOW STATEMENT continued

(b) Analysis of cash flows for headings netted in the Group cash flow statement

i Returns on investments and servicing of finance

Interest received

Interest paid

Interest element of finance lease rentals

Forward interest rate swap settlements (note 30)

2005
£m

12.8

(42.8)

(25.7)

(3.4)

2004
£m

9.4

(31.9)

(18.8)

–

Net cash outflow for returns on investments and servicing of finance

(59.1)

(41.3)

ii Capital expenditure and financial investment

Purchase of intangible fixed assets

Purchase of tangible fixed assets

Grants and contributions:

Infrastructure assets

Non-infrastructure assets

Receipts from disposal of tangible fixed assets

Other investment

2004
Restated
(note 13)
£m

2005
£m

(0.2)

(183.0)

–

(181.9)

2.8

3.4

2.3

–

1.4

1.0

2.9

(2.0)

Net cash outflow for capital expenditure and financial investment

(174.7)

(178.6)

iii Acquisitions

Purchase of businesses

Net cash/(overdrafts) acquired with businesses

Net cash outflow for acquisitions

iv Management of liquid resources

Purchase of current asset investments

Sale of current asset investments

Net cash outflow from management of liquid resources

2005
£m

(30.8)

2.2

2004
£m

(19.8)

(0.2)

(28.6)

(20.0)

2005
£m

2004
£m

(336.5)

328.4

(342.8)

280.7

(8.1)

(62.1)

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

35. NOTES TO THE GROUP CASH FLOW STATEMENT continued

(b) Analysis of cash flows for headings netted in the Group cash flow statement continued

v Financing

Issue of ordinary share capital

Purchase of own shares

Reduction in debt due within one year (other than bank overdrafts)

Increase in debt due after more than one year

Finance lease drawdowns

Capital element of finance lease rental payments

Net cash inflow from financing

Cash at bank and in hand

Current asset investments:

Overnight deposits

Bank overdrafts

Debt due within one year (other than bank overdrafts)

Debt due after more than one year

Finance lease obligations

Current asset investments:

Other than overnight deposits

2004
Restated
(note 13)
£m

2.1

(0.6)

(16.7)

140.0

36.4

(5.5)

154.2

155.7

2005
£m

0.8

–

(75.2)

95.0

57.3

(5.4)

71.7

72.5

At 1 April
2004
£m

Cash flow
£m

14.0

(9.6)

13.5

(7.0)

20.5

(79.7)

(491.5)

(763.6)

36.3
1.9

28.6

75.2

(95.0)

(51.9)

(1,334.8)

(71.7)

Acquisitions
(excluding
cash items)
£m

Non-cash
movements
£m

At 31 March
2005
£m

–

–
–

–

(1.1)

–

(0.3)

(1.4)

–

–
–

–

4.4

49.8

(5.1)

49.1

(14.8)

14.8

(8.6)

(20.4)

(571.7)

(824.4)

(8.6)

(1,416.5)

240.2

8.1

–

0.3

248.6

(1,074.1)

(35.0)

(1.4)

(8.3)

(1,118.8)

Non-cash movements include transfers between categories of debt for changing maturities, increased accrued finance charges within
finance lease obligations and increased accrued interest on unlisted investments.

Pennon Group Plc

NOTES TO THE FINANCIAL STATEMENTS

35. NOTES TO THE GROUP CASH FLOW STATEMENT continued

(d) Reconciliation of net cash flow to movement in net debt

Increase in cash in year
Cash inflow from increase in debt and finance leasing
Cash outflow from increase in liquid resources

Increase in net debt arising from cash flows
Acquisition (excluding cash items):

Loan stock notes issued as consideration for business acquired
Loans acquired with business purchase
Finance lease obligations acquired with business purchase

Non-cash movements:

Loan stock notes issued in settlement of accrued consideration
Increase in accrued finance charges on finance lease obligations
Increase in accrued interest on unlisted investments

Increase in net debt in the year
Net debt at 1 April

Net debt at 31 March

(e) Purchase of businesses

Net assets acquired:

Tangible fixed assets
Debtors: amounts falling due after more than one year
Debtors: amounts falling due within one year
Cash at bank and in hand
Bank overdrafts
Creditors: amounts falling due within one year
Creditors: amounts falling due after more than one year
Provisions for liabilities and charges

Fair value of net assets acquired

Goodwill

Satisfied by:

Cash consideration
Loan stock notes

2005
£m

28.6
(71.7)
8.1

2004
£m

21.7
(154.2)
62.1

(35.0)

(70.4)

(1.1)
–
(0.3)

–
(8.6)
0.3

(3.7)
(0.5)
(2.8)

(0.1)
(8.0)
–

(44.7)
(1,074.1)

(85.5)
(988.6)

(1,118.8)

(1,074.1)

2005
£m

2004
£m

18.8
1.7
6.5
2.2
–
(9.3)
(0.1)
(7.0)

12.8

19.1

31.9

30.8
1.1

31.9

14.4
–
4.1
–
(0.2)
(7.5)
(2.0)
(1.1)

7.7

15.8

23.5

19.8
3.7

23.5

The businesses acquired during the year contributed £10.1 million to the Group’s net cash inflow from operating activities, utilised £0.3
million in respect of taxation and £8.9 million for capital expenditure.

In 2004, the businesses acquired in that year contributed £2.1 million to the Group’s net cash inflow from operating activities, utilised
£0.1 million in respect of net returns on investment and servicing of finance and £1.3 million for capital expenditure.

Pennon Group Plc

INTERNATIONAL FINANCIAL
REPORTING STANDARDS

OVERVIEW

The Group is required to adopt International Financial Reporting
Standards (IFRS) for its 2005/06 financial year, with comparative
figures restated according to IFRS.

The first published results under IFRS will therefore be the interim
results for the six months ending 30 September 2005. The Group
intends to present fuller information on the restatement of the
2004/05 financial accounts on an IFRS basis no later than the
publication of these interim results.

The implementation of IFRS within the Group is a major on-going
project. The principal changes between UK Generally Accepted
Accounting Principles (UK GAAP) and IFRS have been identified,
together with an estimate of their impact upon shareholders’ equity
and reported profits for 2004/05.

The adjustments set out below are presented for illustrative
purposes only and represent the current best estimates of the
impact of IFRS on the specific areas identified in this document,
under the assumption that all existing standards in issue from the
International Accounting Standards Board (IASB) will be fully

endorsed by the European Union (EU). The failure of the EU to
endorse all of these standards for financial reporting in 2005, the
issue of any new or revised standards, or the publishing of further
interpretational guidance, could result in changes to the
financial information presented in this document. These
illustrative adjustments are also subject to the completion of the
on-going IFRS project. All figures are unaudited.

Certain exemptions are allowed under IFRS 1 to assist companies
with the transition process. The Group intends to prepare its
balance sheets at 31 March 2004 and 2005 using the elections
relating to:

– the bringing forward of historic goodwill balances without
restatement to IFRS principles

– the adoption of IAS 32 and IAS 39 (accounting for and
disclosure of financial instruments) with effect from 1 April 2005

– the recognition of the full IAS 19 pension deficit in the Group’s
balance sheet

– the valuation of water and sewerage infrastructure assets at
fair value.

KEY CHANGES

The key changes from IFRS impacting the Group’s financial statements are:

UK GAAP

IFRS

FRS 19

FRS 17

FRS 7

FRS 15

Cos. Act/FRS 21

IAS 12

IAS 19

IFRS 3

IAS 16

IAS 10

The reduction in net worth reflecting these key changes does not
affect compliance with debt covenants since these are subject to
either ‘frozen UK GAAP’ or specific ‘carve-out’ clauses.

The identified reduction in net worth affects Group consolidated
reserves only and consequently will not impact individual
entities’ existing distributable reserves or the current policy to
cover dividend payments from net profit for the reporting period.

Taxation – deferred tax

Pensions

Acquisition accounting and goodwill

Fixed assets – infrastructure accounting

Dividends

Summary

The assessment of the above specific key changes from the
standards identified is estimated to result in a restatement of
total shareholders’ equity at 31 March 2004 from £900 million
under existing UK GAAP to circa £670 million on an IFRS basis,
primarily from reductions through the non-discounting of the
existing deferred tax provision and the recognition of the net
pension deficit.

Reported profit before taxation for 2004/05 is estimated to be
unchanged from the above key factors between UK GAAP and IFRS
and adjusted earnings per share, before deferred tax, also remain as
reported. The non-discounting of the 2004/05 deferred tax charge
reduces basic earnings per share by circa 6p, to 49p.

Pennon Group Plc

INTERNATIONAL FINANCIAL
REPORTING STANDARDS

INCOME STATEMENT

The assessment of the above specific key changes is estimated to result in a restatement of reported profit performance for 2004/05,
before exceptional items, as:

Earnings before interest, taxation, depreciation and amortisation

Group operating profit

Profit before taxation

Adjusted earnings per share (before deferred tax)

Basic earnings per share

UK GAAP
basis
£m

244

148

63p

55p

IFRS
basis
£m

243

149

63p

49p

The illustrative impact of these specific adjustments to Group operating profit on the Group’s 2004/05 reported segmental performance is:

Water and sewerage

Waste management

Other

SHAREHOLDERS’ EQUITY

UK GAAP
basis
£m

122

–

148

IFRS
basis
£m

121

–

149

The assessment of the above specific key changes is estimated to result in a restatement of shareholders’ equity of:

Reported under UK GAAP

Indicative restated to IFRS

ADJUSTMENTS

31 March 2004
£m

31 March 2005
£m

900

c.670

938

c.710

The expected principal differences between accounting under UK GAAP and IFRS specifically identified above may be summarised as:

Taxation

Under UK GAAP, the Group creates a discounted provision for
deferred taxation, as allowed under FRS 19, to reflect an
assessment of the period over which timing differences are
expected to reverse.

Under IFRS (IAS 12) a discounting methodology is not permitted.
Consequently the deferred tax provision
increases and
commensurately reduces shareholders’ equity as indicated below:

Discounted provision – UK GAAP

Undiscounted provision – IFRS

Increase in provision

31 March 2004
£m

31 March 2005
£m

269
206

286

214

Pennon Group Plc

INTERNATIONAL FINANCIAL
REPORTING STANDARDS

ADJUSTMENTS continued

Fixed assets – infrastructure accounting

Taxation continued

Other significant deferred tax effects are estimated to arise from the
recognition under IFRS of deferred tax on property revalued at the time
of acquisitions by Viridor Waste, circa £16 million and the recognition of
the pension deficit, as outlined below.

The non-discounting of deferred tax increases the charge against
2004/05 profits from £11 million to £18 million.

The significant on-going level of capital expenditure projected for the
Group’s operations means that actual payment of tax is expected to
continue to be deferred through the creation of further timing
differences.

Pensions

Under UK GAAP (SSAP 24) the pensions charge is established by reference
to the triennial valuation of the Group’s pension schemes and is set at a
level amount to recognise both the on-going service cost and the
spreading of any actuarial surplus or deficit.

Under IFRS (IAS 19) only the on-going service cost is charged against
operating profit. A net financing cost or credit to reflect expected
changes in liabilities and investment return is included within interest
payable or receivable. An annual update of the valuation of scheme
assets and liabilities results in a movement in the total pension surplus
or deficit which is recognised in the IFRS Statement Of Recognised
Income and Expenditure (SORIE).

The gross pension deficit, circa £80 million at 31 March 2005, is shown
as a balance sheet liability, with the related deferred tax asset, circa £24
million, within the net deferred tax balance.

The recognition of the pension deficit, net of deferred tax, reduces
shareholders’ equity by circa £59 million at 31 March 2004 and circa £51
million at 31 March 2005. Reported 2004/05 profit before tax increases
by circa £4 million, principally due to the on-going service cost no longer
containing an element of deficit recovery.

Acquisition accounting and goodwill

Under UK GAAP goodwill arising on acquisitions is amortised over its
useful life, assessed by the Directors as being 20 years. No separately
identifiable intangible assets are currently included in the fair values
established for acquisitions.

Under IFRS (IFRS 3) a wider range of potential intangible assets arising
on acquisition is required to be considered, identified and amortised
according to the useful lives of the individual components. In addition,
the amortisation of goodwill is not permitted but all goodwill balances
are subject to an annual test for impairment by comparing the carrying
values of assets to the discounted cash flows arising from the future use
of those assets for identifiable cash generating units.

Shareholders’ equity at 31 March 2004 is not affected since the Group is
bringing-forward historic balances (as allowed under the exemption
referred to above).

The 2004/05 reported operating profit is increased by net circa £2
million, comprising the elimination of goodwill amortisation, circa £3
million, partially offset by a charge for the amortisation of intangible
assets acquired under the purchase of Thames Waste Management
Limited, circa £1 million. No impairment charge is required in 2004/05
in relation to the goodwill balances recorded.

Pennon Group Plc

UK GAAP (FRS 15) permits ‘renewals accounting’ as a method for
estimating depreciation on infrastructure assets which has been
adopted by the UK water industry. The depreciation charge represents
the level of annual expenditure required to maintain the operating
capacity of the infrastructure network at a specified level of service
potential by the continuing replacement and refurbishment of its
components. South West Water uses an independently certified Asset
Management Plan to determine the level of annual expenditure
required.

IFRS does not permit the use of renewals accounting. Instead
infrastructure assets are capitalised and depreciated over the estimated
useful lives of major components.

Consequently, infrastructure assets in the opening balance sheet under
IFRS have to be restated from their existing UK GAAP net book value.
Under the first time adoption rules set out in IFRS 1, a fair value can be
used as the deemed cost of the infrastructure assets where it is not
possible to reconstruct a value for historic cost less depreciation on an
IFRS compliant basis. This value is depreciated over the estimated
remaining asset life.

Shareholders’ equity at 31 March 2004 is not expected to be
significantly affected since the opening fair value of infrastructure
assets under IFRS in South West Water is currently estimated to be close
to historic cost.

Reported operating profit for 2004/05 is estimated to be reduced by
circa £4 million as a result of calculating specific depreciation compared
to the previous normative long-term charge based upon the 1999
Periodic Review Asset Management Plan.

The revised estimated total infrastructure depreciation cost of circa £19
million for 2004/05 is circa £2 million below the level of the
infrastructure renewals charge assumed by Ofwat in the Final
Determination for 2005/06.

Dividends

Under UK GAAP (prior to the introduction of FRS 21 with effect from the
2005/06 financial year) dividends payable are recognised in the profit
and loss account for the period to which they relate.

Under IFRS (IAS 10) if dividends are declared after the balance sheet
date, the dividends are not recognised as a liability at the balance sheet
date. In addition, given that interim dividends are approved only by
resolution of the Board, and are thus revocable and discretionary, such
interim dividends should only be recognised when paid. Dividends on
equity instruments are therefore recognised as liabilities under IFRS as
follows:

– Final dividends – when authorised in general meeting

by shareholders.

– Interim dividends – when paid.

Shareholders’ equity is consequently increased at the balance sheet
date, by circa £51 million at 31 March 2004, and circa £55 million at 31
March 2005 as a result of adding-back, for each of the 2003/04 and
2004/05 financial years, the final dividend not authorised until after
the year end and the interim dividend not paid until after the year end.

FIVE YEAR FINANCIAL SUMMARY

PROFIT AND LOSS ACCOUNT

Turnover

Group operating profit

Share of operating profit/(loss) in joint venture and associate

Business disposal profit/(loss)

Net interest payable

Profit on ordinary activities before taxation

Tax on profit on ordinary activities

Profit on ordinary activities after taxation

Dividends

Retained surplus/(deficit) transferred to/(from) reserves

Earnings per share (basic):

Before exceptional items and deferred tax
Exceptional items
Deferred tax

After exceptional items and deferred tax

Dividend per share

CAPITAL EXPENDITURE

Acquisitions
Tangible fixed assets

BALANCE SHEET

Fixed assets
Net current assets
Non-current liabilities

Net assets

2005

£m

554.2

143.1

0.1

5.0

(60.7)

87.5

(18.7)

68.8

(55.1)

13.7

63.1p
0.1p
(8.6)p

54.6p

43.0p

2005

£m

30.8
188.4

2005

£m

2,313.9

137.5

2004

£m

471.3

129.8

(0.3)

–

(57.2)

72.3

(10.8)

61.5

(51.1)

10.4

57.7p
(5.3)p
(2.6)p

49.8p

41.0p

2004

£m

19.8
170.0

2004

£m

2,191.3

75.9

2003

£m

417.2

127.0

(0.7)

–

(52.1)

74.2

(17.1)

57.1

(144.3)

(87.2)

55.0p
–
(10.7)p

44.3p

109.1p

2003

£m

41.8
204.6

2003

£m

2,084.6
17.5

2002

£m

423.9

121.8

(0.5)

5.1

(49.0)

77.4

(3.3)

74.1

(51.4)

22.7

53.0p
3.7p
(2.4)p

54.3p

37.5p

2002

£m

12.1
186.4

2001

£m

435.1

128.1

(0.4)

(2.1)

(51.4)

74.2

(17.6)

56.6

(49.4)

7.2

56.0p
(1.6)p
(12.9)p

41.5p

36.0p

2001

£m

0.9
166.5

2002

£m

1,920.5
100.8

2001

£m

1,824.3
101.5

(1,513.3)

(1,367.6)

(1,213.3)

(1,047.3)

(1,018.7)

938.1

899.6

888.8

974.0

907.1

NUMBER OF EMPLOYEES (average for year)

Water and sewerage business

Waste management

Instrumentation

Construction services

Other businesses

2005

2004

2003

2002

2001

1,336

1,169

–

1,341

895

–

1,343

685

–

1,485

1,537

605

421

–

453

495

617

2,544

2,275

2,063

2,562

3,157

The application of Urgent Issues Task Force Abstract 17 (revised 2003) ‘Employee Share Schemes’ and Abstract 38 ‘Accounting for
ESOP Trusts’ has resulted in a restatement of years 2001 to 2004.

Pennon Group Plc

NOTICE OF ANNUAL GENERAL MEETING

THE SIXTEENTH ANNUAL GENERAL MEETING OF PENNON GROUP
PLC WILL BE HELD AT THE PLYMOUTH PAVILIONS, PLYMOUTH,
DEVON ON THURSDAY 28 JULY 2005 AT 11.00am.

THESE PAGES ARE IMPORTANT AND REQUIRE YOUR IMMEDIATE ATTENTION.

If you are in any doubt about the action you should take, you should immediately consult your
stockbroker, solicitor, accountant, bank manager or other independent financial adviser who is
authorised under the Financial Services and Markets Act 2000.

If you have sold or otherwise transferred some or all of your ordinary shares, please send this Annual Report, together with the accompanying Form of Proxy, as soon as possible, to
the purchaser or transferee or to the stockbroker, bank or other agent through whom the sale or transfer was effected, for delivery to the purchaser or transferee. The Form of Proxy, if
used, should be lodged with the Company’s Registrars, Lloyds TSB Registrars, not less than 48 hours before the time fixed for the meeting.

ANNUAL GENERAL MEETING

Resolution 7

The sixteenth Annual General Meeting of Pennon Group Plc will be
held at The Plymouth Pavilions, Millbay Road, Plymouth, Devon
PL1 3LF on Thursday 28 July 2005 at 11.00 am for the transaction
of the following business:

To propose the following as an ordinary resolution:

That PricewaterhouseCoopers LLP be reappointed auditors of the
Company to hold office until the conclusion of the next Annual
General Meeting at which accounts are laid before the Company.

Resolution 1

Resolution 8

To receive the Report of the Directors and the financial
statements for the year ended 31 March 2005.

To propose the following as an ordinary resolution:

Resolution 2

That the Directors be authorised to fix the remuneration of the
auditors.

To declare a final dividend, recommended by the Directors, for the
year ended 31 March 2005.

Resolution 9

Resolution 3

To propose the following as an ordinary resolution:

That the Directors’ remuneration report for the financial year
2004/05, as contained in the Annual Report 2005, be approved.

That in accordance with Article 5 of the Company’s Articles of
Association, the Directors be authorised to allot relevant
securities up to a maximum nominal amount of £32,802,000, that
such authority shall expire on 27 October 2006 or, if earlier, at the
conclusion of the next Annual General Meeting of the Company.

Resolution 4

To re-elect Mr R J Baty as a Director.

Resolution 5

To re-elect Mr D J Dupont as a Director.

Resolution 6

To re-elect Ms K M H Mortimer as a Director.

Pennon Group Plc

Resolution 10

To propose the following as a special resolution:

That in accordance with Article 6 of the Company’s Articles of
Association: (a) the Directors be given power to allot equity
securities for cash; (b) that for the purpose of paragraph (A)(ii) of
that Article, the nominal amount to which this power is limited is
£7,109,000; and (c) this power shall expire on 27 October 2006
or, if earlier, at the conclusion of the next Annual General
Meeting of the Company.

NOTICE OF ANNUAL GENERAL MEETING

Resolution 11

a Treasury shares

To propose the following as a special resolution:

That the Company is generally and unconditionally authorised to
make market purchases (within the meaning of section 163 of the
Companies Act 1985) of ordinary shares of £1.11 each in the
capital of the Company (‘ordinary shares’) on such terms and in
such manner as the Directors of the Company may from time to
time determine provided that:

a the maximum number of ordinary shares that may be
purchased under this authority is 12,810,000 (being no more
than 10% of the issued share capital of the Company as at 15 June
2005);

b the maximum price which may be paid for an ordinary share
purchased under this authority is an amount equal to 105% of the
average of the middle market quotations for such ordinary shares
(as appropriate), as derived from the London Stock Exchange
Daily Official List for the five business days immediately preceding
the day on which that share is purchased and the minimum price
which may be paid is £1.11 per ordinary share (the nominal value
of that share); and

this authority will, unless previously varied, revoked or
c
renewed, expire at the conclusion of the next Annual General
Meeting of the Company but the Company may make a contract to
purchase ordinary shares under this authority before its expiry
which will or may be executed wholly or partly after the expiry of
this authority and may make purchases of ordinary shares
pursuant to such a contract.

Resolution 12

To propose the following as a special resolution:

That Article 102 of the Articles of Association of the Company be
amended to deduct in determining the borrowings of the
Company any sums held by the Company on deposit.

Resolution 13

To propose the following as a special resolution:

That the Articles of Association set out in the document produced
to the meeting (which incorporate the amendment proposed in
Resolution 12 relating to the borrowing powers of the Company
and signed by the Chairman for purposes of identification) be
adopted as the Articles of Association of the Company in
substitution for, and to the exclusion of, all existing Articles of
Association.

A brief description of the principal changes proposed are set out
below. (The principal changes proposed are set out in more detail
in the Explanatory Notes.)

To include a new definition of treasury shares in accordance
with Section 162A of the Companies Act 1985.

b Share capital

To reflect the authorised share capital of the Company at the
date of adoption of the new Articles of Association.

c Dis-application of pre-emption rights

To clarify that any dis-application of pre-emption rights will
extend to the allotment of treasury shares for cash.

d Uncertificated shares

To facilitate the holding and transfer of shares in
uncertificated form.

Proceedings at general meetings
To ensure the orderly and secure running of shareholders’
meetings.

Number of Directors
The maximum number of Directors to be 12.

g Retirement of Directors

Any Director who has held office for three years or more to
retire from office but be eligible for re-appointment.

h Removal of Directors

To add a provision to permit the removal of a Director by
notice from his co-directors.

Expenses
To permit a Director to have paid out of the funds of the
Company all expenses incurred by him in obtaining
professional advice in connection with the Company’s
affairs or his duties as a Director.

Delegation to individual Directors
To give authority to the Board to delegate its powers to any
Director.

k Directors’ interests and voting

To provide updated provisions as to Directors’ interests and
voting and to give express ability to the Company to purchase
Directors’ and Officers’ insurance.

Issue of share certificates
To permit share certificates to be signed electronically.

m Power to differentiate

To permit the Board to differentiate between holders of
shares.

n Calculation and currency of dividends

To permit dividends to be declared and paid in any currency.

o Indemnity

To provide that the Company may (rather than shall)
indemnify a Director or other Officer (excluding an auditor)
against liabilities incurred by him in connection with his
duties, powers or office.

Pennon Group Plc

NOTICE OF ANNUAL GENERAL MEETING

Resolution 14

To propose the following as an ordinary resolution:

That in accordance with Section 347C of the Companies Act 1985
the Company and
its subsidiaries be generally and
unconditionally authorised to make donations to EU political
organisations and to incur EU political expenditure in an
aggregate amount not exceeding £100,000 during the period
expiring 15 months after the date of the passing of this
resolution, or if earlier at the conclusion of the next Annual
General Meeting unless previously renewed, varied or revoked by
the Company in general meeting. For the purposes of this
resolution,
‘EU political
organisations’ and ‘EU political expenditure’ have the meanings
set out in Part XA of the Companies Act 1985 (as amended by the
Political Parties, Elections and Referendums Act 2000).

the expressions

‘donations’,

By Order of the Board
K D WOODIER, Group General Counsel & Company Secretary
Peninsula House, Rydon Lane, Exeter EX2 7HR (Registered Office)
23 June 2005

IMPORTANT NOTES

Pursuant to Regulation 41 of the Uncertificated Securities
Regulations 2001, only those shareholders registered in the
register of members as at 6.00 pm on 26 July 2005 will be entitled
to attend or vote at the Annual General Meeting in respect of the
number of shares registered in their name at that time. Changes
to entries on the register after 6.00 pm on 26 July 2005 will be
disregarded in determining the rights of any person to attend or
vote at the meeting.

A person entitled to attend and vote at the meeting is entitled to
appoint one or more proxies to attend and on a poll, vote instead
of him or her. A proxy need not be a member of the Company.

To be valid, the Form of Proxy for use at the meeting and power of
attorney or other authority, if any, under which it is signed or a
notarially certified or office copy of such power or authority, must
be deposited at the office of the Company’s Registrars, Lloyds TSB
Registrars, The Causeway, Worthing BN99 6UQ not less than 48
hours before the time fixed for the Annual General Meeting.
Completion and return of the Form of Proxy will not prevent a
shareholder from attending and voting at the Annual General
Meeting instead of his or her proxy, if the shareholder so wishes.

Electronic proxy voting

Shareholders may register the appointment of a proxy for the
Annual General Meeting and any adjournment(s) thereof
electronically at www.sharevote.co.uk a website operated by the
Company’s Registrar, Lloyds TSB Registrars. Shareholders are

Pennon Group Plc

advised to read the terms and conditions shown on the website
relating to the use of this facility before appointing a proxy. Any
electronic communication sent by a shareholder that is found to
contain a computer virus will not be accepted. Electronic
communication facilities are available to all shareholders and
those who use them will not be disadvantaged in any way.

Electronic proxy appointment through CREST

CREST members who wish to appoint a proxy or proxies through
the CREST electronic proxy appointment service may do so for the
Annual General Meeting and any adjournment(s) thereof by
following the procedures described in the CREST Manual.

All messages relating to the appointment of a proxy or an
instruction to a previously-appointed proxy, which are to be
transmitted through CREST, must be received by Lloyds TSB
Registrars (ID 7RA01) no later than 11.00am on 26 July 2005, or,
if the Annual General Meeting is adjourned, close of business on
the day two days prior to the day fixed for the adjourned Annual
General Meeting.

Documents available for inspection

A copy of the proposed new Articles of Association and a copy of
the existing Articles of Association of the Company will be
available for inspection during normal business hours at the
Registered Office of the Company and at Allen & Overy LLP, One
New Change, London EC4M 9QQ up to and including 28 July 2005
and at the Annual General Meeting from 10.00 am on 28 July 2005
until the conclusion of the Annual General Meeting.

In addition, copies of the Executive Directors’ service contracts,
the Chairman’s and the Non-executive Directors’ contracts for
service and the Register of Directors’ Interests in the share capital
of the Company, are available for inspection during normal
business hours at the Registered Office of the Company and will
remain so up to and including 27 July 2005. They will then be
available for inspection at the Annual General Meeting from
10.00 am on 28 July 2005 until the conclusion of the meeting.

EXPLANATORY NOTES ON CERTAIN BUSINESS OF
THE ANNUAL GENERAL MEETING

Remuneration policy

Resolution 3 proposes the approval of the Directors’
remuneration report which is set out on pages 38 to 44 inclusive
of the Annual Report. It is a requirement, pursuant to Schedule
7A of the Companies Act 1985, that the Directors’ remuneration
report be submitted to shareholders for approval, albeit that any
voting on the report is advisory only. No changes have been made
to the policy which was submitted to shareholders for approval at
last year’s Annual General Meeting.

NOTICE OF ANNUAL GENERAL MEETING

Re-election of Directors

Resolutions 4, 5 and 6 propose the re-elections of Messrs Baty
and Dupont and Ms Mortimer as Directors of the Company in
accordance with the Company’s Articles of Association which
require that, at the date of the notice convening the Annual
General Meeting, each Director who has held office for more than
30 months since appointment or re-appointment must retire. The
Directors, being eligible, offer themselves up for re-election. Bob
Baty was appointed a Director of the Company on 1 March 1996
and has extensive knowledge of the water business having joined
South West Water as its engineering and scientific director. Prior
to that he held engineering and operational appointments with
North West Water Authority. David Dupont was appointed a
Director of the Company on 2 March 2002 and has extensive
finance,
strategic planning and business
development experience having formerly been South West
Water’s regulatory and finance director. Prior to that he was
Pennon Group’s strategic planning manager. Kate Mortimer was
appointed a Director of the Company on 1 May 2000. As
demonstrated by her biographical details set out on page 37 of
the Annual Report, Kate Mortimer has extensive financial and
business experience and has been appointed as a member (and
Chairman) of the Remuneration Committee of the Board and as a
member of the Audit and Nomination Committees of the Board.

regulatory,

The Board supports the re-election of these Directors as it
believes that their knowledge and experience assists in ensuring
that the Board has an appropriate balance of skills and
experience for the requirements of the business. The Chairman
confirms that following the formal annual performance
evaluation, Kate Mortimer, as a Non-executive Director,
continues to be effective and continues to demonstrate commit-
ment to the role, including commitment of time for Board and
Committee meetings and other duties as they are likely to arise.

Reappointment of auditors

Resolution 7 proposes the reappointment of Pricewater-
houseCoopers LLP as auditors. PricewaterhouseCoopers LLP have
indicated their willingness to continue in office and their
reappointment is supported by the Audit Committee of the Board.

Authority to allot shares

Resolution 9 requests shareholder approval by way of an ordinary
resolution to renew (in compliance with recently published
institutional guidelines) until 27 October 2006 or, if earlier, at
the conclusion of the next Annual General Meeting of the
Company, the Directors’ existing general and unconditional
authority to allot securities in accordance with the Companies Act
1985 and the Articles of Association of the Company. This
authority would continue that granted in July 2004. The nominal
share capital to which this authority relates of £32,802,000
(being the unissued share capital of the Company) represents
approximately 23% of the issued share capital as at 15 June 2005.

Currently the Company does not hold any shares in the Company
in treasury (see the note to Resolution 11). This authority will
expire on 27 October 2006 or, if earlier, at the next Annual
General Meeting of the Company, although it is the Directors’
intention to renew the authority annually.

Resolution 10 requests shareholder approval by way of a special
resolution to renew until 27 October 2006 or, if earlier, at the
conclusion of the next Annual General Meeting of the Company,
the Directors’ authority to allot equity securities for cash without
first being required to offer such securities to existing
shareholders. The share capital to which this authority relates
represents not more than 5% of the issued share capital as at 15
June 2005. The Directors would not intend to issue more than
7.5% of the Company’s issued share capital in any rolling three
year period without prior consultation with the Investment
Committees of the Association of British Insurers and the
National Association of Pension Funds.

The Directors consider that they should have the above
authorities in order to be able to take advantage of opportunities
as they arise and to retain flexibility although they have no
current plans to issue shares, except pursuant to the Company’s
scrip dividend alternative, the exercise of options arising from
the Company’s all-employee sharesave scheme and new Share
Incentive Plan, the operation of the Company’s Restricted Share
Plan and/or the operation of the deferred bonus share element of
the Company’s Annual Incentive Bonus Plan.

Authority to purchase ordinary shares of the Company

Resolution 11 requests shareholder approval by way of a special
resolution to renew the Company’s authority to purchase up to
10% of its ordinary shares at or between the minimum and
maximum prices specified in the resolution. This authority is
requested in order to increase the Company’s flexibility to
optimise the long-term financial and tax efficiency of its capital
structure. The Directors have no specific plans to exercise such
powers in the immediate future but will keep the matter under
review and will only make such purchases if they would result in
an increase in the Company’s earnings per share and are in the
best interests of the Company’s shareholders generally.

Any shares purchased in this way will, unless the Directors
determine that they are to be held as treasury shares (see below),
be cancelled and the number of shares in issue will be reduced
accordingly. Shares held in treasury will not automatically be
cancelled and will not be taken into account in future calculations
of earnings per share (unless they are subsequently resold or
transferred out of treasury).

The Companies (Acquisition of Own Shares) (Treasury Shares)
Regulations 2003 allows companies to hold shares acquired by
way of market purchase in treasury, rather than having to cancel
them. The Company may therefore consider holding any of its own
shares that it may purchase pursuant to the authority conferred

Pennon Group Plc

NOTICE OF ANNUAL GENERAL MEETING

by this resolution as treasury shares as an alternative to
cancelling them. This would give the Company the ability to re-
issue such treasury shares quickly and cost effectively. No
dividends may be paid on shares held in treasury and no voting
rights may be exercisable in respect of treasury shares.

Authority to redefine the power of the Company to
borrow money

Resolution 12 requests shareholder approval by way of a special
resolution to amend Article 102 of the Company’s Articles of
Association to deduct in determining the borrowings of the
Company, any sums held by the Company on deposit.

This updating of the Article is made to reflect the fact that it is the
policy of the Company to forward borrow to fund the Group’s
capital programme for at least the forthcoming twelve months.

Article 3: Share Capital

This article will reflect the authorised share capital at the date of
adoption of the new Articles of Association. There are no
references in this article to the special rights redeemable
preference share of £1 as this was redeemed on 31 December
1994 and by a special resolution of the Company passed on 25
July 1995, the rights attaching to that class of share were deleted
from the Articles of Association of the Company.

Article 7: Dis-application of pre-emption rights

This article will include a clarification that any dis-application of
pre-emption rights will extend to the allotment of treasury shares
for cash.

Articles 14 and 17: Uncertificated shares

Adoption of proposed new Articles of Association
of the Company

Article 14 will contain specific provisions facilitating the holding
and transfer of shares in uncertificated form.

Resolution 13 requests shareholder approval by way of a special
resolution that the new Articles of Association of the Company
(which incorporates the amendment proposed in Resolution 12)
be adopted. The current Articles of Association were adopted in
1989. Although subsequent amendments have been made, the
Directors propose that new Articles of Association be adopted
which will comply with current regulations, and best practice and
which will generally update, clarify, simplify and re-order the
Articles of Association of the Company. The changes will also
remove the references to the special rights redeemable
preference share which was redeemed on 31 December 1994.

Article 17 will provide that the Company will maintain a record of
uncertificated shares. Further changes will be made to other
articles to facilitate the holding and transfer of uncertificated
shares.

Articles 32, 34, 35, 37 and 38: Proceedings at general meetings

In common with other listed public companies, these articles will
contain amendments to the previous provisions to ensure the
orderly and secure running of shareholders’ meetings for the
benefit of the meeting as a whole.

A summary of the principal differences between the
existing Articles of Association and the proposed new
Articles of Association

The following is a summary of the principal changes proposed to
be contained in the new Articles of Association. Other changes
have been made to bring the Articles of Association into line with
current regulation and best practice, generally to update, clarify
and simplify the Articles of Association of the Company and to re-
order the Articles of Association so as to make them easier to
read. These changes require no further explanation.

Article 51: Number of Directors

This article will provide that the maximum number of Directors
will be 12.

Article 57: Retirement of Directors

This article will simplify and clarify the existing article by
providing that, at each Annual General Meeting, any Director who
has held office for three years or more shall retire from office but
be eligible for re-appointment.

Article 2: Interpretation

Article 58: Removal of Directors

This article will include a new definition of treasury shares in
accordance with Section 162A of the Companies Act 1985. The new
article will clarify that when shares are held in treasury, all rights
relating to those shares are suspended, including the right to
attend and vote in general meetings, the right to receive a dividend
and the right to receive any other distribution from the Company.

In addition to the power of the Company in general meeting to
remove a Director, this article permits the removal of a Director by
notice from his co-directors provided such notice is signed by or on
behalf of all the other Directors (or their alternates) being not less
than three in number.

Pennon Group Plc

NOTICE OF ANNUAL GENERAL MEETING

Article 65: Expenses

Article 128: Indemnity

This article will permit a Director to have paid out of the funds of
the Company all expenses incurred by him in obtaining
professional advice in connection with the affairs of the Company
or the discharge of his duties as a Director subject to any
guidelines and procedures established from time to time by the
Board.

Article 70: Power to borrow money

This article will be updated as set out in Resolution 12 to deduct
any sums held by the Company on deposit when determining the
borrowings of the Company.

This article will provide that the Company may (rather than shall)
indemnify a Director or other Officer (excluding an auditor)
against liabilities incurred by him in connection with his duties,
powers or office. The change is for the purposes of clarification
and reflects a recent determination by the courts that a
company’s articles of association are not automatically binding as
between a company and its officers and that indemnities will not
be available to directors or officers unless they are also
incorporated in a separate contract between the company and the
relevant director or officer. The new article will also reflect recent
changes in company law relating to such indemnities.

Article 71: Delegation to individual Directors

POLITICAL DONATIONS

This article will give the Board the power to delegate any of its
powers to any Director on such terms and conditions as it thinks fit.

Article 75: Directors’ interests and voting

This article will contain updated provisions as to Directors’
interests and voting including the express ability of the Company
to purchase Directors’ and Officers’ insurance for the benefit of
any person who holds a relevant office with the Company.

Article 87: Issue of share certificates

This article will permit share certificates to be signed
electronically.

Article 94: Power to differentiate

This article will provide that, on an issue of shares, the Board may
differentiate between holders of shares in relation to the time
and amount of payment of calls on those shares.

Article 104: Calculation and currency of dividends

This article will allow for dividends to be declared or to be paid in
any currency. It will also allow the Board to agree with a member
to pay a dividend in a currency different from the one in which it
was declared and provides a mechanism for conversion of a
dividend into that other currency.

Whilst Resolution 14 requests shareholder approval by way of an
ordinary resolution to approve donations to political parties,
please note that the Company has a policy that it does not make
donations to, or incur expenditure on behalf of, political parties.
However, the Political Parties, Elections and Referendums Act
2000 (the ‘Act’) amended the Companies Act 1985 and contains
restrictions on companies making donations or incurring EU
political expenditure and it defines these terms very widely and
confirms that activities which form part of the normal
relationship between the Company and bodies concerned with
policy review, law reform and other business matters affecting the
Company may be included. Such activities, which are in the
shareholders’ interests for the Company to conduct, are not
designed to support, or implement support for, a particular
political party.

The Company believes that the authority proposed under this
Resolution (which is similar to that agreed by shareholders at the
Annual General Meeting last year) is necessary to ensure that it
does not commit any technical breach that could arise from the
uncertainty generated by the wide definitions contained within
the Act when carrying out activities in the furtherance of its
legitimate business interests.

RECOMMENDATION

Your Directors consider that all the proposals to be considered
at the Annual General Meeting are in the best interests of the
Company and its shareholders as a whole and recommend
shareholders to vote in favour of the Resolutions.

Pennon Group Plc

SHAREHOLDER INFORMATION

FINANCIAL CALENDAR

Financial year end

Sixteenth Annual General Meeting

2005 Final dividend payable

2005 Interim results announcement

2006 Interim dividend payable

2006 Preliminary results announcement

Seventeenth Annual General Meeting

2006 Final dividend payable

SHAREHOLDER ANALYSIS AT 31 MARCH 2005

Number of
shareholders

Percentage of
total shareholders

Percentage of
ordinary shares

4,921

15,524

3,438

414

132

20.1

63.4

14.0

1.7

0.3

0.5

24,497

100.0

22,341
190

3
1,959
4

24,497

91.2

0.8

–
8.0

–

0.2

5.3

4.7

5.3

3.8

80.7

100.0

9.4

1.2

–
89.1

0.3

100.0

Shares held

1 – 100

101 – 1,000

1,001 – 5,000

5,001 – 50,000

50,001 – 100,000

Over 100,000

Category of shareholder

Individuals
Companies

Trust companies (pension funds etc)
Banks and nominees
Insurance companies

SHAREHOLDER SERVICES

31 March

28 July 2005

5 October 2005

December 2005

April 2006

May 2006

July 2006

October 2006

SUBSTANTIAL SHAREHOLDINGS

At 15 June 2005, interests in the issued share

capital had been notified by:

AXA Investment Managers

5.51%

Lansdowne Partners Limited
Partnership

5.05%

FMR Corp. and Fidelity International

3.82%

Zurich Financial Services

Standard Life Group

Legal & General
Investment Management

3.79%

3.77%

3.64%

Further shareholder information
may be found at:
www.pennon-group.co.uk

Share dealing service

Individual Savings Accounts

The low-cost share dealing service offered by Stocktrade enables
shareholders to buy and sell shares in the Company on a low-cost
basis and to make regular investments in the Company.
Telephone Stocktrade on 0845 601 0995 and quote: LOW CO107.
Commission is 0.5% (Subject to a minimum charge of £15, to
£10,000, then 0.2% thereafter).

Share gift service

Through Sharegift, an independent charity share donation
scheme, shareholders who only have a small number of shares with
a value that makes it uneconomical to sell them, can donate such
shares to charity. Donations can be made by completion of a simple
share transfer form which is available from Lloyds TSB Registrars.

By holding their shares in the Company in a Mini or a Maxi
Individual Savings Account (ISA), shareholders may gain tax
advantages. The corporate ISA is administered by Lloyds TSB
Registrars.

Scrip dividend alternative

A scrip dividend alternative is available to shareholders so that
their dividends may be received in the form of shares instead of
cash.

Details of the above shareholder services are available from the
Company Secretary’s Department, telephone: 01392 257977.

Pennon Group Plc

SHAREHOLDER INFORMATION

Online portfolio service

THE PENNON GROUP WEBSITE

The online portfolio service provided by Lloyds TSB Registrars
gives shareholders access to more information on their
investments. Details of the portfolio service are available from
Lloyds TSB Registrars online at www.shareview.co.uk

Electronic communications

The Pennon Group website at www.pennon-group.co.uk provides
news and details of the Company’s activities plus links to
company websites. The shareholder information section contains
up-to-date information including the Company’s latest results
and dividend payment dates and amounts. It also holds historical
details and a comprehensive share price information section.

Shareholders can elect to receive shareholder communications
electronically by signing up through www.shareview.co.uk

Visit: www.pennon-group.co.uk/shareholder-info/shareprice.asp

ANNUAL GENERAL MEETING

The 2005 Annual General Meeting will be held on Thursday 28 July
2005. Further details are set out in the Notice of Annual General
Meeting on pages 90 to 95.

Appointing a proxy

A proxy form is being sent out to shareholders with this Annual
Report and instructions for its use are shown on the form.

Electronic proxy voting

Shareholders may register the appointment of a proxy for the
Annual General Meeting and any adjournment(s) thereof via
www.sharevote.co.uk – a website operated by Lloyds TSB
Registrars.

Electronic proxy appointment through CREST

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