Pennon Group Annual Report 2006

FY2006 Annual Report · Pennon Group

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a n n u a l r e p o r t & a c c o u n t s

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 3,000 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.

H I G H L I G H T S O F T H E Y E A R

REVENUE UP 17.1% TO £645.7 MILLION

OPERATING PROFIT UP 16.0% TO £175.1 MILLION(1)

PROFIT BEFORE TAX UP 24.6% TO £110.9 MILLION(2)

EARNINGS PER SHARE UP 17.4% TO 75.5p(3)

DIVIDEND PER SHARE UP 20.0% TO 51.6p

(1) Before exceptional items of £14.5 million (2004/05 £4.9 million). Statutory result £160.6 million (2004/05 £146.0 million)

(2) Before exceptional items of £56.8 million (2004/05 £4.9 million). Statutory result £54.1 million (2004/05 £84.1 million)

(3) Before exceptional items and deferred tax. Basic earnings per share are 29.7p

C O N T E N T S

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

Chief Executives’ overviews . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Business review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Board of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Directors’ remuneration report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Corporate governance and internal control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

Directors’ report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

Independent auditors’ report on Group financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

Group financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

Explanation of transition to International Financial Reporting Standards . . . . . . . . . . . . . . . . . . . . . . 84

Five year financial summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

Independent auditors’ report on Pennon Group Plc financial statements . . . . . . . . . . . . . . . . . . . . . . . 93

Pennon Group Plc financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

Shareholder information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107

Ken Harvey

Chairman

Pennon Group Plc

C H A I R M A N ’ S S T A T E M E N T

THE GROUP CONTINUED TO MAKE EXCELLENT PROGRESS DURING THE YEAR
DELIVERING PROFITABLE GROWTH IN ALL AREAS OF THE BUSINESS. THE RESULTS
AFFIRM OUR STRATEGY OF FOCUSING ON THE TWO KEY BUSINESSES, SOUTH
WEST WATER LIMITED AND VIRIDOR WASTE LIMITED.

FINANCIAL OVERVIEW

Group revenue increased by 17.1% to £645.7 million, mainly due
to increased revenue generated by the Ofwat approved tariff
increases in South West Water and another year of strong trading
by Viridor Waste.

Before exceptional items, operating profit increased by 16% to
£175.1 million, profit before tax increased by 24.6% to £110.9
million, and earnings per share increased by 17.4% to 75.5p.

The Directors are recommending a final dividend of 35.1p, a 20.2%
increase which is in line with the Board’s previously stated dividend
policy. Together with the interim dividend of 16.5p, this will result
in a total dividend for the year of 51.6p, a 20.0% increase on the
total dividend for the previous year.

The Board’s policy is to grow the Group dividend by 3% per annum
in real terms at least up to 2009/10. Shareholders will also be given
the opportunity to participate in a Dividend Re-investment Plan,
details of which will be circulated to shareholders in August 2006.

In December 2005, the Board announced its decision to increase
the level of gearing in South West Water to further improve the
efficiency of the Group’s capital structure. As a consequence of this,
circa £145 million has been returned to shareholders via a B Share
Scheme and £55 million is being returned via a share buy back.
In addition, £14.5 million has been paid to South West Water
customers in the form of a one-off payment of £20 per customer.
After the year end, the Board announced – subject to shareholder
approval – a 3 for 1 share split to increase the liquidity and
marketability of the Company’s shares.

SOUTH WEST WATER LIMITED

South West Water’s revenue increased by £41.5 million to £348.5
million and operating profit rose by 15.8% to £141.5 million before
exceptional costs of £14.5 million. Operating costs, including
depreciation, increased by £22.2 million to £207.0 million after
efficiency savings of £4.0 million.

The efficiency targets set by the Director General of Water Services
for the five year period 2005-2010 represent a tough challenge for
South West Water, but results from the first full year of the K4 period
indicate that the company is on track to achieve the necessary
operating cost reductions.

South West Water continued to deliver high levels of product and
customer service. In addition, the successful delivery of its waste
water improvement programme, which provides significant
environmental enhancement, enables the region to boast some of
Europe’s finest bathing waters, beaches and rivers.

During the five year period 2005-2010, a key element of South West
Water’s capital investment is in water mains renovation with an
enhanced programme already well under way. During the year, a
record length of 695 kilometres of water mains were either laid,
replaced or refurbished, providing customers with even higher levels
of drinking water quality. The programme is ahead of schedule and is
on track to meet the delivery targets set by the Drinking Water
Inspectorate.

Drinking water quality remains at a record high level and, as a direct
consequence of careful planning and capital expenditure, the
region’s water storage, treatment and distribution capability has
been progressively and significantly enhanced over the years.

There has not been a water restriction in the region since 1996 and
none is envisaged. The company’s leakage detection and reduction
programme continues to deliver results in line with mandatory
targets set by Ofwat.

VIRIDOR WASTE LIMITED

Viridor Waste’s financial performance during the year was again
strong with revenue increasing by 20.4% to £298.9 million and
operating profit before intangibles amortisation rising by 19.7% to
£35.9 million.

Viridor Waste has, since 2000/01, increased operating profit
before intangibles amortisation at a compound rate of 22.3%
per annum with around 11% being via organic growth and the
remainder as a result of acquisitions.

In June 2005, Viridor Waste acquired Brett Waste Management
Limited, a landfill and power generation business for a cash
consideration of £44.4 million. The company owns strategically
located landfill sites in Kent and Essex with approximately 11
million cubic metres of consented capacity, landfill gas power
generation schemes and other associated activities. The acquisition
complements the company’s existing facilities in the South East.

During the year, Viridor Waste established a 50:50 joint venture
company with Grundon Waste Management Limited and the new
business – Lakeside Energy from Waste Limited – will build and
operate an energy from waste plant in Colnbrook, near Heathrow.
The plant will have a capacity of 400,000 tonnes of waste per
annum and will also provide a power generation capacity of 32
megawatts of electricity. The plant is now under construction
with commissioning scheduled for mid 2008.

In May 2006, Viridor Waste acquired Wyvern Waste Services Limited
from Somerset County Council for £25 million as part of a 25 year
Public Private Partnership with the County. The acquisition includes
5 million cubic metres of consented landfill void, 7 megawatts of
power generation capacity and associated recycling and treatment
operations.

Viridor Waste’s expansion via organic growth and acquisition has
been a notable accomplishment within the waste sector and the
company is well placed to deliver further strong financial
performance in the future.

RETURN OF CAPITAL

On 15 February 2006, Pennon’s shareholders approved the
return of £200 million of cash to shareholders, with circa £145
million of this return by way of a B Share Scheme and circa
£55 million through an on-market share buy back programme. The
B Shares have now been issued with circa £138 million of capital
returned in March and the balance in April 2006.

In order to maintain comparability of the share price after the B Share
Scheme, Pennon undertook a share capital consolidation whereby
shareholders received 10 new Ordinary shares for every 11 existing
Ordinary shares. As a result, the number of Ordinary shares in issue
was reduced from approximately 130.5 million to 118.6 million.

STRATEGY

The Board’s priority continues to be the creation of shareholder
value through its strategic focus on water, sewerage and waste
management. The year’s financial results are testament to the
Board’s strategy of focusing on these key business areas. The move
to a more highly geared structure has enabled the Group to return
value to shareholders and customers and provide an enhanced
dividend.

PROSPECTS

The Board has confidence that South West Water will successfully
deliver the new K4 regulatory contract and significantly grow its
Regulatory Capital Value up to 2010. 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.

BOARD MATTERS

Bob Baty, Chief Executive of South West Water, is due to retire at the
end of July following 45 years’ service in the industry. The Board
would like to take this opportunity to express its gratitude to Bob for
his significant contribution to South West Water since privatisation
in 1989 and to wish him well in his retirement.

The Board looks forward to welcoming Chris Loughlin as an
Executive Director of Pennon and Chief Executive of South West
Water. He will take up his post on 1 August.

EMPLOYEES

During my years as Chairman of the Group, many structural
and organisational changes have taken place. Throughout this
time, employees have continued to demonstrate a high level of
loyalty, commitment and professionalism and I thank them
most sincerely for their efforts.

KEN HARVEY, Chairman, Pennon Group Plc
22 June 2006

Bob Baty

Chief Executive

South West Water Limited

O V E R V I E W

SOUTH WEST WATER CONTINUED TO DELIVER EXCELLENT FINANCIAL PERFORMANCE,
FIRST CLASS LEVELS OF PRODUCT AND ONGOING IMPROVEMENTS IN CUSTOMER
SERVICE, WHILST OUTPERFORMING CHALLENGING REGULATORY TARGETS.

SOUTH WEST WATER LIMITED

The company’s revenue increased by £41.5 million to £348.5 million.
The main factors for this increase were Ofwat approved tariff increases
and 7,400 new customer connections, offset by customers switching
from an unmeasured to a measured charging basis.

South West Water’s operating profit rose 15.8% to £141.5 million
before exceptional costs of £14.5 million from the one-off customer
payment (2004/05 exceptional restructuring costs £3.4 million).
Operating costs, including depreciation, increased by £22.2 million to
£207.0 million. Additional costs from new capital schemes of £7.7
million, inflation of £8.4 million (including energy and chemicals),
and other cost increases of £10.1 million (including increases in
depreciation and increases in direct charging of a proportion of
leakage expenditure to operating cost), were offset by £4.0 million
of efficiency savings.

South West Water is pursuing a long term restructuring and
continuous improvement programme to reduce overhead and
operating costs. This is designed to ensure that the company

continues to outperform the demanding operational and capital
efficiency targets imposed by Ofwat. It is on track to continue to do so
for the remainder of the current regulatory period (K4, 2005-2010).
Since the first Periodic Review in 1995, base cost efficiency savings
totalling £54.2 million have been achieved.

Despite the regulatory pressure to reduce operational expenditure,
provision of first class levels of water and sewage treatment and
ongoing improvements in customer service have remained key
company objectives. Independent market research carried out amongst
South West Water’s customers confirms high levels of satisfaction with
the overall service provided by the company, although levels of charges
remain an issue for some groups of customers. Plentiful supplies of
high quality drinking water are an absolute priority for customers and,
as a direct consequence of careful planning and capital expenditure,
the region’s water storage, treatment and distribution infrastructure
has been progressively and significantly enhanced over the years.

There have been no water restrictions in the region since 1996 and the
company’s leakage detection and reduction programme continues to
deliver results in line with mandatory targets set by Ofwat. During the
winter period, three key reservoirs were replenished by pumping water
from downstream river flows to supplement the natural raw water
inflow. The pumping infrastructure was installed several years ago to
provide enhanced drought protection. This has contributed to reservoir
levels being marginally higher than at the same time last year, despite
lower levels of rainfall.

Capital expenditure increased by 42.0% to £191.0 million. £109.4
million was invested in water supply improvements, including water
mains renovation and water treatment works enhancement. Over 695
kilometres of water mains were laid, replaced or refurbished during the
year and the company’s ‘Putting the Sparkle Back into Your Water’ water
mains renovation programme has seen record levels of expenditure
and refurbished water mains being achieved. Continued high levels of
investment in the water mains renovation programme will be a key
element during the remainder of the K4 period.

Improvements in water supply have been matched with improvements
to water quality. During 2005, the company achieved its highest ever
drinking water compliance level of 99.96% with the quality standards
monitored by the Drinking Water Inspectorate (DWI).

Waste water investment expenditure totalled £81.6 million.
The company’s massive ‘Clean Sweep’ coastal sewage treatment
improvement programme is now virtually complete apart from a
small number of minor schemes which are being delayed because of
planning and other related issues. ‘Clean Sweep’ has transformed the
coastal environment of the South West and 89% of the region’s bathing
waters now meet the stringent EU guideline standards and 99%
conform with EU mandatory standards. These quality achievements are
amongst the very best in the UK and a testament to all those involved
in the delivery of one of the largest environmental improvement
programmes of its kind in the whole of Europe.

Inland waste water treatment works are also being updated and
modernised as part of a rolling programme to ensure compliance with
demanding environmental standards. The successful delivery of both
coastal 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.

Improvements within Ofwat’s ‘Overall Performance Assessment’ (OPA)
have been sustained as capital expenditure, previously constrained
whilst the ‘Clean Sweep’ programme was delivered, is now being
directed to address other areas. Improvements in waste water
treatment works compliance within the OPA continue, but these
have been marginally offset by the increased number of sewer
flooding incidents caused by factors other than hydraulic overload,
such as blockages.

This will be my final contribution to the Pennon Group Annual Report
as I will be retiring from my role as Chief Executive of South West Water
at the end of July this year. I am immensely proud of what South West
Water has achieved since privatisation in 1989 and I feel very
privileged to have been at the helm during a period of tremendous
challenge and change. I consider myself fortunate to have led such a
good team and I would like to take this opportunity to thank them and
all those associated with the company who have enabled me to look
back with pride on the progress made.

Colin Drummond

Chief Executive

Viridor Waste Limited

O V E R V I E W

VIRIDOR WASTE CONTINUES TO DELIVER STRONG GROWTH.

In September 2005, Viridor Waste entered into a joint venture
(Lakeside Energy from Waste Limited) with Grundon Waste
Management Limited to develop and operate a large energy from
waste (EfW) facility at Grundon’s site in Colnbrook, near Heathrow.
This strategically located facility is consented and is now under
construction. It is due to come on stream in 2008, with a capacity
of 400,000 tonnes (kt) waste per annum and power generation of
32MW. It is ideally located to assist councils in meeting their landfill
diversion targets whilst at the same time generating significant
electricity output. This £160 million project is being financed 86%
by non-recourse bank debt with the balance of finance split equally
between Viridor Waste and Grundon.

Landfill inputs excluding cover were 7% higher in 2005/06
compared with the previous year, at 4.3 million tonnes, of which
Brett Waste Management accounted for 0.4 million tonnes. In the
first half of 2005/06, Viridor Waste benefited from a large one-off
disposal contract at its Masons landfill site whilst, as reported last
year, in the first quarter of 2004/05, benefiting from additional
volumes in advance of the change in hazardous waste regulations.
Excluding the effect of the Brett Waste Management acquisition and
the above non-recurring items, landfill volumes were unchanged.
Average revenues per tonne increased by 9.0% reflecting a more
favourable mix of business. Taking account of the Brett Waste
Management acquisition and planning gain offset by usage during
the year, Viridor Waste’s consented landfill void increased from
80 million cubic metres last year to 87 million cubic metres at
31 March 2006.

VIRIDOR WASTE LIMITED

Viridor Waste continued to make 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 (including Private Finance Initiative
(PFI)/Public Private Partnership (PPP) and integrated waste
management contracts).

Financial performance in 2005/06 was again strong. Revenue
at £298.9 million increased by 20.4% over the previous year.
Operating profit (before amortisation of intangibles) at £35.9
million increased by 19.7% over the previous year driven by good
performance from the underlying landfill, power generation and
contracts businesses combined with the positive effect of the Brett
Waste Management Limited acquisition. In the five years since
2000/01, operating profit before amortisation of intangibles has
grown by 22.3% per annum of which around 11% has been organic
with the remainder being from acquisitions. Profit before tax at
£21.9 million was 9.0% up on the previous year. This consistent
strong financial performance reflects the success of Viridor Waste’s
focused strategy.

In June 2005, Viridor Waste acquired Brett Waste Management
Limited for £44.4 million. Brett Waste Management comprised
operational landfills in Kent and Essex with 11 million cubic metres
of consented void, 6 megawatts (MW) of landfill power generation
capacity and associated transfer station, recycling, composting and
transport operations. The acquisition fits well with Viridor Waste’s
stated strategy and complements the company’s existing facilities in
the adjacent counties of East Sussex, Surrey and Suffolk. Brett Waste
Management has now been successfully integrated and was earnings
enhancing at profit before tax (PBT) level (after integration costs
and amortisation of intangibles) in its first nine months, a year
ahead of expectations.

Viridor Waste’s landfill gas power generation output increased from
327 Gigawatt Hours (GWH) to 367GWH due to organic growth and
the Brett Waste Management acquisition. Reflecting the general
increase in underlying energy prices and the renewable premium
in the UK, Viridor Waste’s average revenues per megawatt hour
increased by 10% to £59. As at 31 March 2006 Viridor Waste’s
landfill gas power generation capacity was 61MW compared with
52MW at the previous year end.

Viridor Waste continues to explore suitable PFI/PPP opportunities
as part of its overall strategy. In May 2006, Greater Manchester
Waste Disposal Authority announced that the Viridor Waste
Management Limited/ John Laing Plc joint venture was one of two
parties shortlisted to submit Best and Final Offers for its waste
management services contract.

The Government’s target of diverting municipal waste from landfill
up to 2020 may be expected over time to lead to a decline in the
landfill market. However, with only around six years’ consented
capacity in the UK as a whole (Environment Agency estimate),
Viridor Waste’s 87 million cubic metres is likely to become an
increasingly valuable resource. Meanwhile, the need for councils

to achieve their diversion targets creates attractive opportunities
for PFI/PPP contracts, such as Viridor Waste’s with West Sussex and
Somerset, and for facilities such as the Lakeside EfW plant. As the UK
increasingly relies on imports of energy and seeks to increase its
output of renewables, Viridor Waste’s gas business is also an
increasingly valuable asset.

After the end of the financial year, Viridor Waste announced the
acquisition of Wyvern Waste Services Limited from Somerset County
Council for £25 million as part of a 25 year PPP contract with the
County. The acquisition comprised 5 million cubic metres of
consented landfill void, 7MW of power generation capacity and
associated recycling and treatment operations. It is expected to be
earnings enhancing before intangibles amortisation in its first full
year. This acquisition and associated contract ties in well with the
three clearly defined areas of Viridor Waste’s strategy outlined on
the facing page.

Since privatisation in 1989, 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 the Office of Water Services
(subsumed into the Water Services Regulatory Authority from 1 April
2006 but which continues to be known as Ofwat), the size and
content of which is reviewed at five-yearly intervals. As well as
determining outputs, Ofwat sets prices, inter-alia, to enable
efficient 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 Capital 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 is calculated.

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 and operations at
lower cost than Ofwat assumed.

B U S I N E S S R E V I E W

OVERVIEW AND STRATEGY

PENNON GROUP

Pennon Group operates and invests in the areas of water and
sewerage services and waste management. It has assets of
£2.7 billion and currently employs around 3,000 people. It has
two main subsidiaries – South West Water Limited (South West
Water) and Viridor Waste Limited (Viridor Waste).

The Company’s Mission Statement is to be a pre-eminent operator
in the business areas of water and sewerage services and waste
management. In these main business areas and for all future
business developments, to ensure the hallmark of quality, efficiency
and reliability which will help to meet the three key goals of:

– Satisfying customers
–
– Adding value for shareholders, employees and the

Enhancing the environment

community

The Board’s priority, pursuant to this Mission Statement, is the
creation of shareholder value through its strategic focus on water
and sewerage services and waste management.

Certain terms used throughout this Business Review, including how
forward looking statements are to be interpreted, are explained in
the Interpretation Section on page 26 and the Glossary on page 27.

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
around 450 million litres of treated water per day through 15,000
kilometres of water mains and disposes of around 250 million litres
of waste water each day via 9,000 kilometres of public sewers.

The asset base of South West Water comprises:

Distribution mains

Sewers

Impounding reservoirs

Water treatment works

Waste water treatment works

– including works with ultra violet treatment

Combined sewer overflows

15,000 kms

9,000 kms

624

1,064

VIRIDOR WASTE

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

The main operations of Viridor Waste as at 31 March 2006
comprise:

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

Household waste recycling (civic amenity) sites

340

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 (including PFI/PPP contracts and
integrated waste management contracts).

Viridor Waste’s main UK operations
as at 31 March 2006

Landfill sites - operational

Landfill sites - with planning

Power generation plants

Glass recycling plants

Transport depots

Transfer stations

Incineration plant

MRF plants

Glass recycling depots

Waste treatment plants

Composting sites

Civic amenity sites

Viridor Waste’s landfill market consists of municipal, commercial and
industrial wastes along with 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 biodegradable municipal waste in the UK as
a whole going to landfill can be expected to decline. Municipal waste
is around one third of Viridor Waste’s landfill market. However,
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 is an increasingly valuable asset.

DIVIDEND POLICY AND SHAREHOLDER RETURNS

The Group is committed to a progressive dividend policy.

In December 2005, Pennon announced its decision to move South
West Water to a more highly-geared structure to enhance the
Group’s capital efficiency. As a consequence of this, following
shareholder approval at an Extraordinary General Meeting of the
Company in February 2006, a capital return was made to
shareholders by way of a B Share Scheme of circa £145 million
(equivalent to 110p per share), with an associated share capital
consolidation. In addition to this, a share buy back of £55 million is
being progressed.

The Board also announced its intention to step-up both the interim
and full year Group dividend by 20% per share (after the share
capital consolidation) and its policy to grow it by 3% per annum in
real terms thereafter until 2009/10.

SOUTH WEST WATER REGULATORY &
COMPETITIVE ENVIRONMENT

APPOINTMENTS

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

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 the Consumer Council for Water, a separate statutory
body which has replaced WaterVoice, which was part of Ofwat.

B U S I N E S S R E V I E W

Viridor Waste is one of the largest landfill site operators in the UK
with a total consented landfill capacity of approximately 87 million
cubic metres at 31 March 2006. 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 17 years at current rates of fill
– significantly longer than of the industry as a whole. This capacity
is located as shown on the map on the previous page.

Gas produced from decomposing waste on landfill sites is
increasingly used to generate electricity. It is a form of renewable
energy and now represents around 30% 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 around 4% to a target of 10% in 2010 and 15% in
2015, with an aspiration of 20% in 2020. 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. In April
2002, the NFFO regime was replaced by the renewable obligation
certificates (ROCs) regime. The overall price for electricity supplied
under ROCs is currently higher than that achieved under the most
recent NFFO scheme. This, together with acquisitions, has enabled
Viridor Waste to increase its total generation capacity to a current
61MW at 31 March 2006, compared with 28MW in March 2002.

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

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 nine
acquisitions in the waste sector for an aggregate consideration of
approximately £150 million in the period to 31 March 2006. They
have been integrated into the Viridor Waste group. In May 2006,
Viridor Waste acquired Wyvern Waste Services Limited, details of
which are set out in the Chief Executive’s Overview.

As a result of this focused strategy, Viridor Waste’s revenue
(including landfill tax) has grown from £106.1 million to £298.9
million over the period 2001 to 2006. Its operating profit (before
amortisation of goodwill and intangibles) has increased from £13.1
million to £35.9 million, a compound annual growth rate of 22.3%.
This has been the result of organic growth of the underlying
business of around 11% per annum and the beneficial impact
of recent acquisitions.

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 Retail Price Index (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 instituted a system of ‘comparative competition’ which
compares South West Water’s performance on a wide range of
parameters, including efficiency, customer service, and
environmental performance. Operating and capital cost comparisons
are used by Ofwat to determine the level of efficiency improvement
which might be achieved at each Periodic Review.

Companies are incentivised to be efficient both in terms of their
operating costs and in the implementation of their capital
expenditure programmes. The benefit of any efficiency savings
achieved through effective 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. 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, in certain
circumstances agreed by Ofwat, be logged up or down, with prices
adjusted 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 in December 2004
and are shown below:

Year
2005/06

2006/07

2007/08

2008/09

2009/10

Average

Ofwat Final
Determination
‘K’ factor %
12.5

9.8

1.7

1.4

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 3,200kms of water distribution mains
improvements at 14 water treatment works

–
–
– phosphorous removal at nine sewage treatment works
– work to address 49 unsatisfactory intermittent effluent

discharges

– Resolve or mitigate problems identified in the company’s plan

where overloaded sewers cause internal flooding

– 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).

Municipal waste accounts for around one third of Viridor Waste’s
landfill market.

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 achieves the requirements of the EU Landfill
Directive. Subject to some constraints, local authorities can carry
forward or trade allowances 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 £21 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.

B U S I N E S S R E V I E W

ENVIRONMENT /QUALITY REGULATION

The water industry in the UK is subject to substantial domestic and
European Union (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 groundwater and river water, as well as for estuarine and
coastal water by the end of 2015.

Environmental regulation for water and waste water in England is
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

As the licensed undertaker in Devon, Cornwall and small parts of
Dorset and Somerset, South West Water has no direct competition
for the provision of water and sewerage services to the vast majority
of its customers. A new regime is in place whereby customers using
more than 50 megalitres (Ml) per year can contract with alternative
suppliers for water supply. South West Water has only 36 customers
in this category, whose aggregate water charges account for less
than 2% of its total turnover. During the year, South West Water
submitted indicative access prices and draft agreements to Ofwat
pursuant to the new regime.

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

PLANNING FOR LANDFILL SITES AND WASTE AND RECYCLING
INFRASTRUCTURE

All waste management facilities, including the development of new
landfill sites and the expansion of existing landfill sites, are subject
to planning permission from the relevant local authority. Landfill
sites (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 rigorous assessment by local
authorities who will consider them against the backdrop of policies
contained within waste local plans that have been compiled for their
areas. Applications have to address a wide range of issues, and the
EA is a statutory consultee in this process.

INTEGRATED MUNICIPAL WASTE MANAGEMENT CONTRACTS
AND THE ROLE OF PRIVATE FINANCE INITIATIVES (PFIs) OR
PUBLIC PRIVATE PARTNERSHIPS (PPPs)

To assist in meeting their landfill diversion targets, local authorities
are seeking to let integrated waste management contracts covering
a range of activities which often include household waste recycling
sites (HWRS); composting; recycling and recovery; 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 the PFI 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 waste 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 £25m of PFI credits.

In May 2006, a joint venture between Viridor Waste and John Laing
Plc was chosen as one of two parties shortlisted to submit Best and
Final Offers (BAFOs) for the Greater Manchester waste services PFI.

Councils may also choose to let long term contracts under the PPP
regime. From the waste management contractor’s point of view, the
nature of the contract is very similar whether it is a PFI or a PPP.

In May 2006, Viridor Waste signed a 25 year PPP with Somerset
County Council and at the same time acquired Somerset’s Local
Authority Waste Disposal Company (LAWDC), Wyvern Waste Services
Limited.

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 continue to seek to
secure such contracts.

WASTE REGULATION ENVIRONMENT

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

Waste facilities are also subject to the same regulations as other
industries, including health and safety, control of substances
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 suppliers
and contractors section of this Business Review on page 22.

SOUTH WEST WATER

No single customer accounts for more than 1% of turnover. No
supplier (revenue) accounts for more than 5.0% of turnover and
South West Water sources all its purchases from competitive markets
with the exception of the purchase of magnetite for use at a water
treatment works. Action is being taken to change this treatment
process.

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.

B U S I N E S S R E V I E W

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 Capital Value

Regulatory Capital Value (RCV) is the financial base on which Ofwat
allows a rate of return and sets prices at the Periodic Review. The
opening RCV is adjusted for projected capital and infrastructure
renewals expenditure, grants and contributions, infrastructure
renewals charge and current cost depreciation, together with the
efficiency outperformance from the previous regulatory period.
Ofwat then projects each component for each year of the Review
period. The RCV is adjusted annually for Retail Price Index
movements. At the following price review, the RCV 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 RD08/06, which is available on the Ofwat
website – www.ofwat.gov.uk

The RCV at 31 March 2006 amounted to £2.1 billion.

Projected Regulatory Capital Value

2700

2500

2300

2100

n
o
i
l
l
i

m
£

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

Data is collated for 12 month periods, part calendar year and part
financial year. 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.

Improvements within Ofwat’s OPA index have been sustained as
capital expenditure, previously constrained whilst the coastal clean-
up was delivered, has now been directed to address other areas.

Overall Performance Assessment Scores

400

350

300

250

s
t
n
i
o
p
A
P
O

2005

2006

2007

2008

2009

2010

Financial year ending 31 March

Drinking water compliance

2001

2002

2003

2004

2005

Financial year ending 31 March

Projected RCVs up to 2009/10 are based upon Ofwat’s projections set
out in ‘Future Water and Sewerage Charges 2005-10’ published in
December 2004, adjusted by South West Water’s estimates of RPI
indexation.

The growth in RCV adds directly to shareholder value as a higher
value and therefore return is attributed to South West Water’s asset
base by the Regulator.

Operating profit

South West Water achieved an operating profit before exceptional
items of £141.5 million in 2005/06, up £19.3 million on 2004/05.
For the five year period 2002 to 2006, operating profit was as follows:

Year ended 31 March

2002*
£m

107.0

*UK GAAP

2003*
£m

2004*
£m

2005
£m

2006
£m

111.5

118.9

122.2

141.5

During 2005, South West Water further improved its overall high
level of compliance with the drinking water quality regulations with
99.96% of its regulatory tests meeting the required standards.

Overall Water Quality Compliance

100

99.5

98.5

e
c
n
a
i
l
p
m
o
c
%

2001

2002

2003

2004

2005

Calendar years

VIRIDOR WASTE

Operating profit and profit before taxation (PBT)

Operating profit before intangibles amortisation and PBT are key
measures of Viridor Waste’s performance and are set out in the table
below for the six year period 2001 to 2006.

The table also sets out the Compound Annual Growth Rate (CAGR) of
these measures which is the rate of growth between 2001 and 2006
expressed as a single average figure over the period.

Return on equity investment

Return on equity investment is calculated as profit before taxation
expressed as a percentage of Pennon Group’s equity investment in
Viridor Waste (£207 million at 31 March 2006). This is also set out in
the table below.

Year ended 31 March

Operating profit before intangibles amortisation

Profit before taxation

Return on equity investment after corporate overheads

*UK GAAP

Consented landfill void

2001*

£m

13.1

11.7

6.1%

2002*

£m

15.2

13.5

2003*

£m

19.1

14.2

2004*

£m

22.7

14.7

2005

£m

30.0

20.1

7.1%

7.4%

7.5%

10.3%

2006

£m

CAGR

2001 – 06

35.9

21.9

10.6%

22.3%

13.4%

–

As at 31 March 2006, Viridor Waste had an assessed consented void
capacity of 87 million cubic metres. This can be reconciled to the
disclosed consented void capacity in last year’s Annual Report, as
follows:

Landfill gas electricity generation capacity

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

As at 31 March 2006, Viridor Waste had 61MW of generating
capacity, an increase of 9MW over the year.

As at 31 March 2005

Planning gains (net)

Acquisition

Used in the period

As at 31 March 2006

million cubic metres

Power Generation Capacity

(5)

W
0M

Consented Landfill Void

2001

2002

2003

2004

2005

2006

Financial year ending 31 March

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

2001

2002

2003

2004

2005

2006

Financial year ending 31 March

B U S I N E S S R E V I E W

CORPORATE RESPONSIBILITY

In accordance with its Mission Statement (as set out on page 8), the
Pennon Group endeavours to achieve the appropriate balance between
all its stakeholders, the environment and the needs of the Group.
The Group’s social and ethical policy covers the key areas of finance,
employees, customers and suppliers, community, management
responsibility and communications.

A key objective of the Group is to uphold its reputation for integrity
and fair dealing, which it considers is essential to the long-term
well-being of the Group and its key stakeholders.

The Group also has a ‘Whistleblowing’ policy which 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.
This policy is reviewed regularly.

The Group improved its overall score in the Business in the
Community’s Environmental Index 2005 to 92.97% and was ranked
32nd out of 145 entrants.

The Group is a constituent member of the FTSE4Good Index which
recognises the Company’s fulfilment of the Index’s criteria for
corporate social responsibility.

ENVIRONMENT
INDEX 2005

FTSE4Good

Occupational health and safety are key elements of South West Water’s
risk management philosophy/process. Following privatisation, the
company set out to build an occupational health and safety culture
throughout its supply chain in partnership with stakeholders including
trade unions, regulators, other water companies and construction
partners. South West Water’s reportable accident rate was 12.56
accidents per 1,000 employees in the calendar year 2005, a slight
increase on 12.0 per 1,000 employees in 2004. Whilst the significant
reduction achieved in recent years has largely been maintained, the
company continues to pursue initiatives to improve the health and
safety of all its employees.

A similar business-focused approach is now underway to reduce work-
related ill health. Although the company acknowledges that further
work is required to improve health at work, at a major health conference
hosted by the TUC during the year, South West Water was the only
private sector organisation to be cited by the Minister of Health and
Safety as effectively integrating ethical, commercial and statutory
objectives.

Through the Chief Executive’s chairmanship of the Health and Safety
Group of Water UK, South West Water continues to lead ‘Clear Water
2010’, a 10 year occupational health programme for the water industry.
Independently verified data gathered across the industry has identified
the industry’s greatest work-related challenges as stress and musculo-
skeletal disorders.

An essential aspect of South West Water’s activities with regard to the
safety, health, welfare and well-being of its own workers is the extensive
provision of training in skills acquisition and health and safety, thus
ensuring that employees have the knowledge and expertise to undertake
their jobs in a well-motivated and productive manner.

EMPLOYEES

Viridor Waste

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

South West Water

In 2005, South West Water undertook a major internal reorganisation
including the establishment of a new asset management function,
which is enabling a more efficient approach to its asset investment and
providing improved performance information about the company’s
assets. The reorganisation enabled 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. A second major project is currently underway to
improve the service to customers in relation to the company’s day to
day operational activities and to reduce operational costs. This will
involve the establishment of a new Service Centre in Exeter in 2006,
which will ultimately both manage the customer interface and plan the
activities of field staff who are directly responsible for handling
customer issues.

Viridor Waste is pursuing a number of occupational health and safety
initiatives. It currently has seven sites accredited to the ISO18001
international health and safety standard and is planning to extend this
across further sites. All other sites are covered by the company’s
environmental management system (most accredited to ISO14001),
which is the vehicle for delivering health and safety standards and
procedures.

Viridor Waste’s reportable accident rate per 1,000 employees was 18.1
in 2005/06 (13.2 in 2004/05). Whilst this accident rate still compares
favourably with the industry as a whole, it is recognised that an
increasing focus on health and safety improvement and performance is
necessary. The company has recruited additional health and safety
professionals during the year and continues to raise the level of training
and support available to its staff.

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 which is available on the
Group’s website – www.pennon-group.co.uk/CR

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

The Group is a major generator of renewable energy which supports
the Government’s objective to reduce greenhouse gas emissions. In
2005/06, the Group generated 437GWh, which was the equivalent of
152% of the Group’s total energy consumption.

South West Water

The percentage population served by sanitary compliant waste water
treatment works improved to 99.41% (99.16% in 2004).

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 2005, 99% of the region’s 143 bathing waters achieved EU
mandatory standards (98% in 2004) and 89% achieved the more
stringent guideline standards (81% in 2004).

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 for
energy generation or flared), leachate production and potential local
impacts such as dust, noise, litter and odour.

Viridor Waste developed its own Environmental Management System
(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 achieved to maximise positive
environmental impacts and reduce negative impacts, 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 and has 42 accredited
centres covering 107 operational facilities as at 31 March 2006. It has
also played a leading role in developing and reporting against the
environmental performance indicators for the waste industry as
promoted by the Green Alliance.

The amount of waste recycled by the company increased over the year
to 951,155 tonnes (780,129 tonnes in 2004/05), a 22% increase.

INCIDENTS AND PROSECUTIONS

Both South West Water and Viridor Waste endeavour to manage their
operational activities to minimise the occurrence and impact of any
incidents that occur at operational sites.

South West Water

The number of incidents classified by the EA as ‘Category Two’
(significant pollution incidents) in 2005/06 was six, of which only
three were determined as non-compliant with discharges consents,
compared with three also determined as non-compliant in 2004/05.

During the year, the company was convicted on two occasions for
environmental offences and fined a total of £6,000, compared with
12 convictions and £51,200 in fines in 2004/05. The company has
strategies in place to reduce incidents which may lead to
prosecutions.

In January 2006, an incident occurred in part of the Exeter water
distribution network when diesel fuel entered the supply. To protect
customers a ‘Do Not Drink’ notice was issued for a four day period.

Viridor Waste

In September 2005, Viridor Waste pleaded guilty to one charge of
contravening Section 34 of the Environmental Protection Act – a
littering offence from March 2004 at the Parkwood landfill site in
Sheffield. The company was fined £2,000 plus costs. As a result of
this incident, the company undertook a full review of operations at
the site and has implemented a series of actions to prevent a
recurrence.

SOCIAL AND COMMUNITY ISSUES

The Group is committed to supporting the communities in which it
operates. It does this by carefully targeted sponsorship and
charitable donations to social and community groups, further details
of which can be found in the Group’s Corporate Responsibility Report.

RESOURCES

SOUTH WEST WATER

Human resources

South West Water has a skilled management team and utilises
remuneration and incentive policies which are focused on financial
and operational targets. It has invested significant sums to ensure
that its staff have the experience and competencies to undertake
their roles. For example, NVQ training is provided to operators and
craftsmen to ensure that basic skills are in place and health and
safety requirements met. A range of training opportunities including
assistance to obtain professional qualifications is offered to office-
based staff and managers are encouraged to widen 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’ (IIP) standard and is closely aligned
with business requirements.

B U S I N E S S R E V I E W

Staff turnover is below the national average. Job satisfaction is
supported by encouraging role changes wherever possible around
the company to help employees gain a broad experience of business
activities. The company has introduced a number of ‘Family Friendly’
policies to ensure that a proper balance is maintained between work
and home life. Regular benchmarking of salary levels is carried out
to maintain the company’s competitive position in the job market.
The company will be carrying out an employee survey during 2006,
having last done so towards the end of 2002, and will also be
seeking IIP re-accreditation during this coming year.

Water resources

In 2005/06, South West Water abstracted 175,890 Ml of raw water
from its 61 licensed abstraction locations which have a total annual
licensed volume of 384,466 Ml. The abstraction locations are either
reservoirs, rivers or groundwater 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 target of 84 Ml/d.

South West Water prepares and updates its Water Resources Plan
every five years for a range of climate change and demand scenarios.
The Plan, which is reviewed annually, indicates that no new
reservoirs are required to be built before the planning horizon of
2030 but investment is needed to develop the overall trunk main
infrastructure, to expand treatment capacity and to enhance certain
pumped storage facilities.

Industry reputation and expertise

Viridor Waste is an active member of the Environmental Services
Association, the leading trade body, and other relevant industry
organisations such as the Chartered Institution of Wastes
Management and the Renewable Power Association. Senior staff are
also involved in leading positions on industry committees providing
Government departments with economic and technical information.

Landfill and electricity generation resources

Details of these resources are set out on page 15.

RISKS AND UNCERTAINTIES

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 produce sustainable
earnings growth. This is dependent upon the correct strategies
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.

At 26 March 2006, reservoir storage levels were 82.7% compared
with 80.8% at 27 March 2005.

RISK FACTORS RELATING TO THE GROUP’S WATER AND
WASTE WATER BUSINESS

Systems

The company has a range of sophisticated financial, asset
management and operational systems which are upgraded and
renewed as necessary to ensure reliability, efficiency and
operational effectiveness. In addition, it has back-up and standby
arrangements 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 and supervisory, administrative
and clerical, semi-skilled and unskilled staff. Many are vocationally
trained and have extensive operational experience. Membership of
relevant trade and professional bodies is widespread and is
encouraged.

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

The outcome of Ofwat’s future Price Determinations 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 efficiency expectations in the last two Periodic
Review periods (K2 and K3).

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. This could result in the potential for fines or
other sanctions imposed by either the water regulator or the courts,
including ultimately the loss of South West Water’s Appointment.
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 environment 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 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.

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
customers. Since 1997 water companies are prohibited from
disconnecting domestic water supplies 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 Ofwat
in the Determination for its 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 property 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 IDoK in the event of a
significant shortfall.

Energy cost pressures

Energy costs are the second highest component of South West
Water’s operating costs. A proportion of recent increases was
recognised and allowed for by Ofwat in the last Price Determination.

B U S I N E S S R E V I E W

South West Water mitigates rising energy costs through careful
system operation, by maximising renewable energy generation and
by purchasing energy in the most efficient way.

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 charged by the volume of water used. Most customers in
properties built prior to 1989 can choose to opt for metered 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 metered charges is estimated at each Periodic Review.
South West Water expects that the proportion of customers charged on
a metered basis will align with the estimates made at the last Review
which allow for some 65% of domestic customers to pay by measured
charges by 2010, compared with around 53% of such customers with
meters at 31 March 2006. However, it is possible that a higher
proportion of customers could switch to a metered supply and this
could have an adverse impact on the company’s revenues. As referred
to in the price cap regulation section on page 11, an IDoK may be used
to at least partially recover revenue losses if they exceed the prescribed
materiality threshold.

Other potential uncertainties and 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 or DWI
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.

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), restoration
and aftercare costs, leachate management, landfill gas management
and general site management. Companies such as Viridor Waste, with
landfills engineered to modern standards and which 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.

Landfill sites are filled and restored on a cell by cell basis. Final
restoration, in accordance with the planning permission, and aftercare
of the site takes place after site closure and the costs related to
aftercare are expected to continue for around 30 years post closure.
These costs are best estimates based on Viridor Waste’s own extensive
experience and they are updated at each stage of the capital
expenditure programme, typically every three years. Nevertheless,
as with any estimate of future costs, there is a risk that circumstances
may change which may affect the level of those costs.

Restoration and aftercare costs are recognised on a landfill usage
basis, i.e. per tonne input. This is derived by dividing the total
expected cost by the number of tonnes expected to be input into the
site up to its closure. The number of tonnes expected to be input is
derived from the remaining void space, as estimated by external
consultants, and estimated compaction rates (tonnes per cubic metre).
These are best estimates, based on current information, which are
reviewed every year. However, to the extent that tonnages are over or
underestimated, there is a risk that the amount provided may be too
high or low at a particular point in time.

Municipal waste contracts typically last for a number of years; they
usually have price increases under formulae related to inflation as
measured by the RPI in the UK 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.

The Government’s Waste Strategy, stemming from the Landfill
Directive, may lead to a reduction in volumes of waste being
disposed of via landfill.

The Government’s waste strategy is currently under review and includes
targets for diversion of municipal waste from landfill and increases in
landfill tax as previously announced.

Viridor Waste focuses on the disposal of municipal; industrial and
commercial; construction; and demolition waste. Of this, around one
third (25 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.

Existing Government initiatives are starting to have an impact and the
amount of municipal waste being disposed to landfill appears now to be
declining. Assuming the EU Landfill Directive targets are met, the total
amount of municipal solid waste (MSW) which will 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.

Viridor Waste has seen its underlying landfill volumes holding steady or
slowly increasing, perhaps reflecting an increasing share of the landfill
market. However, the combined effect of the various Government
measures may reduce the total amount of waste being landfilled in
the future.

Not all landfills may meet the standards of the Integrated
Pollution Prevention and Control 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 opened before July 2001 operate under waste management
licences. In 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 it is expected that, after a transitional
period, the average technical and operational standards of landfill in
the UK will improve and it is possible that the number of landfills may
decrease.

All but one of Viridor Waste’s operational landfills have achieved PPC
permits, although in some cases the company is appealing against
certain of the conditions proposed, which might have cost or other
implications for the landfills. The operational landfill which has not yet
received a PPC permit is due to close in three years’ time in any event.
The company is in the process of applying for PPC permits for two new
landfills and whilst it is expected that these applications will be
successful, the EA’s or SEPA’s conclusions cannot be pre-judged.

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.

Pricing and other risks relating to renewable energy

Renewable energy prices under the current ROCs scheme are primarily a
function of the underlying ‘brown’ energy price and the premium
achieved from the sale of ROCs.

Recent underlying ‘brown’ energy prices have risen significantly
reflecting the general energy supply/demand position in the UK and
worldwide. ‘Brown’ energy prices will continue to be determined by the
world and UK energy market and may go down as well as up. Any
changes in underlying energy prices will directly affect Viridor Waste’s
revenues when its sales contracts come up for renewal. (In general,
Viridor Waste has sold its energy one year ahead).

Without a pricing mechanism such as ROCs as identified on page 10,
further investment in renewables energy generation 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.

In its recent consultation on the ROCs regime, the Government
concluded that new landfill gas schemes starting from 2009 onwards
will have reduced eligibility for ROCs. It intends to consult further on
what this means in practice. This will not, however, affect Viridor
Waste’s existing schemes which are likely to form the vast bulk of its
output.

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 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.

Lakeside construction and technical risks

The Lakeside joint venture involves building a 400kt waste to energy
plant at a cost of circa £160 million and operating it for 25 years. 86%
of the project is funded by non-recourse bank debt which limits the
risk to Pennon Group. The remainder is funded by the joint venture,
of which Viridor Waste has 50% of the equity.

The plant is a modern conventional waste to energy facility. As a result
of a competitive procurement procedure it is being supplied by the
Japanese engineering consortium Itochu/Takuma. There are a
significant number of similar plants operating successfully worldwide.

B U S I N E S S R E V I E W

The plant is being supplied on a fixed price contract which was
drawn up with the assistance of specialist external consultants.
Nevertheless, as with any major infrastructure project, unforeseen
circumstances may arise which may affect the construction process.

Efficiencies and output of the plant will be affected by the precise
calorific value of the waste throughput. The plant is well proven with
robust conventional technology designed to take currently projected
waste mix. Nevertheless, if the mix of the waste changes
significantly over the next 25 years, there may be some impact on
efficiencies and output.

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 represents 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

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

The Group has defined benefit pension schemes for existing staff of
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. Future employer costs have been
mitigated from 1 April 2006 through the closure of the existing
defined benefit scheme to new entrants (replaced by a new scheme
with reduced benefits) and an increase in employee contributions.

The last actuarial valuation of the Group defined benefit schemes
was undertaken at 1 April 2004. Under International Accounting
Standard 19 “Employee Benefits”, the Group pension schemes had
net liabilities (after deferred tax) at 31 March 2006 of £29 million
(2005 £56 million). A sound investment performance plus a £44
million prepayment of employer contributions in August 2005 have
been partially offset by an increase in liabilities due to a reduction in
the interest rates used to discount liabilities. The net liabilities
represent circa 2% of the Group’s total market capitalisation as at 31
March 2006.

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

–

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, which 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 and customers

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

The company maintains a continuing dialogue with Ofwat, the EA
and DWI and inputs into national dialogue on developing issues
through its representation at Water UK, the industry trade body.

It works with the Consumer Council for Water South West to ensure
that customer issues and concerns are addressed and a full
understanding of the company’s activities is maintained. In
addition, there is a proactive policy of informing customers through
a customer newspaper entitled ‘Waterlevel’ and through regular
press releases and media briefings.

Suppliers and contractors

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’ opportunities for further reducing cost while
improving performance and service levels.

David Dupont

Group Director of Finance

Pennon Group Plc

VIRIDOR WASTE

Regulation

Landfill (and many other facilities) require waste management
licences or PPC permits, issued and monitored 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.

Liaison groups

A ‘good neighbour’ policy is implemented at all facilities managed
by Viridor Waste with local liaison groups at all major sites
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 and other key local
stakeholders.

FINANCIAL PERFORMANCE

ANALYSIS OF THE GROUP’S FINANCIAL PERFORMANCE

International Financial Reporting Standards

All numbers in this Annual Report are published in accordance with
International Financial Reporting Standards (IFRS) with prior year
figures restated. The principal differences between UK Generally
Accepted Accounting Principles (UK GAAP) and IFRS are shown
on pages 84 to 91 of the notes to the consolidated financial
statements.

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

Revenue and operating profit

Revenue rose by 17.1% to £645.7 million. South West Water revenue
was £348.5 million, up 13.5% on 2004/05, principally resulting from
the additional increase in tariffs approved by the water regulator.
Revenue for Viridor Waste at £298.9 million was 20.4% up on
2004/05. The acquisitions accounted for £21.3 million of the
increase and underlying business £29.3 million. Landfill tax within
revenue increased by £19.8 million.

Group operating profit before exceptional items increased by £24.2
million. South West Water achieved a £141.5 million operating
profit, up £19.3 million on 2004/05. Viridor Waste contributed
£34.3 million (after intangibles amortisation of £1.6 million), up
£5.7 million on 2004/05 and representing 19.6% of the operating
profit of the Group in 2005/06 (2004/05 19.0%).

There were three exceptional items during the year:

– Costs of £14.5 million for the one-off payment of £20 to each

South West Water customer following the financial
restructuring.

–

Costs of £50.2 million relating to the financial restructuring
which involved the capital return to shareholders and the
retirement of the £150 million 10.625% Bond (due 2012).

£7.9 million proceeds arising from a consent fee received upon
the sale of finance leases between financial institutions.

Group earnings before interest, taxation, depreciation and
intangibles amortisation (EBITDA) amounted to £279.2 million
before exceptional items (2004/05 £243.0 million) including South
West Water £213.4 million (2004/05 £186.4 million) and Viridor
Waste £66.7 million (2004/05 £56.4 million).

Total Group operating costs were £470.6 million excluding
exceptional items (2004/05 £400.5 million) and included the
following major categories of expenditure:

Depreciation and intangibles 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

104.1

79.9

76.5

24.0

18.9

18.1

14.6

7.7

5.4

6.9

Offsetting the above power costs was revenue from power
generation of £22.9 million.

Finance costs

Net interest payable before exceptional items was £64.3 million
(2004/05 £62.0 million), which was 2.7 times (2004/05 2.4 times)
covered by Group operating profits.

Before exceptional items gross interest payable was £96.8 million
and interest receivable of £32.5 million was derived from the
investment of temporarily surplus funds.

Net interest payable represents a rate of 5.1% when measured
against average net debt (2004/05 5.6%).

B U S I N E S S R E V I E W

Profit before tax

Viridor Waste

Profit before tax was £110.9 million before exceptional items,
£21.9 million up on 2004/05, an increase of 24.6%.

Taxation

The corporation tax charge for the year was £14.8 million
(2004/05 £7.9 million) before the impact of tax relief on
exceptional items. The deferred tax charge for the year was
£20.2 million (2004/05 £15.6 million). Under IFRS, deferred tax
is accounted for without discounting (as previously permitted by
UK GAAP).

Earnings per share

Landfill

Power generation

Collection

Other

£m

Other expenditure included investment in recycling facilities,
including £12 million in respect of the West Sussex PFI contract.

Earnings per share before deferred tax and exceptional items
increased by 17.4% to 75.5p. Basic earnings per share fell to 29.7p
due to the net exceptional costs of £38.1 million.

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.

Dividends and retained earnings

Share capital

The Directors recommend the payment of a final dividend of 35.1p
per share for the year ended 31 March 2006. Together with the
interim dividend of 16.5p per share paid on 13 April 2006, this
gives a total dividend for the year of 51.6p per share, an increase of
20.0% on the dividend for 2004/05.

Proposed dividends of £61.0 million (2004/05 £55.1 million) are
covered 1.6 times (2004/05 1.5 times) by profit after tax, excluding
exceptional items and deferred tax. Under IFRS, dividends are
recognised in the profit and loss account in the year in which they
are paid.

The retained profit of £37.8 million has been transferred to reserves.

SUBSIDIARY COMPANY FINANCIAL PERFORMANCE

Details of the financial performance of South West Water and Viridor
Waste are set out in the Chief Executives’ Overviews on pages 4 to 7.

GROUP INVESTMENT

Capital expenditure by the Group on tangible fixed assets was
£249.7 million (2004/05 £181.0 million). The major categories of
expenditure comprised:

South West Water

Water mains renovation

Water treatment works

Waste water treatment works and sludge

Sewerage

£m

At an Extraordinary General Meeting (EGM) in February 2006,
shareholders approved the return of cash, by way of a B Share
Scheme, of 110p for each existing issued Ordinary share held at the
close of business on 17 February 2006 and the consolidation of the
existing Ordinary shares on the basis of 10 new Ordinary shares for
every 11 existing Ordinary shares. Shareholder approval was also
obtained to carry out an on-market share buy back programme of
approximately £55 million of the new Ordinary shares. The Directors
intend to progress the share buy back programme during 2006/07.
No shares had been bought back as at 31 March 2006.

B Shares with a total value of £143.5 million were created from the
existing share premium reserve. A corresponding capital redemption
reserve was created upon payment to shareholders or cancellation
of deferred shares. Following the share capital consolidation the
weighted average number of shares in issue during the year was
127.3 million (2004/05 126.0 million).

The value of net assets per share at book value at 31 March 2006
was 490p.

Shareholder approval was obtained at the Annual General Meeting in
July 2005 to purchase up to 10% of the Company’s then existing
ordinary share capital. Renewal of the authority will be sought at the
July 2006 Annual General Meeting.

CAPITAL STRUCTURE

Overall position

With year end net debt of £1,427 million, the Group year end debt to
equity plus debt ratio was 71% (2004/05 61%). Following the return
of capital through the B Share scheme, the Directors intend to
progress the share buy back programme to further enhance the
overall balance sheet efficiency of the Group.

The borrowing powers of the Directors are limited to two and a half
times adjusted capital and reserves, as defined in the Company’s
Articles of Association. At 31 March 2006, the limit was £2.1 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 Capital Value (RCV) was circa
62% at 31 March 2006 (2004/05 52%), within Ofwat’s ‘optimum
range’ of 55% – 65%. The completion of the current financial
restructuring including the share buy back programme referred to
above is expected to increase the debt to RCV of South West Water
on a pro forma basis to circa 65%.

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 £201
million (2004/05 £131 million), equivalent to 3.0 times EBITDA
(2004/05 2.3 times).

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 2006, loans and finance lease obligations were £1,526
million and the Group held current asset investments and cash of
£99 million.

During 2005/06, the Group drew down £142 million additional
financing under new finance lease arrangements, £70 million
additional credit facilities from the European Investment Bank and
£57 million bilateral bank loans. In January 2006, the £150 million
Sterling bond, due for repayment in February 2012, was retired.

Pennon Group debt has a maturity of 0 – 35 years with an average
maturity of 12 years. The major components of debt finance are:

–

Finance leasing – £955 million

EIB loans – £236 million

Bank bilateral debt – £313 million

Interest rate management

Net interest costs before exceptional items of £64 million equated to
an average interest rate of 5.1% for the Group. South West Water's
average interest rate equated to 4.7%.

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 67% of existing net debt up
to 31 March 2007, and 62% up to 31 March 2010. In addition, South
West Water has index linked 10% of its current net debt up to 2041.
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. These instruments are analysed in more
detail in note 21 to the financial statements.

Refinancing risk management

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 a credit rating threshold approved by the
Board.

CASH FLOWS

The net cash inflow from operations was £232 million (2004/05
£242 million). Capital expenditure cash outflow in 2005/06 was
£214 million, an increase of £49 million from £165 million in
2004/05. The net cash outflow for acquisitions was £41 million
(2004/05 £29 million). Equity dividends paid and servicing of net
debt involved a cash outflow of £140 million (2004/05 £87 million).
There was a £44 million outflow for the prepayment of pension
contributions and £138 million for the B Share Scheme.

Group net debt increased from £1,118 million at 31 March 2005 to
£1,427 million at 31 March 2006.

Overall, the net cash outflow of the Group was £40 million
(2004/05 £38 million inflow).

Modelling future power generation requires consideration 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 such
assessment 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.

FORWARD LOOKING STATEMENTS

This Business Review 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 forward looking statements, including, without
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 Business Review, 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 pages 18 to 22.

By Order of the Board
KEN WOODIER, Group General Counsel & Company Secretary
22 June 2006

B U S I N E S S R E V I E W

LIQUIDITY

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.

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.

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.

INTERPRETATION

LANDFILL VOID SPACE AND POWER GENERATION
CALCULATIONS

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

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
calculations necessarily involve an element of 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.

GLOSSARY

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

Appointments

Licences of appointments of companies by Government to provide water and waste water services

BMW

DEFRA

Determination or
Price Determination

DWI

EfW

GWh

HWRS

IDoK

IFRS

Biodegradable municipal waste

Department for Environment, Food and Rural Affairs

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

Drinking Water Inspectorate

Environment Agency

Energy from Waste

Gigawatt hours

Household waste recycling sites

Interim Determination of ‘K’

International Financial Reporting Standards

ISO 14001

International environmental accreditation standard

LATS

LAWDC

LTCS

Ml/d

MSW

MWh

NFFO

Periodic Review period 2000 – 2005 for South West Water

Periodic Review period 2005 – 2010 for South West Water

Landfill Allowance Trading Scheme

Local Authority Waste Disposal Company

Landfill Tax Credit Scheme

Megalitres

Megalitres per day

Municipal solid waste

Megawatts

Megawatt hours

Non fossil fuel obligation

Ofwat or water regulator

Water Services Regulatory Authority

OPA

PFI

PPC

PPP

Ofwat Overall Performance Assessment system

Private finance initiative

Pollution, Prevention and Control

Public Private Partnership

Periodic Review

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

RCV

RPI

ROCs

SEPA

Regulatory capital value

The UK Government’s Retail Price Index

Renewable obligation certificates

Scottish Environment Protection Agency

UK GAAP

United Kingdom Generally Accepted Accounting Principles

B O A R D O F D I R E C T O R S

Kenneth George Harvey BSc, CEng, FIEE (65)
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 the
senior independent non-executive director of National
Grid Plc.

Robert John Baty OBE, FREng, CEng, FICE,
FCIWEM, CCMI, ACIArb (62)
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. He will retire as the Chief
Executive of South West Water and as a director of Pennon
Group on 31 July 2006.

Colin Irwin John Hamilton Drummond MA, MBA,
LTCL, CCMI (55)
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 (52)
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. He is a member of the
South West Council of the Confederation of British Industry.

Gerard Dominic Connell MA, (48)
Senior Independent Non-executive Director
Was appointed on 1 October 2003. Gerard is currently Group
Finance Director of Wincanton Plc. He was previously a
director of Hill Samuel and 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 (60)
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 (62)
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.

COMMITTEES OF THE BOARD

Group General Counsel & Company Secretary
Ken Woodier

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

Registered office
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

D I R E C T O R S ’ R E M U N E R A T I O N R E P O R T

THE REMUNERATION COMMITTEE

The Remuneration Committee comprises three Non-executive
Directors: Kate Mortimer, who chairs the Committee, Gerard
Connell and Dinah Nichols. The 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/engagement of the
Chairman, the Executive Directors and senior management of
the Group. 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) and
Hewitt Bacon & Woodrow Limited, pensions and remuneration
consultants (appointed by the Committee), in respect of
executive pensions and calculating total shareholder return for
the Company's Restricted Share Plan.

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

GROUP REMUNERATION POLICY

The policy of the Group 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. This policy will be
applied by the Remuneration Committee in 2006/07 and
currently it is also intended to be applied in each subsequent
year. The policy in respect of Non-executive Directors is set
out on page 32 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. In 2006/07
(subject to fluctuations in the Company’s share price) it is
expected that just under 45% of Directors’ potential direct
remuneration (i.e. excluding pensions, car benefit and health
cover) will be performance related compared with just over 60%
in 2005/06. This reduced percentage is because there will not be
the potential for a Restricted Share Plan award to vest in
2006/07 (no award was made in 2003 because of the existence
of unpublished price sensitive information). Nonetheless, the
Committee’s overall policy remains that around 60% of total
possible remuneration will be performance related in the normal
course and it is intended that this balance will continue to apply
for subsequent financial years.

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 £11,000 in 2005/06 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 33
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 generally
available conducted by remuneration consultants 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 are 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 in the Company which must
usually be held for a period of three years before release. During
this period, the Directors are entitled to receive any dividends
declared by the Company in respect of these shares. Because the
award of these shares is based on performance, no additional
performance conditions are considered appropriate by the
Committee apart from continuous service with the Company.

The following corporate and individual objectives of the
Executive Directors applicable to the performance related bonus
award for 2006/07 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 2006/07):

Bob Baty

– As Bob Baty is due to retire as the Chief Executive of South
West Water and as a director of the Company on 31 July 2006,
any bonus will be determined on a pro-rata basis to the date of
his retirement and will not include any conditional share awards.
It will be based on personal performance targets set by the
Remuneration Committee which relate to key business issues of
South West Water which Bob Baty can influence up to the date of
his retirement.

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 the profit before
tax and net debt budgets of Viridor Waste; 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.

D I R E C T O R S ’ R E M U N E R A T I O N R E P O R T

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 (with the exception of Bob Baty whose performance
for the period to his retirement will be assessed following his
retirement at the end of July 2006). 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. The Executive
Directors received a conditional award of shares in the Company
up to a value of 75% of their basic salary on the basis that they
provided 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.

During the year (in September 2005) 50% of the shares awarded
pursuant to the Plan in 2002 to Directors vested at the end of
the three year restricted period because the performance
condition had been met to the extent necessary to permit a 50%
vesting only. The remaining 50% of the award lapsed. For each
of the years 2002 to 2005 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.

If the TSR 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 comparator group applicable for awards made during the
year to 31 March 2006 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 Power Group Plc

Kelda Plc

National Grid Plc

Northumbrian Water Group Plc

Pennon Group Plc

Scottish & Southern Energy Plc

Scottish Power Plc

Severn Trent 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.

The TSR performance condition was applied by the Committee
because, based upon advice received previously 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 TSR 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
50% of the other companies in the comparator group.

The TSR of each company in the comparator group is measured
by Hewitt Bacon & Woodrow assuming that all dividends are
reinvested 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. No retesting of performance
is permitted for any shares that do not vest after the three year
performance period and any such shares lapse.

As the current restricted share plan will have been operated for
10 years with the next awards due in September 2006, the
Company intends to seek shareholder approval at next year’s
AGM to introduce a new scheme from 2007 onwards. The new
scheme will be developed by the Remuneration Committee with
advice from an independent firm of remuneration consultants.

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

Since the year end, the Company has launched a Share Incentive
Plan (SIP) which is an all-employee plan where performance
conditions will not apply. Executive Directors are also entitled to
participate in this plan.

(v) Service Agreements – In accordance with Company policy,
all Executive Directors have service agreements which are
subject to one year’s notice and which are due to 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:

Bob Baty

26 February 1996

Colin Drummond

5 March 1992

David Dupont

2 January 2003

(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 restrictions in respect of the Earnings Cap which apply to
Colin Drummond and David Dupont) in respect of past
pensionable service with the Company until 5 April 2006.

Having been subject to the Earnings Cap, Colin Drummond and
David Dupont have both been 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 have received payments
equivalent to the tax liability which arises in respect of Company
contributions to the Supplementary Pension Scheme.

With effect from 6 April 2006, the Earnings Cap no longer applies
to pension schemes as part of the simplification of taxation of
pensions legislation. The Remuneration Committee accordingly
decided to amend the provisions of the Pennon Group Executive

Pension Scheme to permit Executive Directors to accrue a
pension of up to two thirds of final pensionable pay within the
Scheme dependent on length of service in respect of future
service with the Company from 6 April 2006. The tax
consequences of the change will be borne by the Executive
Directors. The Supplementary Pension Scheme has therefore
subsequently been closed.

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 the costs of providing individual pension
arrangements.

TOTAL SHAREHOLDER RETURN GRAPH

The graph shows the value, over the five year period ending in
March 2006, of £100 invested in Pennon Group on 31 March
2001 compared with the value of £100 invested in the FTSE Gas,
Water & Multiutilities Index (formerly the FTSE All-Share Utilities
(Other) Index and in the FTSE Utilities Index). The other points
plotted are the values at intervening financial year ends. This
Index is considered appropriate as it is a broad equity market
index of which the Company is a constituent.

320

280

240

200

160

120

2001

2002

2003

2004

2005

2006

Year ending 31 March

Pennon Group

FTSE Gas, Water & Multiutilities

This graph has been produced in accordance with Schedule 7A of
the Companies Act 1985.

D I R E C T O R S ’ R E M U N E R A T I O N R E P O R T

As referred to on page 29, the Chairman’s remuneration is set by
the Remuneration Committee and is due to be reviewed after
eighteen months in September 2006. The policy of the
Committee to be applied in 2006/07 (which is also currently
intended to be applied in each subsequent year) is the same as
that of the Board in reviewing the fees of the Non-executive
Directors. In addition to a fee (last determined with the advice
of and market information from Deloitte & Touche) the Chairman
receives car benefit (fully expensed) and health cover. The
Chairman receives no other benefits or remuneration.

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.

NON-EXECUTIVE DIRECTORS AND THE CHAIRMAN

Non-executive Directors’ remuneration (excluding that of the
Chairman, Ken Harvey) consisting of fees only as set out below,
is determined by the Board of Directors (in the absence of the
Non-executive Directors) and is usually reviewed biennially.
However, since 2003/04 it has been reviewed each 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 last
reviewed in September 2005. In reviewing the fees, the
Chairman and the Executive Directors take account of market
information on non-executive directors’ fees, most recently from
the Monks Partnership. With effect from 1 October 2005, Non-
executive Directors’ fees were revised to a base fee of £30,000
per annum and a fee of £3,500 per annum for membership of
each of the Audit and Remuneration Committees, together with
fees of £5,000 and £2,500 per annum for the Chairmanship of
the Audit and Remuneration Committees respectively. The policy
to be applied in 2006/07 (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. The Chairman
and the Executive Directors believe that this policy is
appropriate to attract and retain suitably experienced non-
executive directors on the Board.

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 2009
11 June 2009

*The Board has approved the extension of the contract with Gerard Connell to 30 September 2009.

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 the Chairman and the Non-executive Directors reflect corporate governance good practice (as suggested in
the Higgs Report appended to the Combined Code) and, together with the Executive Directors’ service contracts, are available for
inspection at the Company’s registered office during normal business hours.

The information set out on the remaining pages of this Remuneration Report (pages 33 to 35) 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 2006
£000

Total 2005
£000

175

210

38
36

913

–

–
–

–

223

–
–

–

–
–

–

195

290

397

368

190

289 **

350

322

35
33

148

1,358

1,250

**Bob Baty waived £74,000 of this total in 2005 which represented the cash element of his performance related bonus.
*Other emoluments are car benefit, health cover and professional subscriptions.

† 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) “Performance Related Bonus Plan (Deferred Bonus Shares)” on page 35.

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 2005/06 are shown in the table below:

Director

Bob Baty

Colin Drummond

David Dupont

Increase in
accrued pension
during 2005/06
(net of inflation)
£000
a

Increase in
accrued
pension
during 2005/06
£000
b

Accrued
pension at
31 March 2006
£000
c

Transfer
value at
31 March 2006
£000
d

Transfer
value at
31 March 2005
£000
e

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

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

158

3,016

1,488

1,076

2,903

1,030

744

102

447

321

133

104

Column a above is the increase in accrued pension during 2005/06 (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 2005/06.
Column c is the accrued pension at 31 March 2006 payable at normal retirement age.
Column d is the transfer value of the accrued pension set out in column c as at 31 March 2006.
Column e is the transfer value of the accrued pension at the end of the previous financial year on 31 March 2005.
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.

D I R E C T O R S ’ R E M U N E R A T I O N R E P O R T

DIRECTORS’ PENSIONS (continued)

The Supplementary Pension Scheme, which funded pension provision above the Earnings Cap, provided benefits in tax-paid lump sum
form at retirement. Appropriate figures have been included in the accrued pension totals shown on page 33. Immediately following the
year end, the Supplementary Pension Scheme was terminated by the Company. Future accrual of pension provision above the Earnings
Cap is to be provided in the Pennon Group Executive Pension Scheme as described in (vi) ‘Provision for Pension’ on page 31.

Directors have the option to pay additional voluntary contributions; neither the contributions nor the resulting benefits are included in
the table shown on page 33.

DIRECTORS’ SHARE INTERESTS

(a) Shareholdings

The number of shares of the Company in which Directors held beneficial interests at 31 March 2006 and 31 March 2005 were:

Director

Bob Baty
Colin Drummond
David Dupont

2006
Deferred shares†
(110p each)

2006
B Shares*
(110p each)

2006
Ordinary shares
(122 1/10p each)

2005
Ordinary shares
(110p each)

–
24,562
33,644

111,785
7,900
26,330

55,145
35,541
29,882

49,959
29,062
25,595

Director

Ken Harvey
Kate Mortimer

2006
Deferred shares†
(110p each)

2006
B Shares*
(110p each)

2006
Ordinary shares
(122 1/10p each)

2005
Ordinary shares
(110p each)

–
–

2,403
250

2,644
265

†B Shares were converted into Deferred Shares upon shareholders electing to take the B Share dividend of 110p per share on
27 February 2006 pursuant to the B Share Scheme approved by shareholders at an Extraordinary General Meeting on 15 February 2006
as part of a return of cash to shareholders. The Deferred Shares were all redeemed by the Company on 6 April 2006 pursuant to the
provisions of the B Share Scheme. The Directors received no payment for the redemption of these shares.

*The remaining B Share holdings of the Directors were redeemed on 6 April 2006 at 110p each in accordance with the provisions of the B
Share Scheme.

Additional Ordinary shares (1221/10p each) have been acquired by the Directors since 31 March 2006 as follows as a result of participation
in Personal Equity Plans and Individual Savings Accounts:

Bob Baty

David Dupont

Colin Drummond

There have been no other changes in the beneficial interests or the non-beneficial interests of the Directors in the Deferred Shares,
B Shares or the Ordinary shares of the Company between 1 April 2006 and 30 May 2006.

(b) Restricted Share Plan (Long Term Incentive Plan)

In addition to the above beneficial interests, the following Directors have or had a contingent interest in the number of Ordinary 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
16/9/02
16/9/04
27/9/05

Colin Drummond
16/9/02
16/9/04
27/9/05

David Dupont
16/9/02
16/9/04
27/9/05

Conditional
awards
held at
1 April 2005

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 2006

18,514
37,059
–

14,694
35,206
–

–
–
14,719

638p
809.5p
1,070p

9,257 *
–
–

7,347 *
–
–

98,772
–
–

78,392
–
–

–

33,690 †
13,380 †

–

33,690 †
13,380 †

–

32,005 †
13,380 †

–
15/9/07
26/9/08

† The number of shares in each of the awards for the years 2004 and 2005 have been reduced to the numbers shown (in the ratio 10 for
11) consequent upon the Company’s share capital consolidation on 17 February 2006.

* 50% of the 2002 awards vested on 19 September 2005 at a price of 1067p per share because the criterion described in paragraph (iii) on
page 30 was met to the extent necessary to permit a 50% vesting only. The balance of the shares of 50% lapsed on 19 September 2005.

Because of the existence of unpublished price-sensitive information, no award was made during 2003 to the Executive Directors.
Accordingly, with Shareholder approval, the usual award was made in 2004 together with a further award of shares equivalent to 75% of
basic salary.

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 £23,896; Colin Drummond £23,896; David Dupont £21,457. In addition, the Directors received a B Share in respect
of each of the above shares in accordance with the B Share Scheme (as noted in “(a) Shareholdings” on page 34) and either upon their
election received a dividend of 110p in respect of each of the shares (whereupon they became deferred shares of nil value to the
Director) or they redeemed the shares for 110p each (or a combination of each option).

Director and date
of award

Bob Baty
26/7/02
25/7/03
28/6/04
10/8/05

Colin Drummond
26/7/02
3/12/02
25/7/03
28/6/04
10/8/05

David Dupont
26/7/02
25/7/03
28/6/04
10/8/05

Conditional
awards
held at
1 April 2005

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 2006

7,885
6,435
6,262

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

4,728
6,146
5,834

–
–
–
7,479

–
–
–
–
6,910

–
–
–
6,823

652p
652p
778.5p
984p

652p
607p
652p
778.5p
984p

652p
652p
778.5p
984p

80,506

56,706
13,677

48,273

7,885
–
–

5,554
1,161
–
–

4,728
–
–

–

5,850 †
5,692 †
6,799 †

–
–

7,263 †
6,890 †
6,281 †

–

5,587 †
5,303 †
6,202 †

–
24/7/06
27/6/07
9/8/08

–
–
24/7/06
27/6/07
9/8/08

–
24/7/06
27/6/07
9/8/08

† The number of shares in each of the awards for the years 2003, 2004 and 2005 have been reduced to the numbers shown (in the ratio
10 for 11) consequent upon the Company’s share capital consolidation on 17 February 2006.

* The July 2002 award vested on 5 August 2005 at a price of 1,021p per share and the December 2002 award vested on 16 January 2006
at a price of 1,178p per share.

A further conditional award of shares will be made in 2006/07 to the value of the amount of the performance related cash bonus shown
in the Emoluments of Directors table on page 33. (Paragraph (ii) on page 29 sets out the provisions relating to the conditional award of
shares pursuant to the Performance Related 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 £8,850; Colin Drummond £9,582; David Dupont £7,185. In addition, the Directors
received a B Share in respect of each of the above shares in accordance with the B Share Scheme (as noted in “(a) Shareholdings” on
page 34) and either, upon their election, received a dividend of 110p in respect of each of the shares (whereupon they became deferred
shares of nil value to the Director) or they redeemed the shares for 110p each (or a combination of either option).

It is anticipated that the shares will vest under the 2003 awards in 2006/07 as the criterion (described in “(ii) Performance related
bonus” on page 29) 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 2005

Granted
in year

Exercised
in year

Market price
on exercising

Options held
at 31 March 2006

Exercise
price

Exercise period/
maturity date

Bob Baty
8/7/03

Colin Drummond
8/7/03

David Dupont
9/7/02

1,047

1,745

2,924

–

1,047

530p

1/9/06 – 1/3/07

1,745

530p

1/9/06 – 1/3/07

2,924

566p

1/9/07 – 1/3/08

(e) Share price
The market price of the Company’s shares at 31 March 2006 was 1,341p (2005 976p) and the range during the year was 947p to 1,429p
(2005 677p to 1,016p).

By Order of the Board
KEN WOODIER, Group General Counsel & Company Secretary
22 June 2006

C O R P O R A T E G O V E R N A N C E A N D I N T E R N A L C O N T R O L

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
Combined Code have been applied by the Company in practice.
Throughout the year, the Company considers that it has
complied with the provisions of the 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 28
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
when they have held office for three years or more.

During the year, the Board met in accordance with its schedule
of meetings on 11 occasions and at each meeting all Directors
were present with the exception of Bob Baty and Gerard Connell
each on one occasion and Dinah Nichols on two occasions. The
Board also held two special meetings during the year at which
all Directors were present with the exception of Bob Baty and
Kate Mortimer each on one occasion. In accordance with Group
Policy, the Board has a schedule of matters reserved for its
decision and delegates 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
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
current and relevant financial experience, and the other
members of the Committee were Kate Mortimer and Dinah
Nichols. During the year, the Committee met on six occasions
and all members were present at each meeting. In discharging
its Terms of Reference, the Committee receives reports and
meets regularly in particular to:

– 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, re-appointment
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.

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 6 to the financial statements on page
59. 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.

Towards the end of the year, in accordance with guidance issued
by the Audit Committee, a review was undertaken of the
provision of external audit services and a number of audit firms
were invited to submit and present proposals to the Company for
audit services. Following a detailed selection process, including
presentations by a shortlist of audit firms to the Audit
Committee, the Chairman of the Company and the Group Director
of Finance, PricewaterhouseCoopers LLP were selected to
continue as the auditors of the Group to be recommended at the
Annual General Meeting on 27 July 2006.

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 one occasion
(at which all members were present) to review succession plans
for the Executive Directors of the Board and senior management;
to formally determine the selection process for an Executive
Director appointment which involved open advertising and the
engagement of an external search consultancy followed by
interviews of a shortlist of candidates by the Committee and
subsequent meetings with the preferred candidate by the
Executive Directors; and to consider the appointment for a third
three year term of a Non-executive Director.

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 Bob Baty on
one occasion. It is responsible for reviewing and monitoring the
environmental policies of Group companies, their achievement
of environmental and social objectives and targets and for
considering the Group’s annual corporate responsibility report.

REMUNERATION COMMITTEE

INTERNAL CONTROL

The Remuneration Committee was chaired by Kate Mortimer.
Gerard Connell and Dinah Nichols were the other members of the
Committee. The Committee met on seven occasions during the
year at which all members were present. 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 29 to 35.

Wider aspects of internal control

The Board 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 have been in place throughout the year
2005/06 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.

C O R P O R A T E G O V E R N A N C E A N D I N T E R N A L C O N T R O L

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 Business Review on pages 18 to 22.

Internal control framework

As well as the risk management policy of the Group there is an
established internal control framework which comprises:

(a) 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;

(b) 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;

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
(d) 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.

Internal control review

An evaluation of the effectiveness of overall internal control
compliance by the Group is now undertaken in respect of each
calendar year (previously each financial year ending 31 March) to
assist the Audit Committee in considering the Group internal audit
plan for the forthcoming financial year and also the Business Review
for the Annual Report. The Group General Counsel & Company
Secretary initially carried out the review with Directors and senior
management for consideration by the Audit Committee and
subsequently for final evaluation by the Board.

In addition, the Audit Committee regularly reviews the operation and
effectiveness of the internal control 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. For

2005 and up to the date of the approval of the Annual Report and
Accounts, both the Audit Committee and the Board were satisfied
with the effectiveness of the risk management policy and the
internal control framework and their operation within the Group.

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.

DIRECTORS’ RESPONSIBILITIES STATEMENT

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. 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
22 June 2006

D I R E C T O R S ' R E P O R T

THE DIRECTORS SUBMIT THEIR REPORT AND AUDITED FINANCIAL STATEMENTS
FOR THE YEAR ENDED 31 MARCH 2006

Business Review

16–18

FINANCIAL INSTRUMENTS

PRINCIPAL ACTIVITIES 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
Chief Executives’ Overviews and in the Business Review on pages
2 to 27. The information that fulfils the requirements of the
Business Review (as required by Section 234ZZB of the
Companies Act 1985), which is incorporated in this Directors’
Report by reference, can be found on the following pages of this
Annual Report:

Information

Location

Chairman’s statement
and Chief Executives’
overviews

Business Review

Pages

2–7

14–15,
23–25

Development and performance
during the financial year

Position at the year end
including analysis and key
performance indicators

Other performance,
including environmental and
employee matters

Principal risks and uncertainties
facing the business

Business Review

18–22

Explanation of amounts
included in the
annual accounts

Business Review
and Notes to financial
statements

23–26
46–91

The principal subsidiaries of the Company are listed in note 37 to
the financial statements on page 82.

FINANCIAL RESULTS AND DIVIDEND

Group profit for the year after taxation was £37.8 million.
The Directors recommend a final dividend of 35.1p per Ordinary
share to shareholders on the register on 4 August 2006, making
a total for the year of 51.6p.

The Business Review on pages 8 to 27 analyses the results in
more detail and sets out other financial information, including
the Directors’ opinion on asset values (page 24).

DIRECTORS

Bob Baty will retire as Chief Executive of South West Water
Limited and from the Board on 31 July 2006. Chris Loughlin has
been appointed by the Board as Bob Baty’s successor and as a
Director with effect from 1 August.

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 33. Further details relating to the
Directors and their service contracts or contracts for services are
set out on pages 29 to 35 and details of the Directors’ interests
in shares of the Company are given on pages 34 and 35.

STATEMENT AS TO DISCLOSURE OF INFORMATION
TO AUDITORS

(a)

(b)

So far as each of the Directors is aware, there is no
relevant audit information of which the Company’s
auditors are unaware, and
Each of the Directors has taken all the steps they ought
to have taken individually as a director in order to make
themselves aware of any relevant audit information and
to establish that the Company’s auditors are aware of
that information.

Details of the financial risk management objectives and policies
of the Group and the exposure of the Group to price, credit,
liquidity and cash flow risk are set out in the Business Review on
page 25 and also note 3 to the financial statements on page 53.

EMPLOYMENT POLICIES AND EMPLOYEE
INVOLVEMENT

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

The Group 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,
applications for employment are welcome from disabled persons
and special arrangements and adjustments as necessary are
made to ensure disabled applicants are treated fairly when
attending interviews 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

D I R E C T O R S ' R E P O R T

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 issues and events.

The Group encourages share ownership amongst its employees
by operating an HM Revenue & Customs approved Sharesave
Scheme open to all eligible employees and has recently
launched an HM Revenue & Customs approved Share Incentive
Plan to further encourage share ownership.

Further information relating to employee matters is set out in
the Business Review on page 16.

representing 0.135% of the issued share capital of the Company
prior to the commencement of the repurchases.

The shares have been repurchased pursuant to the return of cash
to shareholders as set out in the Circular to shareholders dated
23 January 2006 and in connection with the decision to move
South West Water to a more highly-geared structure to enhance
the Group’s balance sheet. The shares have been repurchased
for cancellation.

SUBSTANTIAL SHAREHOLDINGS

Details are set out in the Shareholder information section on
page 107.

RESEARCH AND DEVELOPMENT

AUDITORS

Research and development activities within the Group involving
water and waste treatment processes amounted to £0.1 million
during the year (2004/05 £0.1 million).

CHARITABLE DONATIONS

During the year, charitable donations amounting to £47,000
were made to registered charities involved in a wide range of
activities and initiatives where funding assists groups including
disadvantaged adults and children, local community
organisations, educational establishments, special needs groups
and other similar deserving causes. Further details relating to
charitable donations are set out in the Group’s Corporate
Responsibility Report. No political donations were made.

TAX STATUS

PricewaterhouseCoopers LLP were appointed auditors until
the conclusion of the seventeenth 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. 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
14 July 2006 upon application to the Company Secretary at
Peninsula House, Rydon Lane, Exeter EX2 7HR.

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

ANNUAL GENERAL MEETING

PAYMENTS TO SUPPLIERS

It is the Group’s payment policy for the year ending 31 March
2007 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 2005/06 and the amount owed to its trade
creditors at 31 March 2006, was 33 days.

ACQUISITION OF SHARES

The Company has authority from shareholders to repurchase
up to 10% of its own ordinary shares (expiring at the conclusion
of the Annual General Meeting to be held on 27 July 2006).
This authority was not used during 2005/06 but has been
used subsequent to the year end to buy back through the
market ordinary shares (of nominal value 1221/10p each).
Up to and including 14 June 2006 160,000 shares were
repurchased for an aggregate consideration of £2,090,045,

The seventeenth Annual General Meeting will be held at the
Plymouth Pavilions, Millbay Road, Plymouth, Devon PL1 3LF on
Thursday, 27 July 2006 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

undertake a share split

eliminate authorised share capital created for the purposes
of the return of cash to shareholders earlier this year,
which is no longer required.

Details of the resolutions are set out in the separate Notice of
Annual General Meeting circulated to shareholders with this
Annual Report.

By Order of the Board
KEN WOODIER, Group General Counsel & Company Secretary
22 June 2006

I N D E P E N D E N T A U D I T O R S ’ R E P O R T

INDEPENDENT AUDITORS’ REPORT TO THE
MEMBERS OF PENNON GROUP PLC

We have audited the group financial statements of Pennon
Group Plc for the year ended 31 March 2006 which comprise the
Group income statement, the Group statement of recognised
income and expense, the Group balance sheet, the Group cash
flow statement and the related notes. These group financial
statements have been prepared under the accounting policies
set out therein.

We have reported separately on the parent company financial
statements of Pennon Group Plc for the year ended 31 March
2006 and on the information in the Directors’ remuneration
report that is described as having been audited.

RESPECTIVE RESPONSIBILITIES OF DIRECTORS
AND AUDITORS

The Directors’ responsibilities for preparing the Annual Report
and the Group financial statements in accordance with
applicable law and International Financial Reporting Standards
(IFRS) as adopted by the European Union are set out in the
Directors’ responsibilities statement.

Our responsibility is to audit the Group financial statements in
accordance with relevant legal and regulatory requirements and
International Standards on Auditing (UK and Ireland). 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 Group financial
statements give a true and fair view and whether the Group
financial statements have been properly prepared in accordance
with the Companies Act 1985 and Article 4 of the IAS Regulation.
We report to you whether in our opinion the information given in
the Directors’ report is consistent with the Group financial
statements. We also report to you if, in our opinion, we have not
received all the information and explanations we require for our
audit, or if information specified by law regarding Directors’
remuneration and other transactions is not disclosed.

We review whether the Corporate governance statement reflects
the Company’s compliance with the nine provisions of the 2003
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 form an
opinion on the effectiveness of the Group’s corporate
governance procedures or its risk and control procedures.

We read other information contained in the Annual Report and
consider whether it is consistent with the audited Group
financial statements. The other information comprises only the
Chairman’s statement, the Chief Executives’ overviews, the
Business review, the Directors’ report and the corporate
governance statement. We consider the implications for our
report if we become aware of any apparent misstatements or
material inconsistencies with the Group financial statements.
Our responsibilities do not extend to any other information.

BASIS OF AUDIT OPINION

We conducted our audit in accordance with International
Standards on Auditing (UK and Ireland) issued by the Auditing
Practices Board. An audit includes examination, on a test basis,
of evidence relevant to the amounts and disclosures in the group
financial statements. It also includes an assessment of the
significant estimates and judgments made by the Directors in
the preparation of the Group financial statements, and of
whether the accounting policies are appropriate to the Group’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 Group financial statements 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
Group financial statements.

OPINION

In our opinion:

•

the Group financial statements give a true and fair view, in
accordance with IFRS as adopted by the European Union, of
the state of the Group’s affairs as at 31 March 2006 and of its
profit and cash flows for the year then ended;

the Group financial statements have been properly prepared
in accordance with the Companies Act 1985 and Article 4 of
the IAS Regulation; and

the information given in the Directors’ report is consistent
with the Group financial statements.

PricewaterhouseCoopers LLP
Chartered Accountants and Registered Auditors
Bristol
22 June 2006

C O N S O L I D A T E D I N C O M E S T A T E M E N T
for the year ended 31 March 2006

Continuing operations

Revenue

Operating costs
Manpower costs

Raw materials and consumables used

Other operating expenses

Depreciation

Amortisation of intangibles

Operating profit

Interest payable and similar charges

Interest receivable

Share of post-tax profit from joint venture

Profit before tax

Tax on ordinary activities

Before
exceptional
items
2006
£m

Exceptional
items
(note 9)
2006
£m

Before
exceptional
items
2005
£m

Exceptional
items
(note 9)
2005
£m

Total
2006
£m

Total
2005
£m

Notes

645.7

(79.9)

(40.7)

(245.9)

(102.5)

(1.6)

–

(14.5)

–

645.7

551.4

–

551.4

(79.9)

(40.7)

(260.4)

(102.5)

(1.6)

(68.3)

(32.8)

(207.3)

(90.7)

(1.4)

(3.0)

–

(71.3)

(32.8)

(1.9)

(209.2)

–

(90.7)

(1.4)

175.1

(14.5)

160.6

150.9

(4.9)

146.0

(96.8)

(50.2)

(147.0)

(89.3)

32.5

0.1

7.9
–

110.9

(56.8)

40.4

0.1

54.1

27.3

0.1

89.0

–

(4.9)

(89.3)

27.3

0.1

84.1

(35.0)

18.7

(16.3)

(23.5)

–

(23.5)

Profit/(loss) for the year from continuing operations

75.9

(38.1)

37.8

65.5

(4.9)

60.6

Discontinued operations
Post-tax business disposal profit

Profit/(loss) for the year

Profit/(loss) attributable to equity shareholders

–

75.9

–

(38.1)

Earnings per share (pence per share)

– Basic

– Diluted

Earnings per share from continuing operations

– Basic
– Diluted

The notes on pages 46 to 91 form part of these financial statements.

–

65.5

5.0

0.1

–

37.8

29.7

29.4

29.7

29.4

5.0

65.6

52.1

51.7

48.1
47.8

C O N S O L I D A T E D S T A T E M E N T O F
R E C O G N I S E D I N C O M E A N D E X P E N S E
for the year ended 31 March 2006

Notes

2006
£m

37.8

(2.8)

1.0

0.8

(1.0)

36.8

8.6

45.4

2005
£m

65.6

1.9

–

(0.6)

1.3

66.9

–

66.9

Profit for the year

Actuarial (losses)/gains on defined benefit schemes

Cash flow hedges
Net fair value gains

Tax on items taken directly to or transferred from equity

Net (losses)/gains not recognised directly in

income statement

Total recognised income for the year

Adjustments on adoption of IAS 32/39 1 April 2005 (net of tax)

Attributable to equity shareholders

The notes on pages 46 to 91 form part of these financial statements.

C O N S O L I D A T E D B A L A N C E S H E E T
at 31 March 2006

Assets
Non-current assets
Goodwill
Intangible assets
Property, plant and equipment
Trade and other receivables
Investments accounted for using equity method

Current assets
Inventories
Trade and other receivables
Financial assets

Derivative financial instruments

Cash and cash equivalents

Liabilities
Current liabilities
Financial liabilities
Borrowings
Derivative financial instruments

Trade and other payables
Current tax liabilities
Provisions for liabilities and charges

Net current (liabilities)/assets

Non-current liabilities
Financial liabilities
Borrowings

Other non-current liabilities
Retirement benefit obligations
Deferred tax liabilities
Provisions for liabilities and charges

Net assets

Shareholders’ equity
Share capital
Share premium account
Capital redemption reserve
Retained earnings and other reserves

Total shareholders’ equity

Notes

2006
£m

2005
£m

14
15
16
17
18

19
20

21
22

25
21
23
24
29

25
26
27
28
29

30
31
32
33

98.6
5.7
2,415.9
6.0
1.3

64.4
6.0
2,218.5
3.3
–

2,527.5

2,292.2

5.0
94.5

3.1
99.4

4.7
99.6

–
303.4

202.0

407.7

(54.7)
(3.0)
(170.1)
(24.0)
(11.4)

(54.8)
–
(127.8)
(23.6)
(8.4)

(263.2)

(214.6)

(61.2)

193.1

(1,471.8)
(2.2)
(41.7)
(302.8)
(66.6)

(1,366.8)
(19.1)
(79.8)
(282.8)
(27.9)

(1,885.1)

(1,776.4)

581.2

708.9

184.2
10.2
98.4
288.4

142.0
153.7
–
413.2

581.2

708.9

The notes on pages 46 to 91 form part of these financial statements.

The financial statements on pages 42 to 91 were approved by the Board of Directors on 22 June 2006 and were signed on
its behalf by:

K G HARVEY, Chairman

C O N S O L I D A T E D C A S H F L O W
S T A T E M E N T
for the year ended 31 March 2006

Notes

7, 9

2006
£m

2005
£m

232.1

(128.9)

–

(2.2)

242.4

(68.5)

(3.4)

(0.4)

101.0

170.1

22.5

(44.7)

(1.1)

5.0

–

12.8

(28.6)

–

–
4.2

(0.2)

(218.6)

(167.1)

4.8

2.3

(232.1)

(176.6)

1.6

177.1

182.5

(224.3)

141.6

(15.8)

(34.1)

0.8

–

150.0

(130.2)

57.3

(5.4)

(28.3)

–

90.8

44.2

(40.3)

120.6

37.7

82.9

80.3

120.6

(137.8)

Cash flows from operating activities
Cash generated from operations

Interest paid (including exceptional item, note 9)

Forward interest rate swap settlement

Tax paid

Net cash generated from operating activities

Cash flows from investing activities
Interest received (including exceptional item, note 9)

Acquisition of subsidiaries (net of cash acquired)

Investment in joint venture

Proceeds of business disposal
Proceeds from sale of available for sale investments

Purchase of intangible assets

Purchase of property, plant and equipment

Proceeds from sale of property, plant and equipment

Net cash used in investing activities

Cash flows from financing activities
Net proceeds from issue of ordinary share capital

Release of restricted deposits

Net proceeds from new borrowing

Repayment of borrowings

Finance lease drawdowns

Finance lease principal repayments

Dividends paid

B Share payments

Net cash received from financing activities

Net (decrease)/increase in cash and cash equivalents

Cash and cash equivalents at beginning of the year

Cash and cash equivalents at end of the year

The notes on pages 46 to 91 form part of these financial statements.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

1. GENERAL INFORMATION

Pennon Group Plc is a company incorporated in the United Kingdom under the Companies Act 1985. The address of the registered office
is given on page 28. The nature of the Group’s operations and its principal activities are set out in the Directors’ report on page 39.

These consolidated financial statements have been approved by the Board of Directors on 22 June 2006.

2. SIGNIFICANT ACCOUNTING POLICIES

The principal accounting policies adopted in the preparation of these financial statements are set out below. These policies have been
consistently applied to all the years presented unless otherwise stated.

(a) Basis of preparation

These are the first financial statements to have been prepared in accordance with International Financial Reporting Standards (IFRS) as
adopted by the European Union. The disclosures required by IFRS 1 “First-time adoption of IFRS” concerning the transition from UK
Generally Accepted Accounting Principles (UK GAAP) to IFRS are set out in note 42.

These financial statements have been prepared under the historical cost convention in accordance with International Financial
Reporting Standards and International Financial Reporting Interpretation Committee (IFRIC) interpretations, as adopted by the
European Union (EU), with those parts of the Companies Act 1985 applicable to companies reporting under IFRS and the requirements
of the Financial Services Authority. A summary of the main accounting policies is set out below, together with an explanation of where
changes have been made to previous policies on the adoption of new accounting standards in the year.

IFRS 7 “Financial Instruments: Disclosure” has been adopted by the EU for implementation in 2007, but has not been adopted early in
these financial statements.

The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and
assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Although these estimates are based on management’s best assessment of the
amounts, events or actions, actual results ultimately may differ from those estimates.

(b) First time adoption of IFRS

The Group’s date of transition to IFRS was 1 April 2004 and all comparative information in the financial statements has been restated to
reflect the Group’s adoption of IFRS, except where otherwise required or permitted by IFRS 1 “First Time Adoption of International
Financial Reporting Standards”.

All accounting policies have been consistently applied except where the Group has taken advantage of the exemption in IFRS 1 from the
requirement to restate comparative information for IAS 32 and 39. These Standards have been applied with effect from 1 April 2005.

IFRS 1 requires an entity to comply with each IFRS effective at the reporting date for its first IFRS financial statements. As a general
principle, IFRS 1 requires the standards effective at the reporting date to be applied retrospectively. There are, however, a number
of optional exemptions from full retrospective application. The Group has elected to take advantage of certain exemptions under IFRS 1
as follows:

–

not to apply IFRS 3 “Business Combinations” retrospectively to past business combinations;

to establish a deemed cost for the opening balance sheet carrying value of the water and waste water infrastructure fixed assets
by reference to the fair value of these assets at the date of transition to IFRS, 1 April 2004. All non-infrastructure assets have
been carried forward using the depreciated historical cost UK GAAP balances as the deemed IFRS cost;

to recognise all cumulative actuarial gains and losses relating to defined benefit pension schemes at the date of transition;

not to apply the requirements of IFRS 2 “Share-based Payment” to options granted under the Group’s share incentive schemes
prior to 7 November 2002.

2. SIGNIFICANT ACCOUNTING POLICIES (continued)

The financial statements include the results of Pennon Group Plc and its subsidiary and joint venture undertakings.

The results of subsidiaries and joint venture undertakings are included from the date of acquisition or incorporation, and excluded
from the date of disposal. The results of subsidiaries are consolidated where the Group has the power to control a subsidiary.
The results of joint venture undertakings are accounted for on an equity basis where the company exercised joint control under
a contractual arrangement.

On acquisition, the assets and liabilities and contingent liabilities of a subsidiary or joint venture acquired are measured at their
fair values and any excess of the cost of acquisition over the fair values of the identifiable net assets acquired is recognised as goodwill.
Any deficiency of the cost of acquisition below the fair values of the identifiable net assets acquired is credited to profit and loss in the
year of acquisition.

(d) Revenue recognition

Revenue represents the fair value of consideration receivable, excluding value added tax, trade discounts and intercompany sales, in
the ordinary course of business for goods and services provided.

Revenue is not recognised until the service has been provided to the customer, or the goods which the sale relates to have been
despatched to the customer.

Income from main water and waste water charges includes an estimation of the amount of unbilled charges at the period end based
upon a defined methodology reflecting historical consumption and current tariffs.

(e) Landfill tax

Landfill tax is included within both revenue and operating costs.

(f) Segmental reporting

Each of the Group’s business segments provide services which are subject to risks and returns which are different from those of the
other business segments. The Group’s internal organisation and management structure and its system of internal financial reporting is
based primarily on business segments. The business segments comprise the regulated water and sewerage services undertaken by South
West Water Limited and the waste management business of Viridor Waste Limited. Segmental revenue, expense and results include
transactions between businesses. Inter-segmental transactions are eliminated on consolidation.

(g) Goodwill

Goodwill arising on consolidation from the acquisition of subsidiary and joint venture undertakings represents the excess of the
purchase consideration over the fair value of net assets acquired.

Goodwill is recognised as an asset and reviewed for impairment at least annually. Any impairment is recognised immediately in the
income statement and is not subsequently reversed. Further details are contained in accounting policy (l).

When a subsidiary or joint venture undertaking is sold, the profit or loss on disposal is determined after including the attributable
amount of unamortised goodwill.

Goodwill arising on acquisitions before the date of transition to IFRS has been retained at the previous UK GAAP amounts subject to
being tested for impairment at that date and annually thereafter. Goodwill written off to reserves under UK GAAP prior to 1998 has not
been reinstated and will not be included in determining any subsequent profit or loss on disposal.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

2. SIGNIFICANT ACCOUNTING POLICIES (continued)

(h) Intangible assets

Intangible assets acquired in a business combination are capitalised at fair value at the date of acquisition. Following initial
recognition, finite life intangible assets are amortised on a straight-line basis over their estimated useful economic lives, with the
expense taken to the income statement through operating expenses.

(i) Property, plant and equipment

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

Infrastructure assets are included at fair value on transition to IFRS and subsequent additions at cost less accumulated depreciation.
Expenditure to increase capacity or enhance infrastructure assets is capitalised where it can be reliably measured and it is probable that
incremental future economic benefits will flow to the entity. The cost of day to day servicing of infrastructure components is recognised
in the income statement as it arises.

Infrastructure assets are depreciated over their useful economic lives on a straight-line basis, which are principally as follows:

Dams and impounding reservoirs
Water mains
Sewers

200 years
40 – 100 years
40 – 100 years

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

ii) Landfill sites

Landfill sites are included within land and buildings at cost less accumulated depreciation. Cost includes acquisition and development
expenses. The cost of a landfill is depreciated to its residual value (which is linked to gas production at the site post-closure) over its
estimated operational life taking account of the usage of void space.

Where the obligation to restore a landfill site gives access to future economic benefits, a tangible fixed asset is recognised and
depreciated based on the usage of void space.

iii) Other assets (including properties, over-ground plant and equipment)

Other assets are included at cost less accumulated depreciation.

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

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

30 – 60 years
Over the period of the lease
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 which are incremental to the Group. Borrowing costs that
are directly attributable to the construction of a qualifying asset (an asset which necessarily takes a substantial period of time to be
prepared for its intended use) are capitalised as part of the asset.

Asset lives and residual values are reviewed annually.

2. SIGNIFICANT ACCOUNTING POLICIES (continued)

(j) Grants and contributions

Grants and contributions receivable in respect of property, plant and equipment are deducted from the cost of those assets.

Grants and contributions receivable in respect of expenditure charged against profits in the year have been included in the
income statement.

(k) 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 borrowings. 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.

(l)

Impairment of assets

Assets which have an indefinite useful life are not subject to amortisation and are tested annually for impairment, or whenever events
or changes in circumstance indicate that the carrying amount may not be recoverable.

Assets which are subject to amortisation are tested for impairment whenever events or changes in circumstances indicate that the
carrying amount may not be fully recoverable.

An impairment loss is recognised for the amount by which the asset’s carrying amount exceeds its recoverable amount. The recoverable
amount is the higher of an asset’s fair value less costs to sell and value in use. For the purposes of assessing impairment, assets are
grouped at the lowest levels for which there are separately identifiable cash flows (cash-generating units). Value in use represents the
present value of projected future cash flows expected to be derived from a cash-generating unit, discounted using a pre-tax discount
rate which reflects an assessment of the cost of capital of the cash-generating unit.

Impairments are charged to the income statement in the year in which they arise.

(m) Joint ventures

Joint ventures are entities over which the group has joint control. Investments in joint ventures are accounted for using the equity
method of accounting. Any excess of the cost of acquisition over the Group’s share of the fair values of the identifiable net assets of the
joint venture at the date of acquisition is recognised as goodwill.

The carrying value of the Group’s investment is adjusted for the Group’s share of post-acquisition profits or losses recognised in the
income statement. Losses of a joint venture in excess of the Group’s interest are not recognised unless the Group has a legal or
constructive obligation to fund those losses.

(n) Inventories

Inventories and work in progress are stated at the lower of cost and net realisable value. Cost includes labour, materials and
attributable overheads.

(o) Cash and cash equivalents

Cash and cash equivalents includes cash in hand, short-term deposits held at banks and other short-term highly liquid deposits subject
to insignificant risk of changes in value. Bank overdrafts are shown within current borrowings.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

2. SIGNIFICANT ACCOUNTING POLICIES (continued)

(p) Derivatives and other financial instruments

The Group has taken advantage of the IFRS 1 exemption from application of IAS 32 “Financial Instruments: Disclosure and
Presentation” and IAS 39 “Financial Instruments: Recognition and Measurement” and has applied these standards from 1 April 2005.
Accordingly, for the 2005 comparative information, financial instruments are accounted for and presented under UK GAAP.
As a result of applying IAS 39 at 1 April 2005, net assets have been reduced by £1 million for the Group’s debt interest rate swaps,
by £1 million reflecting the discounted proceeds of receivables and increased by £10 million (net of tax) following the release of
deferred income which does not qualify as a hedge under IFRS.

The Group has classified its financial instruments in the following categories from 1 April 2005.

Loans and receivables

All loans and borrowings are initially recognised at cost, being the net fair value of the consideration received. Following initial
recognition, interest-bearing loans and borrowings are subsequently measured at amortised cost.

Gains and losses are recognised in the income statement when the liabilities are de-recognised or impaired. Premiums, discounts and
other costs and fees are recognised in the income statement through the amortisation process.

Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least
12 months after the balance sheet date.

ii) Derivative financial instruments

The Group uses derivative financial instruments, principally interest rate swaps, to hedge its risks associated with interest rate
fluctuations. Such derivative instruments are initially recorded at cost and subsequently re-measured at fair value for the reported
balance sheet.

The gain or loss on re-measurement is taken to the income statement except for cash flow hedges that meet the conditions for hedge
accounting, when the portion of the gain or loss on the hedging instrument which is determined to be an effective hedge is recognised
directly in equity, and the ineffective portion in the income statement. The gains or losses deferred in equity in this way are
subsequently recognised in the income statement in the same period in which the hedged underlying transaction or firm commitment is
recognised in the income statement.

In order to qualify for hedge accounting, the Group is required to document in advance the relationship between the item being hedged
and the hedging instrument. The Group is also required to document and demonstrate an assessment of the relationship between the
hedged item and the hedging instrument, which shows that the hedge will be highly effective on an on-going basis. This effectiveness
testing is re-performed at the end of each reporting period to ensure that the hedge remains highly effective.

iii) Trade receivables

Trade receivables do not carry any interest and are stated at their nominal value as reduced by appropriate allowances for estimated
irrecoverable amounts and the impact of discounting.

iv) Trade payables

Trade payables are not interest bearing and are stated at their nominal value.

2. SIGNIFICANT ACCOUNTING POLICIES (continued)

(q) Taxation including deferred tax

Tax payable for the year is provided at current rates. Deferred taxation is provided in full, using the liability method, on temporary
differences between the tax basis of assets and liabilities and their carrying amounts in the financial statements. A deferred tax asset
is only recognised to the extent it is probable that sufficient taxable profits will be available in the future to utilise it.

(r) Provisions for liabilities and charges

Provisions are made where there is a present legal or constructive obligation as a result of a past event and it is probable that there will
be an outflow of economic benefits to settle this obligation and a reliable estimate of this amount can be made. The Group’s policy on
provisions for specific areas is as follows:

Landfill restoration costs

Provisions for the cost of restoring landfill sites are made when the 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.

ii) Environmental control and aftercare costs

Environmental control and aftercare costs are incurred over the operational life of each landfill site and may be incurred for a
considerable period thereafter. Provision for all such costs is made over the operational life of the site and charged to the income
statement on the basis of the usage of void space.

Provisions for restructuring costs are recognised when the Group has a detailed formal plan for the restructuring that has been
communicated to affected parties.

Where the effect of the time value of money is material, the current amount of a 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
interest payable and similar charges.

(s) Share capital and treasury shares

Debt and equity instruments are identified according to their underlying factors, as required by IAS 32 “Financial Instruments:
Disclosure and Presentation”.

Shareholders approved a £200 million return of capital, by way of a B Share Scheme and an on-market buy back programme, at the
Company’s Extraordinary General Meeting on 15 February 2006. Shareholders were given the options of receiving an initial
dividend payment of 110 pence for each B Share held, or redeeming the B Shares on 27 February 2006, the Initial Redemption Date,
or on 6 April 2006, the Final Redemption Date, or a combination of these options.

Ordinary shares are classified as equity and B Shares as debt.

The Group balance sheet incorporates the shares held by the Pennon Employee Share Trust and which have not vested by the balance
sheet date. These are shown as a deduction from shareholders’ equity until such time as they vest.

(t) Dividend distributions

Dividend distributions are recognised as a liability in the Group’s financial statements in the period in which the dividends are approved
by the Company’s shareholders. Interim dividends are recognised when paid; final dividends when approved in general meeting
by shareholders.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

2. SIGNIFICANT ACCOUNTING POLICIES (continued)

(u) Employee benefits

i) Pension obligations

The Group operates defined benefit and defined contribution pension schemes.

Defined benefit schemes
Defined benefit pension scheme assets are measured using bid price. Defined benefit pension scheme liabilities are measured by an
independent actuary using the projected unit method and discounted at the current rate of return on high quality corporate bonds of
equivalent term to the liability. The increase in the present value of the liabilities of the Group’s defined benefit pension schemes
expected to arise from employee service in the period is charged to operating profit. The expected return on scheme assets and the
increase during the period in the present value of scheme liabilities, arising from the passage of time, are included in other finance
income or cost. Past-service costs are recognised immediately in income.

Actuarial gains and losses arising from experience adjustments, changes in actuarial assumptions and amendments to pension plans are
charged or credited to equity and recorded in the statement of recognised income and expense.

Defined contribution schemes
Costs of the defined contribution pension scheme are charged to the income statement in the period in which they arise.

ii) Share-based payment

The Group operates a number of equity settled, share-based payment plans for employees. The fair value of the employee services
required in exchange for the grant is recognised as an expense over the vesting period of the grant.

Fair values are calculated using an appropriate pricing model. Non-market based vesting conditions are adjusted for assumptions as to
the number of awards which are expected to vest.

(v) Pre-contract costs

Pre-contract costs are expensed as incurred, except where it is virtually certain that the contract will be awarded, in which case they are
recognised as an asset which is amortised to the income statement over the life of the contract.

(w) Fair values

The fair value of the interest rate swaps is based on the market price of comparable instruments at the balance sheet date if they are
publicly traded.

The fair values of short-term deposits, loans and overdrafts with a maturity of less than one year are assumed to approximate to their
book values. In the case of bank loans and other loans due in more than one year, the fair value of financial liabilities for disclosure
purposes is estimated by discounting the future contractual cash flows at the current market interest rate available to the Group for
similar financial instruments.

3. FINANCIAL RISK MANAGEMENT

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.

Treasury operations are managed in accordance with policies established by the Board. Major transactions are individually approved by
the Board. Treasury activities are reported to the Board and are subject to review by internal audit.

Financial instruments are used to raise finance and to manage risk. The Group does not engage in speculative activity.

The principal financial risks faced by the Group relate to interest rate and counterparty risk.

Interest rate risk

The Group has both interest bearing assets and interest bearing liabilities. The Group has a policy of maintaining at least 50% of
interest bearing liabilities at fixed rates. At the year end 68% of net borrowings were at fixed rates. The Group uses a combination of
fixed rate borrowings and fixed rate interest swaps as cash flow hedges of future variable interest payments to achieve this policy. 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. In addition, a £142 million finance lease was converted to an RPI-linked basis (1.365% real) during the year to
take advantage of historically low index-linked rates and also to reduce earnings volatility. These instruments are analysed in more
detail in note 25.

ii) Liquidity risk

The Group actively maintains a mixture of long-term and short-term committed facilities that are designed to ensure the Group has
significant available funds for operations and planned expansions and facilities equivalent to at least one year’s forecast requirements
are maintained at all times. Details of undrawn committed facilities and short-term uncommitted facilities are provided in note 25.

iii) Refinancing risk management

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

iv) Counterparty risk management

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 is controlled through credit limits, counterparty approvals, and rigorous monitoring procedures.
The Group has no other significant concentration of credit risk. 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 a credit rating threshold approved
by the Board.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

4. CRITICAL ACCOUNTING JUDGEMENTS

The Group’s principal accounting policies are set out in note 2 to these financial statements. Management is required to exercise
significant judgement and make use of estimates and assumptions in the application of these policies.

Areas which management believes require the most critical accounting judgements are:

Exceptional items
The Directors consider that items of income or expense which are material and non-recurring by virtue of their nature and amount
should be disclosed separately if the financial statements are to fairly present the financial position and financial performance of the
Group. The Directors label these items collectively as “exceptional items”.

Landfill 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. For the year ended 31 March 2006 the Directors believe the appropriate accounting methodology is to record the
full amount of the discounted restoration cost of landfills as a tangible fixed asset and then depreciate according to the usage of void
space. This is a change from the previous methodology of creating restoration provisions through a charge to operating cost as void
space is filled. The financial effects of this change in methodology are to create an asset with a corresponding liability as shown in notes
16 and 29 to these financial statements.

Private Finance Initiative (PFI) projects
PFI contracts are reviewed to ascertain whether the risks and rewards of assets acquired lie substantially with the Group or the client
entity. All current contracts indicate that the most significant risks remain with the Group and therefore assets are accounted for as
tangible fixed assets, with depreciation charged over the shorter of the useful life of the asset or the concession period.

Joint ventures
The results, assets and liabilities of joint ventures are accounted for using the equity method of accounting as this reflects the
contractual and control arrangements with the joint venture partners.

Borrowing costs
The Group capitalises borrowing costs which are material and directly attributable to the construction of qualifying assets, which are
assets that necessarily take a substantial period of time to be prepared for their intended use. Currently only the assets under
construction in the Lakeside Energy from Waste joint venture meet the criteria for capitalisation.

Retirement benefit obligations
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 pension cost under IAS19 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, supplemented by discussions between the actuary and management. The assumptions are disclosed in note 27 of the
financial statements.

4. CRITICAL ACCOUNTING JUDGEMENTS (continued)

Areas which management believes require the most critical accounting estimation are as follows:

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 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 2 of the consolidated financial statements. The carrying
value of tangible fixed assets as at 31 March 2006 was £2,416 million. In the year ended 31 March 2006 additions to tangible fixed
assets totalled £250 million and the depreciation charge was £104 million. The estimated useful economic lives of tangible fixed assets
are based on management’s judgement and experience. When management identifies that actual useful lives differ materially from the
estimates used to calculate depreciation, that charge is adjusted prospectively. Due to the significance of tangible fixed asset
investment to the Group, variations between actual and estimated useful lives could impact operating results both positively and
negatively. Historically, only minor changes to estimated useful lives have been required.

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.

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 including, 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 2006 trade debtors were £95 million.

Impairment of intangible assets
The Group records all assets and liabilities acquired in business acquisitions, including goodwill, at fair value. Intangible assets which
have an indefinite useful life, principally goodwill, are assessed annually for impairment.

The initial goodwill recorded and subsequent impairment analysis require management to make estimations of future cash flows,
terminal values and an assessment of the long-term pre-tax discount rate to be applied to those cash flows to reflect the cost of capital
of the cash-generating unit.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

5. SEGMENTAL REPORTING

Continuing operations

Revenue
Water and sewerage

Waste management

Other

Less intra-segment trading*

Segment result

Operating profit before depreciation, amortisation and exceptional items (EBITDA)
Water and sewerage

Waste management

Other

Operating profit before amortisation and exceptional items
Water and sewerage

Waste management

Other

Operating profit before exceptional items
Water and sewerage

Waste management

Other

Operating profit
Water and sewerage

Waste management

Other

Profit before tax and exceptional items
Water and sewerage

Waste management

Other

Discontinued operations
Other

The exceptional items are detailed in note 9.

2006
£m

2005
£m

348.5

298.9

7.3

(9.0)

307.0

248.3

6.9

(10.8)

645.7

551.4

213.4
66.7

(0.9)

186.4

56.4

0.2

279.2

243.0

141.5

35.9

(0.7)

122.2

30.0

0.1

176.7

152.3

141.5

34.3

(0.7)

122.2

28.6

0.1

175.1

150.9

127.0

34.3

(0.7)

118.8

28.6

(1.4)

160.6

146.0

87.4

21.9

1.6

70.0

20.1

(1.1)

110.9

89.0

–

5.0

*Intra-segment trading between and to other segments by the water and sewerage and waste management segments is under normal commercial terms and conditions that
would also be available to unrelated third parties. Intra-segment revenue of the Other segment is at cost.

5. SEGMENTAL REPORTING (continued)

Balance sheet

31 March 2006
Assets (excluding investment in joint ventures)

Investments in joint ventures

Total assets

Liabilities

Net assets

31 March 2005
Assets

Liabilities

Net assets

Other information

31 March 2006
Amortisation of intangible assets (note 15)

Capital expenditure (including acquisitions)

Depreciation

31 March 2005
Amortisation of intangible assets (note 15)

Capital expenditure (including acquisitions)

Depreciation

Employees (average) number
The average monthly number of employees

(including executive directors) was:

Water and sewerage

Waste management

Other

Group totals

Water and
sewerage
£m

Waste
management
£m

Other
£m

Eliminations
£m

Group
£m

2,229.3

–

472.7

1.3

534.0

–

(507.8)

2,728.2

–

1.3

2,229.3

474.0

534.0

(507.8)

2,729.5

(1,795.5)

(390.6)

(470.0)

507.8

(2,148.3)

433.8

83.4

64.0

–

581.2

2,302.6

(1,700.1)

343.6

(271.9)

638.4

(603.7)

(584.7)

584.7

2,699.9

(1,991.0)

602.5

71.7

34.7

–

708.9

Water and
sewerage
£m

Waste
management
£m

Other
£m

Group
£m

–

191.0

71.9

–

134.5

64.2

1.6

104.5

30.8

1.4

78.1

26.4

–

(0.2)

–

0.3

0.1

1.6

295.5

102.5

1.4

212.9

90.7

2006

2005

1,299

1,388

1,336

1,169

2,722

2,544

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

5. SEGMENTAL REPORTING (continued)

The total number of employees at 31 March 2006 was 2,775 (2005 2,566).

The water and sewerage business comprises the regulated water and sewerage services undertaken by South West Water Limited. The
waste management business is the waste treatment, recycling and disposal services provided by Viridor Waste Limited. Other includes
parent company financing of business acquisitions made before 1999. Segment assets include goodwill and other intangible assets,
property, plant and equipment, inventories, trade and other receivables and operating cash and mainly exclude investments. Segment
liabilities comprise operating liabilities and exclude taxation and certain corporate borrowings. Capital expenditure, comprises
additions to property, plant and equipment, including additions resulting from acquisitions through business combinations.

Geographical segments
Separate disclosure by geographical segment is not shown since the operations of the Group are substantially all located in the United
Kingdom and management do not use geographical location to control or monitor the Group’s activities.

6. OPERATING COSTS

Manpower costs (note 12)

Raw materials and consumables

Other operating expenses include:
Profit on disposal of fixed assets

Operating lease rentals payable:

– Plant and machinery

– Property

Research and development expenditure

Trade receivables impairment

Depreciation of property, plant and equipment:

– Owned assets

– Under finance leases

Amortisation of intangible assets (note 15)

Fees payable to the Group’s auditors in the year were as follows:

Audit services

– Statutory audit

– Audit – related regulatory reporting

Other assurance services

Tax services

– Compliance services

– Advisory services

Other services

2006
£m

79.9

40.7

2005
£m

68.3

32.8

(1.1)

(1.4)

6.9

1.3

0.1

5.6

77.7

24.8

1.6

4.8

3.8

0.1

6.9

69.2

21.5

1.4

2006
£000

2005
£000

307

321

102

873

308

220

105

752

Other assurance services and tax advisory services in 2006 include costs relating to the transition to IFRS and the financial
restructuring in the Company. 2005 includes costs relating to the abortive acquisition of the UK landfill operations of Shanks Group Plc.

A description of the work of the Audit Committee is set out on pages 36 and 37 which includes an explanation of how auditor objectivity
and independence are safeguarded when non-audit services are provided by the auditors.

The Group’s pension schemes are also audited by PricewaterhouseCoopers LLP.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

7. NET FINANCE COSTS

Interest payable (before the exceptional item)
Bank borrowings and overdrafts
Other loans
Interest element of finance lease rentals
Other finance costs
Interest cost on retirement benefit obligations
Unwinding of discounts in provisions

Interest payable and similar charges

Interest receivable (before the exceptional item)

Expected return on pension scheme assets

Interest receivable

Net finance costs

2006
£m

2005
£m

(25.7)
–
(39.4)
(11.7)
(16.6)
(3.4)

(96.8)

14.7

17.8

32.5

(23.5)
(16.2)
(32.7)
(0.6)
(15.3)
(1.0)

(89.3)

13.3

14.0

27.3

(64.3)

(62.0)

The exceptional interest items, totalling £42.3 million, are detailed in note 9.

8. TAXATION

Analysis of charge in year

Continuing operations
Current tax
Deferred tax (note 28)

Before exceptional
items 2006
£m

Exceptional items
(note 9) 2006
£m

Total
2006
£m

14.8
20.2

35.0

(18.7)
–

(18.7)

(3.9)
20.2

16.3

2005
£m

7.9
15.6

23.5

No tax charge arose from the business disposal profit in relation to the prior year.

UK corporation tax is calculated at 30% (2005 30%) of the estimated assessable profit for the year. The tax for the year differs from the
theoretical amount that would arise using the standard rate of corporation tax in the UK (30%). The differences are explained below:

Profit before tax: Continuing operations

Profit before tax multiplied by standard rate of
corporation tax in the UK of 30% (2005: 30%)

Effects of:
Expenses not deductible for tax purposes
Other
Adjustments to tax in respect of prior year

Tax charge for year

2006
£m

54.1

2005
£m

84.1

16.2

25.2

1.4
(1.4)
0.1

2.8
(2.5)
(2.0)

16.3

23.5

The average effective tax rate for the year was 30% (2005 28%).

In addition to the amount charged to the income statement, a deferred tax credit relating to share-based payment of £1.2 million
(2005 £0.3 million) and a deferred tax credit relating to actuarial losses on defined benefit schemes of £0.8 million (2005 £0.6 million
charge on actuarial gains) have been credited directly to equity.

9. EXCEPTIONAL ITEMS

The exceptional items are:

Continuing operations
Customer payment
Abortive acquisition costs
Business restructuring costs

Manpower costs
Other external charges

Operating profit

Net finance costs
Bond retirement
Receipt on transfer of lease

Profit before tax
Tax arising on exceptional items

Discontinued operations
Post-tax disposal profit

2006
£m

2005
£m

14.5
–

–
–

14.5

50.2
(7.9)

42.3

56.8
(18.7)

38.1

–

38.1

–
1.5

3.0
0.4

4.9

–
–

–

4.9
–

4.9

(5.0)

(0.1)

The customer payment and bond retirement relate to financial restructuring in the Company and South West Water Limited.

The receipt on transfer of lease relates to a consent fee paid to South West Water Limited arising from the sale of finance leases between
financial institutions.

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

The business restructuring costs arose in the water and sewerage segment.

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.

No tax charge arose from the business disposal profit.

10. EARNINGS PER SHARE

Basic earnings per share are calculated by dividing the earnings attributable to ordinary shareholders by the weighted average
number of ordinary shares outstanding during the year, excluding those held in the employee share trust (note 30), which are
treated as cancelled.

For diluted earnings per share, the weighted average number of ordinary shares in issue is adjusted to include all dilutive potential
ordinary shares. The Group has two types of dilutive potential ordinary shares: those share options granted to employees where the
exercise price is less than the average market price of the Company’s ordinary shares during the year and the contingently issuable
shares under the Group’s Restricted Share Plan and the deferred shares element of the Performance Related Bonus Plan to the extent
that the performance criteria for vesting of the awards are expected to be met.

A reconciliation of the weighted average number of shares and earnings used in the calculations is set out below.

Number of shares (millions)

For basic earnings per share

Effect of dilutive potential ordinary shares:

Share options

For diluted earnings per share

Earnings per share from discontinued operations (in pence per share)

– Basic
– Diluted

2006

2005

127.3

126.0

1.1

0.9

128.4

126.9

–
–

4.0
3.9

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

10. EARNINGS PER SHARE (continued)

Adjusted basic and diluted earnings per share

Adjusted earnings per share have been calculated to exclude the impact of the 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. Adjusted earnings
have been calculated:

Profit
after tax
£m

37.8
38.1
20.2

96.1

2006

Earnings per share

Basic
p

29.7
29.9
15.9

75.5

Diluted
p

29.4
29.7
15.7

74.8

Profit
after tax
£m

60.6
4.9
15.6

81.1

2005

Earnings per share

Basic
p

48.1
3.9
12.3

64.3

Diluted
p

47.8
3.8
12.3

63.9

Earnings per share from

continuing operations
Exceptional items (net of tax)
Deferred tax

Adjusted earnings per share
from continuing operations

11. DIVIDENDS

Amounts recognised as distributions to equity holders in the year:

Interim dividend paid for the year ended
31 March 2005: 13.8p (2004: 13.2p) per share

Final dividend paid for the year ended
31 March 2005: 29.2p (2004 27.8p) per share

Proposed dividends
Proposed interim dividend for the year ended
31 March 2006: 16.5p (2005: 13.8p) per share

Proposed final dividend for the year ended
31 March 2006: 35.1p (2005: 29.2p) per share

2006
£m

2005
£m

17.7

16.4

37.4

55.1

34.7

51.1

19.4

17.7

41.6

61.0

37.4

55.1

The proposed interim and final dividends have not been included as liabilities in these financial statements. The proposed interim dividend
was paid on 13 April 2006 and the proposed final dividend is subject to approval by shareholders at the Annual General Meeting.

12. EMPLOYMENT COSTS

Employment costs comprise:
Wages and salaries
Social security costs
Pension costs
Share-based payments

Total employment costs

Charged as follows:

Manpower costs:

Before exceptional costs
Exceptional costs (note 9)

Capital schemes
Restructuring provision

Total employment costs

2006
£m

72.5
6.5
9.8
1.7

90.5

79.9
–
10.0
0.6

90.5

2005
£m

64.8
5.6
9.2
1.5

81.1

68.3
3.0
9.8
–

81.1

12. EMPLOYMENT COSTS (continued)

Details of Directors’ emoluments are set out in note 13. There are no personnel other than Directors, who as key management exercise
authority and responsibility for planning, directing and controlling the activities of the Group.

13. DIRECTORS’ EMOLUMENTS

Executive Directors:

Salary

Performance related bonus payable

Vesting of Restricted Share Plan awards

Vesting of Performance Related Bonus Plan awards

Other emoluments

Payments in respect of tax liability from supplementary pension arrangements

Non-executive Directors

Total emoluments

2006
£000

630

223

276

199

148

303

2005
£000

590

209

607

–

108
289

1,833

1,857

The 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.

Total gains made by Directors on the exercise of share options were nil (2005 £3,000).

Total emoluments include £828,000 (2005 £911,000) payable to Directors for services as directors of subsidiary undertakings.

At 31 March 2006 and 31 March 2005 retirement benefits were accruing to three Directors under defined pension schemes.
The accrued pension entitlement at 31 March 2006 under defined benefit schemes of the highest paid Director was £81,000
(2005 £73,000). No pension contributions were payable to defined contribution schemes in 2006 or 2005.

More detailed information concerning Directors’ emoluments, shareholdings and share options is shown in the Directors’
remuneration report on pages 29 to 35.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

14. GOODWILL

Cost:
At 1 April 2004
Recognised on acquisition of subsidiaries

At 1 April 2005
Recognised on acquisition of subsidiaries (note 36)

At 31 March 2006
Carrying amount:

At 31 March 2005

At 31 March 2006

£m

47.6
16.8

64.4
34.2

98.6

64.4

98.6

Goodwill acquired in a business combination is allocated at acquisition to the cash-generating unit (CGU) expected to benefit
from that business combination. All of the carrying amount of goodwill is allocated to the waste management segment which
is considered to be a single CGU, as it is an integrated business.

Goodwill is reviewed annually or when other events or changes in circumstances indicate that the carrying amount may not
be fully recoverable.

The recoverable amount of the waste management segment is determined from value in use calculations. The key assumptions in those
calculations relate to discount rates, cash flows, price increases and for landfill, the compaction rate. Cash flow projections are based
on approved budgets and plans for the next five years and beyond this period on long-term growth rates for the waste sector based on
GDP. The cash flows have been discounted using a pre-tax discount rate of 13%.

15. INTANGIBLE ASSETS

Acquired intangible assets

Cost:

At 1 April 2004

Acquisitions

Additions

At 31 March 2005

Acquisitions

At 31 March 2006

Aggregate amortisation and impairment:

At 1 April 2004

Charge for the year

At 31 March 2005

Charge for year

At 31 March 2006

Carrying amount:

At 31 March 2005

At 31 March 2006

Customer
contracts
£m

Patents
£m

Total
£m

–

7.2

–

7.2

1.3

8.5

–

1.4

1.6

3.0

5.8

5.5

–

0.2

–

0.2

–

0.2

–

7.2

0.2

7.4

1.3

8.7

–

1.4

1.6

3.0

6.0

5.7

15. INTANGIBLE ASSETS (continued)

Customer contracts are amortised over the useful economic life of each contract which at acquisition ranged between 3 and 8 years.
The average remaining life is 6 years.

Patents are amortised over their estimated useful economic lives which at acquisition was 13 years. The average remaining life is 11 years.

The carrying value of intangible assets are reviewed annually or when events or changes in circumstance indicate that the carrying
amount may not be recoverable.

16. PROPERTY, PLANT & EQUIPMENT

Land and
buildings
£m

Infrastructure
assets
£m

Operational
properties
£m

206.0

9.0

23.9

(0.3)

(2.1)

(3.8)

976.4

545.0

–

39.0

(2.8)

–

16.5

–

0.6

–

(0.9)

2.6

Fixed and
mobile plant,
vehicles and
computers
£m

840.8

9.8

54.1

(5.8)

(12.2)

52.4

Cost:
At 1 April 2004

Arising on acquisitions

Additions

Grants and contributions

Disposals

Transfers/reclassifications

At 31 March 2005

232.7

1,029.1

547.3

939.1

Arising on acquisitions

Additions

Other (note 29)

Grants and contributions

Disposals

Transfers/reclassifications

18.4

26.7

–

(13.1)

0.6

–

56.4

–

(1.1)

–

23.6

–

3.5

–

(5.8)

12.3

5.1

66.8

–

(2.5)

(68.7)

30.3

Landfill
restoration
£m

Construction
in progress
£m

–

3.1

–

32.3

–

74.8

–

63.4

–

(0.1)

(67.7)

70.4

–

96.3

–

(66.8)

Total
£m

2,643.0

18.8

181.0

(8.9)

(15.3)

–

2,818.6

26.6

249.7

32.3

(3.6)

(87.6)

–

At 31 March 2006

265.3

1,108.0

557.3

970.1

35.4

99.9

3,036.0

Depreciation:

At 1 April 2004

Charge for year

Disposals

Transfers/reclassifications

At 31 March 2005

Charge for year

Disposals

At 31 March 2006

Net book value:

At 31 March 2005

80.4

15.1

(2.1)

(0.2)

93.2

14.1

(10.2)

97.1

–

11.6

–

11.6

13.2

–

24.8

139.5

1,017.5

At 31 March 2006

168.2

1,083.2

108.6

9.7

(0.9)

(0.5)

116.9

10.3

(5.8)

333.4

55.7

(11.4)

0.7

378.4

63.6

(67.9)

121.4

374.1

430.4

435.9

560.7

596.0

–

2.7

–

2.7

–

32.7

–

522.4

92.1

(14.4)

–

600.1

103.9

(83.9)

620.1

70.4

99.9

2,218.5

2,415.9

Landfill restoration assets have been included following a change in accounting methodology, as described in note 4 to these
financial statements.

Out of the total depreciation charge of £103.9 million (2005 £92.1 million), £1.4 million (2005 £1.4 million) has been charged to
capital projects and £102.5 million (2005 £90.7 million) against profits.

Asset lives and residual values are reviewed annually.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

16. PROPERTY, PLANT & EQUIPMENT (continued)

Assets held under finance leases included above:

Cost:

At 31 March 2005

At 31 March 2006

Depreciation:

At 31 March 2005

At 31 March 2006

Net book amount:

At 31 March 2005

At 31 March 2006

17. TRADE AND OTHER RECEIVABLES NON-CURRENT

Amounts owed by joint ventures

Other receivables

The fair values of trade and other receivables are as follows:

Amounts owed by joint ventures
Other receivables

Infrastructure
assets
£m

Operational
properties
£m

Fixed and
mobile plant,
vehicles and
computers
£m

Construction
in progress
£m

Total
£m

147.1

315.0

248.1

59.0

769.2

188.2

318.8

261.2

147.2

915.4

1.5

13.7

49.0

54.6

112.9

126.5

–

163.4

194.8

145.6

266.0

135.2

59.0

605.8

174.5

264.2

134.7

147.2

720.6

2006
£m

2.8

3.2

6.0

2006
£m

4.8

3.3

8.1

2005
£m

0.2

3.1

3.3

2005
£m

0.2
3.2

3.4

18. INVESTMENTS

Joint ventures

At 1 April 2004

At 31 March 2005

Acquisitions

Additions

At 31 March 2006

Shares
£m

Loans
£m

–

1.1

–

0.2

–

0.2

Total
£m

–

0.2

1.1

1.3

Details of principal subsidiary and joint venture undertakings of the Group are set out in note 37.

The Group’s share of the results of its joint ventures and its share of the joint ventures assets and liabilities are:

2005

Echo South West Limited

2006

Echo South West Limited

Lakeside Energy from Waste

Holdings Limited

19. INVENTORIES

Raw materials and consumables

Work in progress

20. TRADE AND OTHER RECEIVABLES – CURRENT

Trade receivables
Less: provision for impairment of receivables

Trade receivables net
Amounts owed by joint ventures
Other receivables
Other prepayments and accrued income

Assets

Liabilities

Non-current
£m

Current
£m

Non-current
£m

Current
£m

Revenues
£m

Profit
£m

0.2

0.7

(0.3)

(0.9)

4.5

0.1

25.3

25.4

0.7

1.6

2.3

(0.1)

(0.9)

(25.7)

(25.8)

(1.5)

(2.4)

4.9

–

4.9

2006
£m

4.8

0.2

5.0

2006
£m

91.2
(27.6)

63.6
1.1
4.6
25.2

94.5

0.1

–

0.1

2005
£m

4.6

0.1

4.7

2005
£m

83.6
(19.7)

63.9
1.1
10.1
24.5

99.6

The Directors consider that the carrying amount of trade and other receivables approximates to their fair value.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

21. DERIVATIVE FINANCIAL INSTRUMENTS

Interest rate swaps – cash flow hedges:

Assets

Liabilities

IFRS
2006
£m

UK GAAP
2005
£m

3.1

(3.0)

–

Interest rate swaps and fixed rate borrowings are used to manage the mix of fixed and floating rates to ensure at least 50% of net
borrowings is at fixed rate. At 31 March 2006 68% of net borrowings was at fixed rate (2005 69%).

At 31 March 2006 interest rate swaps to hedge financial liabilities with a notional principal value of £676.0 million existed, with a
weighted average maturity of 3.5 years (2005 £365.0 million, with 2.4 years) to swap from floating to fixed rate. The weighted average
interest rate of the swaps was 4.9% (2005 5.0%).

The amounts above are the fair value of swaps based on the market value of equivalent instruments at the balance sheet date. All the
interest rate swaps are designated and effective as cash flow hedges and the fair values have been deferred in equity.

22. CASH AND CASH EQUIVALENTS

Cash at bank and in hand

Short-term bank deposits

2006
£m

7.7

91.7

99.4

2005
£m

4.4

299.0

303.4

The effective interest rate on short-term deposits was 4.7% (2005 4.9%) and these deposits have an average maturity of 3 days.

During the year restricted deposited funds of £177.1 million as at 31 March 2005, used to counter–indemnify letters of credit by
financial institutions to lessors in order to secure rental obligations, were released (note 25).

23. TRADE AND OTHER PAYABLES – CURRENT

Trade payables

Amounts owed to joint venture

Other tax and social security

Other payables

Accruals

Deferred income

The Directors consider that the carrying amount of trade and other payables approximates to their fair value.

24. CURRENT TAX LIABILITIES

Corporation tax

2006
£m

93.8

0.4

24.8

17.4

33.5

0.2

2005
£m

61.2

0.4

19.2

15.9

31.1

–

170.1

127.8

2006
£m

2005
£m

24.0

23.6

25. BORROWINGS

Current
Bank overdrafts

Short-term loans

European Investment Bank

Unsecured loan stock notes

Obligations under finance leases

Non-current
Sterling bond

European Investment Bank

Bank loans

Obligations under finance leases

Total borrowings

2006
£m

18.5

0.1

4.2

3.9

26.7

28.0

54.7

–

232.2

312.7

544.9

926.9

2005
£m

5.1

0.1

14.7

5.6

25.5

29.3

54.8

150.0

166.4

255.3

571.7

795.1

1,471.8

1,366.8

1,526.5

1,421.6

The Sterling bond, due for repayment in February 2012, was retired in January 2006.

The Directors consider that the carrying amounts of current borrowings approximate to their fair value.

The fair value of the non-current borrowings are:

Sterling bond

European Investment Bank

Bank loans

Obligations under finance leases

2006

2005

Book value
£m

Fair value
£m

Book value
£m

Fair value
£m

–

232.2

312.7

544.9

926.9

–

226.9

312.7

539.6

884.5

150.0

166.4

255.3

571.7

795.1

196.1

163.2

255.3

614.6

749.2

1,471.8

1,424.1

1,366.8

1,363.8

Where market values are not available, fair values of borrowings have been calculated by discounting expected future cash flows at
prevailing interest rates.

The exposure to interest rate changes and the re-pricing dates at the balance sheet date is:

6 months or less

6 – 12 months

1 – 5 years

Over 5 years

2006
£m

384.0

140.7

896.8

105.0

2005
£m

373.5

245.5

547.6

255.0

1,526.5

1,421.6

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

25. BORROWINGS (continued)

The maturity of non-current borrowings is:

Between 1 and 2 years

Between 2 and 5 years

Over 5 years

The effective interest rates at the balance sheet date were:

Bank overdrafts
Short-term loans

European Investment Bank

Unsecured loan stock notes

Sterling bond

Bank loans

Finance leases

Finance lease liabilities – minimum lease payments:

Within one year

In the second to fifth years inclusive

After five years

Less: future finance charges

2006
£m

64.4

150.4

1,257.0

2005
£m

92.0

297.9

976.9

1,471.8

1,366.8

2006
%

5.5

4.7

4.0

–

4.9

3.8

2006
£m

38.8

219.1

2005
%

5.7
5.7

5.5

4.3

10.6

5.3

3.9

2005
£m

39.4

191.3

1,379.2

1,172.0

1,637.1

1,402.7

(682.2)

(578.3)

954.9

824.4

Included above are accrued finance charges arising on obligations under finance leases totalling £109.2 million (2005 £104.6 million),
of which £23.8 million (2005 £22.7 million) is repayable within one year.

Within obligations under finance leases, South West Water Limited has utilised finance lease facilities of £180.0 million for certain water
and sewerage business tangible fixed assets and had at 31 March 2005 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.

During the year, these deposited funds, which at 31 March 2005 totalled £177.1 million (including interest earned) were released. The
existing bank letters of credit, covering the full period of the finance leases, remain in place, but are renewable between the financial
institutions and South West Water Limited at five-yearly intervals, the next being March 2011.

25. BORROWINGS (continued)

The Group has undrawn committed borrowing facilities:

Floating rate:

Expiring within one year

Expiring after one year

In addition, the Group has short-term uncommitted bank facilities of £90.0 million.

26. OTHER NON-CURRENT LIABILITIES

Other creditors

27. RETIREMENT BENEFIT OBLIGATIONS

2006
£m

2005
£m

50.0

160.0

–

240.0

210.0

240.0

2006
£m

2.2

2005
£m

19.1

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.

Defined contribution schemes
Pension costs for defined contribution schemes were £0.5 million (2005 £0.3 million).

Defined benefit schemes
In the most recent actuarial valuation under IFRS of the Pennon Group Pension Scheme, the principal assumptions made by the
qualified actuary were:

Rate of increase in pensionable pay
Rate of increase for present and future pensions
Rate used to discount schemes’ liabilities
Inflation

The amounts recognised in the income statement were:

Current service cost
Past service cost

Total included within employment costs (note 12)

Expected return on pension schemes’ assets
Interest cost on retirement benefit obligations

Total included within net finance costs (note 7)

Total charge

The actual return on schemes’ assets was £52.0 million (2005 £23.8 million).

2006
%

3.8
2.8
5.0
2.8

2005
%

3.7
2.7
5.5
2.7

2006
£m

(8.3)
(1.0)

(9.3)

2004
%

3.7
2.7
5.5
2.7

2005
£m

(8.3)
(0.6)

(8.9)

17.8
(16.6)

14.0
(15.3)

1.2

(1.3)

(8.1)

(10.2)

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

27. RETIREMENT BENEFIT OBLIGATIONS (continued)

The amounts recognised in the statement of recognised income and expense were:

Actuarial (losses)/gains recognised in the year

The amounts recognised in the balance sheet were:

Fair value of schemes’ assets

Present value of defined benefit obligations

Net liability recognised in the balance sheet

2006
£m

(2.8)

2005
£m

1.9

2006
£m

2005
£m

317.5

(359.2)

223.8

(303.6)

(41.7)

(79.8)

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

2006

2005

2004

Equities

Property

Bonds

Other

Movements in the balance sheet liability were:

At 1 April

Income statement

Statement of recognised income and expenditure

Regular contributions

Prepayment of contributions

At 31 March

Movements in the fair value of schemes’ assets were:

At 1 April

Expected return on schemes’ assets

Actuarial gains

Members’ contributions

Benefits paid

Group regular contributions

Prepayment of Group regular contributions

At 31 March

Return
%

7.7

4.7

Value
£m

198.5

14.9

91.6

12.5

317.5

Return
%

7.8

4.8

Value
£m

172.0

5.3

42.7

3.8

223.8

Return
%

7.7

–

4.7

4.3

2006
£m

(79.8)

(8.1)

(2.8)

4.8

44.2

Value
£m

154.3

–

38.2

8.4

200.9

2005
£m

(77.5)

(10.2)

1.9

6.0

–

(41.7)

(79.8)

2006
£m

223.8

17.8

34.2

2.0

(9.3)

4.8

44.2

2005
£m

200.9

14.0

9.8

1.9

(8.8)

6.0

–

317.5

223.8

27. RETIREMENT BENEFIT OBLIGATIONS (continued)

Movements in the present value of defined benefit obligations were:

At 1 April

Service costs

Interest cost

Members’ contributions

Benefits paid

Actuarial losses

At 31 March

2006
£m

2005
£m

(303.6)

(278.4)

(9.3)

(16.6)

(2.0)

9.3

(37.0)

(8.9)

(15.3)

(1.9)

8.8

(7.9)

(359.2)

(303.6)

The Group’s transition date to IFRS was 1 April 2004 and the following historical data has been presented from that date. The historical
data will be built up to a rolling five-year record over the next three years.

Fair value of schemes’ assets

Present value of defined benefit obligations

Net liability recognised

Experience gains on schemes’ assets

Amount (£m)

Percentage of schemes’ assets

Experience losses on defined benefit obligations

Amount (£m)

Percentage of defined benefit obligations

2006
£m

2005
£m

317.5

223.8

(359.2)

(303.6)

(41.7)

(79.8)

34.2

10.8%

9.8

4.4%

(37.0)

(10.3)%

(7.9)

(2.6)%

As a result of the prepayment of contributions made in 2006 no further Group regular contributions are expected to be paid to the
schemes during the year ended 31 March 2007.

28. DEFERRED TAX LIABILITIES

Deferred tax is calculated in full on temporary differences under the liability method using a tax rate of 30% (2005 30%).

Movements on the deferred tax account were:

At 1 April

Charged to the income statement

(Released)/charged to equity

Arising on acquisitions

At 31 March

2006
£m

282.8

20.2

(2.0)

1.8

2005
£m

263.9

15.6

0.3

3.0

302.8

282.8

Deferred tax assets have been recognised in respect of all temporary differences giving rise to deferred tax assets because it is probable
that these assets will be recovered.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

28. DEFERRED TAX LIABILITIES (continued)

All deferred tax assets and liabilities are within the same jurisdiction and may be offset as permitted by IAS12. Movements in deferred
tax assets and liabilities during the year were:

Deferred tax liabilities

At 1 April 2004

Charged/(credited) to the income statement

Arising on acquisitions

At 31 March 2005

Charged/(credited) to the income statement

Arising on acquisitions

At 31 March 2006

Deferred tax assets

At 1 April 2004

Charged/(credited) to the income statement

Charged/(credited) to equity

Arising on acquisitions

At 31 March 2005

Charged/(credited) to the income statement

Credited to equity

Arising on acquisitions

At 31 March 2006

Net deferred tax liability

At 31 March 2005

At 31 March 2006

The deferred tax credited/(charged) to equity during the year was:

Actuarial gains/(losses) on defined benefit schemes

Share-based payment (note 33)

Accelerated
tax depreciation
£m

275.6

18.9

(1.1)

293.4

15.9

(3.2)

Other
£m

21.6

(0.6)

4.7

25.7

(1.3)

5.3

Total
£m

297.2

18.3

3.6

319.1

14.6

2.1

306.1

29.7

335.8

Retirement
benefit
obligations
£m

Provisions
£m

(9.5)

0.7

–

(0.6)

(9.4)

2.0

–

(0.3)

(23.3)

(1.2)

0.6

–

(23.9)

12.2

(0.8)

–

Other
£m

(0.5)

(2.2)

(0.3)

–

(3.0)

(8.6)

(1.2)

–

Total
£m

(33.3)

(2.7)

0.3

(0.6)

(36.3)

5.6

(2.0)

(0.3)

(7.7)

(12.5)

(12.8)

(33.0)

282.8

302.8

2005
£m

(0.6)

0.3

(0.3)

2006
£m

0.8

1.2

2.0

29. PROVISIONS FOR LIABILITIES AND CHARGES

At 1 April 2005
Charged to the income statement
Arising on acquisitions
Landfill restoration
Utilised during year

At 31 March 2006

Environmental
and landfill
restoration
£m

Restructuring
£m

Other
provisions
£m

33.5
4.3
9.3
32.3
(2.8)

76.6

2.6
0.9
–
–
(2.3)

1.2

0.2
–
–
–
–

0.2

Total
2006
£m

36.3
5.2
9.3
32.3
(5.1)

78.0

A landfill restoration provision has been included following a change in accounting methodology with a matching addition of
£32.3 million to tangible fixed assets, as described in note 4 and shown in note 16 to these financial statements.

The analysis of provisions between current and non-current is:

Current
Non-current

2006
£m

11.4
66.6

78.0

2005
£m

8.4
27.9

36.3

Environmental and landfill restoration provisions will be utilised over the period from 2007 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 in
the next financial year.

30. CALLED-UP SHARE CAPITAL

Authorised
143,325,090 Ordinary shares of £1.22 1/10 each
131,818,190 B Shares of £1.10 each (35,858,521 converted to Deferred Shares of £1.10 each)

(2005 157,657,600 Ordinary shares of £1.11 each)

Allotted, called-up and fully paid
118,608,847 Ordinary shares of £1.22 1/10 each
35,858,521 Deferred Shares of £1.10 each

(2005 127,944,340 Ordinary shares of £1.11 each)

Ordinary shares allotted during the year

2006
£m

2005
£m

175.0

145.0

–

144.8

39.4

–

175.0

–

142.0

184.2

142.0

2006
number

(Ordinary
shares of

(Ordinary
shares of
£1.11 each) £1.22 1/10 each)

2005
number
(Ordinary
shares of
£1.11 each)

In lieu of £21.0 million (2005 £22.8 million) cash under scrip dividend alternative
For consideration of £1.6 million under the Company’s Sharesave Scheme (2005 £0.8 million)
Issued in respect of share options granted

2,087,293
314,962
116,886

–
5,683
–

3,151,305
163,276
344,980

2,519,141

5,683

3,659,561

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

30. CALLED-UP SHARE CAPITAL (continued)

During the year a capital return to shareholders was made by way of the B Share Scheme amounting to £143.5 million, of which
£39.4 million was by way of the initial dividend payment and £104.1 million was through share redemption. The B Shares which received
the initial dividend were subsequently converted into Deferred Shares, redeemed at the close of business on 6 April 2006 for a total
aggregate consideration of one pence and then were cancelled. At 31 March 2006, £39.4 million of the capital return via the B Share
Scheme was outstanding and held in Share Capital and £5.7 million of the B Shares not redeemed until 6 April 2006 were held within
other payables, note 23.

In addition, there was a consolidation of the Ordinary shares of the Company whereby for every 11 existing Ordinary shares of £1.11 each
held on 17 February 2006, shareholders received 10 new Ordinary shares of £1.22 1/10 each. As a result, the number of Ordinary shares in
issue was reduced by 11,860,317.

Employee share schemes

The Group operates a number of share plans for the benefit of employees. Details of each plan are set out below:

Sharesave Scheme

An all-employee savings related plan is operated which enables employees, including executive directors, to invest up to a maximum of
£250 per month for three or five years. These savings can then be used to buy shares at a price set at a 20% discount to the market value
at the start of the savings period at the third, fifth or seventh anniversary of the option being granted. Options expire six months
following the exercise date and, except for certain specific circumstances such as redundancy, lapse if the employee leaves the Group
before the option exercise period commences.

Outstanding options to subscribe for shares of £1.22 1/10 each under the Company’s share option schemes are:

Nature of scheme

Sharesave

Date granted and
subscription price fully paid

7 July 1998
6 July 1999
5 July 2000
4 July 2001
9 July 2002
8 July 2003
6 July 2004
5 July 2005

775p
825p
461p
489p
566p
530p
601p
810p

Period when
options normally
exercisable

2001 – 2005
2002 – 2006
2003 – 2007
2004 – 2008
2005 – 2009
2006 – 2010
2007 – 2011
2008 – 2012

Thousands of shares
in respect of which options
outstanding at 31 March

2006

–
6
67
60
82
417
284
239

2005

8
6
258
63
198
441
308
–

1,155

1,282

At 31 March 2006 there were 1,121 participants in the Sharesave Scheme (2005 1,133).

The number and weighted average exercise price of Sharesave options are:

2006

2005

Number of

Ordinary

(thousands)

1,282
248
(321)
(54)

1,155

Weighted

average exercise

price per

540
810
508
587

603

Number of

Ordinary

(thousands)

1,208
323
(163)
(86)

1,282

Weighted

average exercise

price per

524
601
514
558

540

At 1 April
Granted
Exercised
Expired

At 31 March

The weighted average price at the date of exercise of Sharesave options during the year was 1,034p (2005 827p). The options
outstanding at 31 March 2006 had a weighted average exercise price of 603p (2005 540p) and a weighted average remaining
contractual life of 2.0 years (2005 2.1 years).

30. CALLED-UP SHARE CAPITAL (continued)

Employee share schemes (continued)

Sharesave Scheme (continued)

The aggregate fair value of options granted during the year was £0.6 million (2005 £0.5 million), determined using the Black-Scholes
valuation model. The significant inputs into the valuation model were:

Weighted average share price

Weighted average exercise price

Expected volatility

Expected life

Risk-free rate

Expected dividend yield

2006

2005

779p

623p

23.7%

654p

523p

25.0%

3.9 years

3.8 years

4.5%

4.2%

4.6%

5.5%

Expected volatility was determined by calculating the historical volatility of the Group’s share price over the previous two years.

ii) Long-term incentive plan

Under this plan, Executive Directors and senior management receive a conditional award of shares in the Company. The eventual
number of shares, if any, which vest is dependent upon the achievement of the performance condition of the plan over the restricted
period, being not less than three years.

The number and weighted average price of shares in the restricted share plan are:

Number of

Ordinary

(thousands)

512

141

(75)

(84)

(45)

449

2006

2005

Weighted

average

price per

738

1,070

638

–

861

Number of

Ordinary

(thousands)

390

305

(183)

–

512

Weighted

average

price per

585

810

610

–

738

At 1 April

Granted

Vested

Lapsed

Share consolidation

At 31 March

The awards outstanding at 31 March 2006 had a weighted average price of 861p (2005 738p) and a weighted average remaining
contractual life of 1.7 years (2005 1.8 years). The Company’s share price at the date of the awards ranged from 585p to 1,070p.

The aggregate fair value of awards granted during the year was £0.9 million (2005 £1.6 million), determined using a Monte-Carlo
simulation model. The significant inputs into the valuation model were:

Weighted average share price

Expected volatility

Risk-free rate

2006

2005

861p

23.6%

4.6%

779p

25.0%

4.8%

Expected volatility was determined by calculating the historical volatility of the Group’s share price over the previous two years.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

30. CALLED-UP SHARE CAPITAL (continued)

Employee share schemes (continued)

iii) Performance Related Bonus Plan

Awards under the plan to Executive Directors and senior management involve the release of Ordinary shares in the Company to
participants, usually conditional upon continuous service with the Group for a period of three years from the award.

The number and weighted average price of shares in the performance related bonus plan are:

Number of

Ordinary

(thousands)

178
62
(54)
(3)
(16)

167

2006

2005

Weighted

average

price per

696
984
652
652
–

806

Number of

Ordinary

(thousands)

118
62
–
(2)
–

178

Weighted

average

price per

652
778
–
652
–

696

At 1 April
Granted
Vested
Lapsed
Share consolidation

At 31 March

The awards outstanding at 31 March 2006 had a weighted average price of 806p (2005 696p) and a weighted average remaining
contractual life of 1.5 years (2005 2.2 years). The Company’s share price at the date of the awards ranged from 652p to 984p.

The aggregate fair value of awards granted during the year was £0.6 million (2005 £0.5 million), determined from market value.
No option pricing issues arise as dividends declared on the shares are receivable by the participants in the scheme.

Options granted to Directors, included above, are shown in the Directors’ remuneration report on pages 29 to 35.

31. SHARE PREMIUM ACCOUNT

At 1 April 2004

Adjustment for shares issued under the scrip dividend alternative

Premium on shares issued for cash consideration

At 31 March 2005

Adjustment for shares issued under the scrip dividend alternative

Premium on shares issued

Utilised on creation of 130,463,483 B Shares of £1.10 each

At 31 March 2006

32. CAPITAL REDEMPTION RESERVE

At 1 April 2004

At 31 March 2005

Transferred from retained earnings on redemption of 89,404,091 B Shares of £1.10 each

At 31 March 2006

£m

154.2

(3.5)

3.0

153.7

(2.3)

2.3

(143.5)

10.2

£m

–

98.4

33. RETAINED EARNINGS AND OTHER RESERVES

At 1 April 2004

Profit for the year

Other recognised income and expense for the year

Adjustment for shares issued under the scrip dividend alternative

Dividends paid

Goodwill on previously acquired business

Adjustment in respect of share-based payment

Deferred tax in respect of share-based payment

Own shares issued to the Pennon Employee Share Trust

in respect of share options granted

Adjustment in respect of share options vesting

At 31 March 2005

Adjustments on adoption of IAS32/39 1 April 2005

Profit for the year

Other recognised income and expense for the year

Adjustment for shares issued under the scrip dividend alternative

Dividends paid

Adjustment in respect of share-based payment

Deferred tax in respect of share-based payment

Own shares issued to the Pennon Employee Share Trust

in respect of share options granted

Adjustment in respect of share options vesting

B Share payments

At 31 March 2006

Hedging

reserve

£m

–

(0.9)

–

1.0

–

Own

£m

(4.7)

–

(2.8)

1.6

(5.9)

–

(1.2)

1.1

–

Retained

earnings

£m

380.5

65.6

1.3

22.8

(51.1)

(0.2)

1.5

0.3

–

(1.6)

Total

£m

375.8

65.6

1.3

22.8

(51.1)

(0.2)

1.5

0.3

(2.8)

–

419.1

413.2

9.5

37.8

(2.0)

21.0

(55.1)

1.7

1.2

–

(1.1)

(137.8)

8.6

37.8

(1.0)

21.0

(55.1)

1.7

1.2

(1.2)

–

(137.8)

0.1

(6.0)

294.3

288.4

The own shares reserve represents the cost of shares in Pennon Group Plc issued to or purchased in the market and held by the
Pennon Employee Share Trust to satisfy awards under the Group’s Long Term Incentive Plan and Performance Related Bonus Plan.

During the year, 117,000 of the Company’s Ordinary shares of £1.11 each were issued to the trustees of the Employee Share Ownership
Plan, financed through non-interest bearing advances made by sponsoring group companies (2005 345,000).

The market value of the 616,000 Ordinary shares of £1.22 1/10 each (2005 690,000 Ordinary shares of £1.11 each) held by the trust at
31 March 2006 was £8.3 million (2005 £6.7 million).

The B Share payments of £137.8 million comprise £98.4 million for shares redeemed and £39.4 million for amounts paid as dividend.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

34. CASH FLOW FROM OPERATING ACTIVITIES

Reconciliation of operating profit to cash generated from operations:

Cash generated from operations

Continuing operations

Profit for the year

Adjustments for:

Employee share schemes

Deferred income released to profits

Profit on disposal of property, plant and equipment

Depreciation charge

Amortisation of intangible assets
Share of post-tax profit from joint venture

Interest payable and similar charges

Interest receivable

Taxation

Changes in working capital (excluding the effect of
acquisition of subsidiaries)
Increase in inventories

Decrease/(increase) in trade and other receivables

Decrease in long-term deposits

Increase in trade and other payables

(Decrease)/increase in retirement benefit obligations

Decrease in provisions for liabilities and charges

2006
£m

2005
£m

37.8

60.6

1.7

(0.3)

(1.1)

102.5

1.6

(0.1)

147.0

(40.4)

16.3

(0.3)

2.0

–

8.4

(39.7)

(3.3)

1.5

(0.2)

(1.4)

90.7

1.4
(0.1)

89.3

(27.3)

23.5

(0.2)

(0.9)

(3.5)

8.5

2.9

(2.4)

Cash generated from operations

232.1

242.4

35. NET BORROWINGS

Cash and cash equivalents

Borrowings – current
Bank overdrafts

Other current borrowings

Finance lease obligations

Total current borrowings

Borrowings – non current
Bank loans

Other non-current borrowings

Finance lease obligations

Total non-current borrowings

Total net borrowings

2006
£m

2005
£m

99.4

303.4

(18.5)

(8.2)

(28.0)

(5.1)

(20.4)

(29.3)

(54.7)

(54.8)

(312.7)

(232.2)

(926.9)

(255.3)

(316.4)

(795.1)

(1,471.8)

(1,366.8)

(1,427.1)

(1,118.2)

36. ACQUISITIONS

On 21 June 2005 the entire issued share of Brett Waste Management Limited (now renamed Viridor Waste Kent Limited) was purchased
by Viridor Waste Management Limited for a cash consideration of £44.7 million, including costs of £0.3 million. The acquisition has
been accounted for using the acquisition method.

Viridor Waste Kent Limited contributed revenues of £21.3 million and net profit of £3.4 million for the period from 21 June 2005 to
31 March 2006. If the acquisition had occurred on 1 April 2005, Group revenues for the year would have been £28.2 million and profit
for the year would have been £4.4 million. These amounts have been calculated after applying the Group’s accounting policies and
adjusting the results to reflect the fair value adjustments as if they had applied from 1 April 2005.

All intangible assets have been recognised at their respective fair values. The residual excess over the net assets acquired has
been recognised as goodwill. The goodwill is attributed to the profitability of the acquired business and the anticipated future
operating synergies arising from the combination.

Intangible fixed assets
Property, plant and equipment
Investment in joint venture
Inventories
Receivables
Payables
Provisions – environmental
Taxation – current
Taxation – deferred
Loans

Net assets acquired

Goodwill

Total consideration

Satisfied by:
Cash
Directly attributable costs

Book

value

£m

–
26.9
0.2
0.3
5.4
(7.0)
(8.1)
–
0.5
(2.7)

15.5

Fair value

adjustment

£m

1.3
(0.3)
–
(0.3)
(0.2)
–
(1.2)
(2.0)
(2.3)
–

(5.0)

Fair

value

£m

1.3
26.6
0.2
–
5.2
(7.0)
(9.3)
(2.0)
(1.8)
(2.7)

10.5

34.2

44.7

44.4
0.3

44.7

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

36. ACQUISITIONS (continued)

Net cash outflow arising on acquisition

Cash consideration

£m

44.7

The intangible assets acquired as part of the acquisition relate to customer contracts.

On 30 September 2005, Viridor Waste Management Limited acquired 50% of the entire issued share capital of Lakeside Energy from
Waste Limited for a cash consideration of £1.1 million. The joint venture has been accounted for using the equity method.

On 21 December 2005, Viridor Waste Management Limited acquired 50% of the entire issued share capital of Lakeside Energy from
Waste Holdings Limited in return for its 50% interest in Lakeside Energy from Waste Limited. Neither company has traded in the year.

Lakeside Energy from Waste Limited is constructing an energy from waste plant which is expected to be operational in 2008.

On 13 May 2006, the entire share capital of Wyvern Waste Services Limited (now renamed Viridor Waste (Somerset) Limited) was
purchased by Viridor Waste Management Limited for a cash consideration of £25.0 million before costs. The acquisition will be
accounted for using the acquisition method. Provisional goodwill of £9.9 million and intangible assets of £7.5 million will be
capitalised. The intangible fixed assets will be amortised evenly over the Directors’ estimate of their useful economic life.
Cash balances on acquisition amounted to £3.0 million. This acquisition will be accounted for in the 2006/07 financial year.

37. PRINCIPAL SUBSIDIARY AND JOINT VENTURE UNDERTAKINGS AT 31 MARCH 2006

Country of incorporation, registration and principal operations

Water and sewerage
South West Water Limited*

Peninsula Leasing Limited
Peninsula Properties (Exeter) Limited

Waste management
Viridor Limited*

Viridor Waste Limited

Viridor Waste Disposal Limited
Viridor Waste Exeter Limited

Dragon Waste Limited

Viridor Waste Management Limited
Viridor EnviroScot Limited
Viridor Glass Recycling Limited
Viridor Parkwood Holdings Limited
Parkwood Group Limited

Viridor Waste Kent Limited
Viridor Waste (Landfill Restoration) Limited
Viridor Waste (Bristol Holdings) Limited
Viridor Waste (Bristol) Limited

Viridor Waste Suffolk Limited

Viridor Waste (Thames) Limited
Viridor Waste (West Sussex) Limited

Other
Peninsula Insurance Limited*
Peninsula Water Limited*

* Indicates the shares are held directly by Pennon Group Plc, the Company.

† Operations are carried out in England.

England
England
England

England
England
England
England
England
England
Scotland
England
British Virgin Islands †
England
England
England
England
Scotland
England
England
England

Guernsey
England

37. PRINCIPAL SUBSIDIARY AND JOINT VENTURE UNDERTAKINGS (continued)

During the year Viridor Limited was acquired as a dormant company with an issued share capital of £2. In consideration for the
Company’s investment in Viridor Waste Limited of £195.2 million, a further share was allotted to the Company.

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, a wholly-owned subsidiary of Viridor Waste Limited. All companies above
are consolidated in the Group financial statements.

Joint ventures
Both joint ventures and the subsidiary of Lakeside Energy from Waste Holdings Limited are incorporated and registered in England
which is also their country of operation.

Share capital in issue

Percentage held

Activity

Echo South West Limited

100,000 A Ordinary shares
100,000 B Ordinary shares

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

Lakeside Energy from Waste Holdings Limited

1,000,000 A Ordinary shares
1,000,000 B Ordinary shares

Lakeside Energy from Waste Limited

100%
–

–
100%

Customer contact management

Waste management

Shares in Lakeside Energy from Waste Holdings Limited are held by Viridor Waste Management Limited.

38. OPERATING LEASE COMMITMENTS – MINIMUM LEASE PAYMENTS

Commitments under non-cancellable operating leases expiring:

Within one year

Later than one year and less than five years

After five years

2006
£m

2005
£m

0.5

1.5

2.4

4.4

0.4

1.0

2.2

3.6

The group leases various offices, warehouses under non-cancellable operating lease agreements. The leases have various terms,
escalation clauses and renewal rights. The Group also leases plant and machinery under non-cancellable operating lease agreements.

39. CONTINGENT LIABILITIES

Guarantees:

Performance bonds

Letters of credit

Other

2006
£m

80.8

7.6

6.9

95.3

2005
£m

60.2

–

6.9

67.1

Guarantees in respect of performance bonds are entered into in the normal course of business. No liability is expected to arise in respect
of the guarantees.

The guarantee in respect of letters of credit has been given by Viridor Waste Limited in support of the borrowings of the joint venture of
Viridor Waste Management Limited, Lakeside Energy from Waste Holdings Limited. In addition, Viridor Waste Management Limited has
given a commitment to supply 200,000 tonnes of waste per annum (or pay market-price based compensation) to the energy from waste
plant of the joint venture. The plant is expected to be commissioned by July 2008. The Directors consider that the committed waste
volume will be available in the ordinary course of business.

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.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

40. CAPITAL COMMITMENTS

Contracted but not provided

Share of commitment contracted but not provided by joint venture

41. RELATED PARTY TRANSACTIONS

During the year, group companies entered into the following transactions with joint ventures:

Sales of goods and services
Echo South West Limited

Purchase of goods and services
Echo South West Limited

Year end balances

Receivables due from related parties (notes 17 and 20)
Echo South West Limited

Lakeside Energy from Waste Limited

Payables due to related parties (note 23)
Echo South West Limited

2006
£m

66.6

64.2

130.8

2005
£m

46.1

–

46.1

2006
£m

2005
£m

2.5

9.0

8.0

2006
£m

1.2

2.7

3.9

2005
£m

1.3

–

1.3

0.4

All amounts relate to trading balances except for £2.8 million of loans included within receivables due for repayment in instalments
between 2009 and 2030. Interest is charged at 6% until 2008 then 15% thereafter.

42. EXPLANATION OF TRANSITION TO IFRS

Pennon Group Plc reported under UK GAAP in its previously published financial statements for the year ended 31 March 2005.
The analysis opposite shows a reconciliation of net assets and profit as reported under UK GAAP as at 31 March 2005 to the revised net
assets and profit under IFRS as reported in these financial statements. In addition, there is a reconciliation of net assets under UK
GAAP to IFRS at the transition date, which for the Group was 1 April 2004.

42. EXPLANATION OF TRANSITION TO IFRS (continued)

Consolidated balance sheet

Reconciliation at 31 March 2005

Reported

under UK

GAAP

£m

63.0
0.2

2,248.1

3.3

2,314.6

4.7

99.6
303.4

407.7

(54.8)
(192.5)
(23.6)

(8.4)

(279.3)

128.4

(1,366.8)

(37.8)

–
(72.4)

(27.9)

(1,504.9)

938.1

142.0
153.7

642.4

Assets
Non-current assets
Goodwill
Intangible assets
Property, plant and
equipment
Trade and other
receivables

Current assets
Inventories
Trade and other
receivables

Cash and cash equivalents

Liabilities
Current liabilities
Financial liabilities
Borrowings

Trade and other payables
Current tax liabilities
Provisions for liabilities
and charges

Net current assets

Non-current liabilities
Financial liabilities
Borrowings
Other non-current
liabilities
Retirement benefit
obligations
Deferred tax liabilities
Provisions for liabilities
and charges

Net assets

Shareholders’ equity
Share capital
Share premium account
Retained earnings

and other reserves

Total shareholders’ equity

938.1

IFRS 3

Goodwill

£m

IAS 10

Dividend

£m

Impact of IFRS

IAS 16

IAS 12

Infrastructure

Tax

£m

renewals

£m

IAS 19

Pensions

£m

Other

£m

IFRS

£m

1.0
5.8

0.4

64.4
6.0

(5.6)

(24.0)

2,218.5

3.3

6.8

–

(5.6)

–

(23.6)

2,292.2

4.7

99.6
303.4

407.7

(54.8)
(127.8)
(23.6)

(8.4)

(214.6)

193.1

–

(4.7)

2.1

55.1

4.0

5.6

–

4.0

5.6

(1,366.8)

18.7

(19.1)

0.6

(79.8)
(282.8)

(27.9)

19.3

(1,776.4)

1.3

708.9

(79.8)
23.9

(55.9)

(51.9)

142.0
153.7

413.2

708.9

(51.9)

1.3

–

(5.6)

(230.2)

–

(230.2)

55.1

(230.2)

55.1

(230.2)

55.1

(230.2)

The UK GAAP balances have been restated in IFRS format.

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

42. EXPLANATION OF TRANSITION TO IFRS (continued)

ii) Consolidated income statement

Reconciliation for the year ended 31 March 2005

Continuing operations
Revenue

Operating costs
Manpower costs
Raw materials and

consumables used
Other operating expenses
Depreciation
Amortisation of intangibles
Abortive acquisition costs
Business restructuring costs

Operating profit

Operating profit before

depreciation amortisation
exceptional items

Operating profit before
exceptional items
Abortive acquisition costs
Business restructuring costs

Operating profit

Interest payable and
similar charges

Interest receivable

Share of post-tax profit from

joint venture

Profit before tax

Tax on profit on ordinary

activities

Profit for the year from

continuing operations

Discontinued operations
Post-tax business disposal

profit

Profit for the year

Profit attributable to equity

shareholders

Impact of IFRS

IAS 16

IFRS 3

Goodwill

£m

IAS 12

Infrastructure

Tax

£m

renewals

£m

IAS 19

Pensions

£m

Other

£m

IFRS

£m

2.1

–

2.1

–

(2.8)

551.4

4.7

0.1

(68.3)

(7.3)
3.3

1.7
1.1

(32.8)
(207.3)
(90.7)
(1.4)
(1.5)
(3.4)

(4.0)

4.7

0.1

146.0

(7.3)

4.7

(1.0)

243.0

(4.0)

4.7

0.1

150.9
(1.5)
(3.4)

(4.0)

4.7

0.1

146.0

(15.3)

14.0

(89.3)

27.3

0.1

2.1

–

(4.0)

3.4

0.1

84.1

Reported

under UK

GAAP

£m

554.2

(73.1)

(32.8)
(201.7)
(95.1)
(3.5)
(1.5)
(3.4)

143.1

246.6

148.0
(1.5)
(3.4)

143.1

(74.0)

13.3

0.1

82.5

(18.7)

63.8

2.1

(6.2)

(4.0)

(6.2)

1.2

4.6

0.2

(23.5)

0.3

60.6

5.0

68.8

2.1

(6.2)

(4.0)

4.6

0.3

5.0

65.6

68.8

2.1

(6.2)

(4.0)

4.6

0.3

65.6

The UK GAAP balances have been restated in IFRS format.

42. EXPLANATION OF TRANSITION TO IFRS (continued)

iii) Consolidated balance sheet

Reconciliation at 1 April 2004

Non-current assets
Goodwill
Property, plant and
equipment
Trade and other
receivables

Current assets
Inventories
Trade and other
receivables
Financial assets

Available for sale
investments

Cash and cash equivalents

Liabilities
Current liabilities
Financial liabilities
Borrowings

Trade and other payables
Current tax liabilities
Provisions for liabilities
and charges

Net current assets

Non-current liabilities
Financial liabilities
Borrowings

Other non-current liabilities
Retirement benefit obligations
Deferred tax liabilities
Provisions for liabilities
and charges

Impact of IFRS

IAS 16

IAS 10

Dividend

£m

IAS 12

Infrastructure

Tax

£m

renewals

£m

IAS 19

Pensions

£m

Other

£m

IFRS

£m

47.6

(1.6)

(18.9)

2,120.6

2,195.7

–

(1.6)

3.1

(18.9)

2,171.3

(3.9)

(0.7)

–

(0.7)

–

51.1

1.0

1.5

–

1.0

0.3

(224.0)

(77.5)
23.3

1.5

17.9

0.1

4.5

91.6

4.2
264.1

364.4

(107.0)
(117.3)
(15.7)

(9.0)

(249.0)

115.4

(1,234.8)
(20.9)
(77.5)
(263.9)

(21.7)

Reported

under UK

GAAP

£m

47.6

2,141.1

7.0

4.5

92.3

4.2
264.1

365.1

(107.0)
(170.9)
(15.7)

(9.0)

(302.6)

62.5

(1,234.8)
(38.8)
–
(63.3)

(21.7)

Net assets

899.6

51.1

(224.0)

(1,358.6)

–

(224.0)

–

(1.6)

(54.2)

18.0

(1,618.8)

(57.8)

0.6

667.9

Shareholders’ equity
Share capital
Share premium account
Retained earnings

and other reserves

Total shareholders’ equity

137.9
154.2

607.5

899.6

The UK GAAP balances have been restated in IFRS format.

51.1

(224.0)

51.1

(224.0)

(1.6)

(57.8)

0.6

137.9
154.2

375.8

667.9

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

42. EXPLANATION OF TRANSITION TO IFRS (continued)

iv) Notes to the reconciliation of net assets and profit

First time adoption

IFRS 1 “First-time Adoption of International Financial Reporting Standards” requires that IFRS be applied retrospectively unless a
specific exemption is applied. In preparing these financial statements, the Group has adopted the following exemptions:

• not to apply IFRS 3 “Business Combinations” retrospectively to past business combinations;

• to establish a deemed cost for the opening balance sheet carrying value of the water and waste water infrastructure fixed assets
by reference to the fair value of these assets at the date of transition to IFRS, 1 April 2004. All non-infrastructure assets have
been carried forward on transition using the depreciated historical cost UK GAAP balances as the deemed IFRS costs;

• to recognise all cumulative actuarial gains and losses relating to defined benefit pension schemes at the date of transition;

• not to apply the requirements of IFRS 2 “Share-Based Payment” to options granted under the Group’s share incentive schemes

prior to 7 November 2002.

Property, plant and equipment

UK GAAP (FRS 15) permitted the use of “renewals accounting” as a method for estimating depreciation on infrastructure assets and
was adopted by the UK water industry. The depreciation charge represented 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 used 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.

Infrastructure assets in the opening balance sheet under IFRS have consequently been restated from their existing UK GAAP net book
value. In accordance with the first time adoption rules set out in IFRS 1, fair value has been used as deemed cost of the infrastructure
assets on restatement. This value is depreciated over the estimated remaining asset life.

Shareholders’ equity at 31 March 2004 has not been significantly affected since the opening fair value of infrastructure assets under
IFRS in South West Water Limited was close to the net book value under UK GAAP.

Reported operating profit for the year ended 31 March 2005 has been reduced by £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.

However, the revised total infrastructure depreciation cost of £19 million for 2004/05 is £2 million lower than the level of infrastructure
renewals charge assumed by Ofwat in the Final Determination for 2005/06.

The Group has also reclassified all grants and contributions received for non-infrastructure assets to property, plant and equipment,
totalling £19 million.

42. EXPLANATION OF TRANSITION TO IFRS (continued)

iv) Notes to the reconciliation of net assets and profit (continued)

Retirement benefits

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

Under IFRS (IAS 19) only the on-going service cost is charged against operating profit. A net financing cost or credit to reflect expected
interest on liabilities and asset investment return is included within interest payable or receivable. An annual update of the valuation of
scheme assets and liabilities will take place, and any movements in the total actuarial gains or losses are to be recognised in the IFRS
Statement Of Recognised Income and Expenditure (SORIE).

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

The recognition of the pension deficit (net of deferred tax) and other pension adjustments under IFRS, reduced shareholders’ equity by
£58 million at 1 April 2004 and £52 million at 31 March 2005. Reported profit before tax increased by £3 million, principally due to the
pension charge no longer containing an element of deficit recovery.

Acquisition accounting, goodwill and intangibles

Under UK GAAP, goodwill arising on acquisitions was amortised over its useful life, assessed by the Directors as being 20 years. No
separately identifiable intangible assets were 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 their recoverable amounts, being the higher of value-in-use (discounted cash flows arising
from future use of those assets for identifiable cash generating units) and fair value less costs of sale.

Shareholders’ equity at 1 April 2004 was not affected since the Group is bringing forward historic balances (as allowed under the IFRS 1
exemption referred to above).

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

N O T E S T O T H E F I N A N C I A L S T A T E M E N T S

42. EXPLANATION OF TRANSITION TO IFRS (continued)

iv) Notes to the reconciliation of net assets and profit (continued)

Deferred taxation

Under UK GAAP the Group created 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 a discounting methodology is not permitted and consequently the deferred tax provision increases, with a commensurate
reduction to shareholders’ equity, as indicated below:

Discounted provision – UK GAAP

Undiscounted provision – IFRS

Increase in provision

31 March

2005

£m

283

211

2004

£m

264

201

Other significant deferred tax effects arise from the recognition under IFRS of deferred tax on property revalued at the time of
acquisitions by Viridor Waste, £13 million, and the recognition of the pension deficit in the balance sheet, as outlined above in the
retirement benefits note.

The amount of deferred tax charged against 2004/05 profits increased from £11 million under UK GAAP to £16 million under IFRS,
primarily through the impact of not discounting liabilities.

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.

Dividends payable

Under UK GAAP dividends payable were recognised in the profit and loss account for the period to which they related.

Under IFRS (IAS 10) dividends are only recognised when there is a legal or constructive obligation for them to be paid. Dividends on
equity instruments are therefore recognised under IFRS as follows:

– Final dividends – when authorised by shareholders at the Annual General Meeting.

– Interim dividends – when paid, as they are revocable and discretionary until that time.

Shareholders’ equity is consequently increased at the balance sheet date by £51 million at 1 April 2004, and by £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.

Other differences

All other differences between IFRS and UK GAAP are included within the “Other” column, with the principal adjustment to profit
before taxation being the impact of fair valuing shares awarded under employee share options granted under the Group’s share schemes
after 7 November 2002. The fair value cost of shares awarded is charged to the income statement over the vesting period, in accordance
with IFRS 2.

42. EXPLANATION OF TRANSITION TO IFRS (continued)

iv) Notes to the reconciliation of net assets and profit (continued)

Financial instruments

IFRS 1 permits the Group to continue to apply UK GAAP in respect of financial instruments for the year ended 31 March 2005 and to
apply IAS 32 and 39 with effect from 1 April 2005. The comparative information for 2004/05 within the 31 March 2006 IFRS financial
statements therefore reflects financial instruments accounted for according to existing UK GAAP accounting policies.

The Group uses derivative financial instruments, principally interest rate swaps, to manage the mix of fixed and floating rate debt.
Relatively low interest rates resulted in the Group fixing 70% of existing net debt at March 2005.

Under UK GAAP, debt is initially recorded as the net proceeds of issue. In subsequent periods, this is adjusted for accrued finance costs
and payments made. The fair values of derivatives are not recognised in the balance sheet, but are disclosed in the notes to the
financial statements.

Under IAS 39, debt is carried at amortised cost, whilst derivatives are recognised separately on the balance sheet at fair value with
movements in those fair values reflected through the income statement. In the case of cash flow hedges, movements in the fair value of
derivatives are deferred within reserves until they can be recycled through the income statement to offset the future income statement
effect of changes in the hedged risk.

In order to apply this treatment, it must be demonstrated that the derivative has been, and will continue to be, an effective hedge of
the hedged risk in the underlying debt within the criteria set out in IAS 39. Any hedge ineffectiveness outside the range deemed
acceptable by IAS 39 is recognised immediately within the income statement. At 1 April 2005, the Group held interest rate swaps as
hedges against its exposure to interest rate fluctuations for periods up to 2010. The swap portfolio is designed to hedge the debt
portfolio and provide an overall effective economic hedge. The swaps are individually designated to particular liabilities and therefore
meet the criteria for hedge accounting under IAS 39.

As a result of applying IAS 39 at 1 April 2005 net assets have been reduced by £1 million for the Group’s debt interest rate swaps,
by £1 million reflecting the amortised proceeds of trade receivables and increased by £10 million (net of tax), following release of
deferred income which does not qualify as a hedge under IFRS.

v) Cash flow statement

The move from UK GAAP to IFRS does not change any of the cash flows of the Group. The IFRS cash flow format is similar to UK GAAP but
presents some cash flows in different categories and in a different order from the UK GAAP cash flow statement. All of the IFRS
adjustments net out but differences in disclosure arise from the change in treatment of infrastructure assets (see above) and the
inclusion of liquid investments with a maturity of less than three months as cash and cash equivalents under IFRS.

F I V E Y E A R F I N A N C I A L S U M M A R Y

INCOME STATEMENT

Revenue

Operating profit

Net interest payable

Share of operating profit/(loss) in joint ventures

Business disposal profit

Profit before tax

Taxation

Profit for the year

Dividends proposed

Earnings per share (basic):

From continuing and discontinued operations
Before exceptional items and deferred tax

Exceptional items

Deferred tax

After exceptional items and deferred tax

Proposed dividend per share

CAPITAL EXPENDITURE

Acquisitions

Property, plant and equipment

BALANCE SHEET

Non-current assets

Net current (liabilities)/assets

Non-current liabilities

IFRS

2006

£m

645.7

160.6

(106.6)

0.1

–

54.1

(16.3)

37.8

61.0

75.5p

(29.9)p

(15.9)p

29.7p

51.6p

IFRS

2005

£m

551.4

146.0

(62.0)

0.1

5.0

89.1

(23.5)

65.6

55.1

64.3p

(3.9)p

(12.3)p

48.1p

43.0p

UK GAAP

2004

£m

UK GAAP

2003

£m

UK GAAP

2002

£m

471.3

129.8

(57.2)

(0.3)

–

72.3

(10.8)

61.5

51.1

57.7p

(5.3)p

(2.6)p

49.8p

41.0p

417.2

127.0

(52.1)

(0.7)

–

74.2

(17.1)

57.1

144.3

55.0p

–

(10.7)p

44.3p

109.1p

41.8

204.6

423.9

121.8

(49.0)

(0.5)

5.1

77.4

(3.3)

74.1

51.4

53.0p

3.7p

(2.4)p

54.3p

37.5p

12.1

186.4

45.8

249.7

30.8

181.0

19.8

170.0

2,527.5

(61.2)

2,292.2

193.1

2,191.3

75.9

2,084.6

17.5

1,920.5

100.8

(1,885.1)

(1,776.4)

(1,367.6)

(1,213.3)

(1,047.3)

Net assets

581.2

708.9

899.6

888.8

974.0

NUMBER OF EMPLOYEES

(average for year)

Water and sewerage business

Waste management

Instrumentation

Other businesses

1,299

1,388

–

2,722

1,336

1,169

–

2,544

1,341

895

–

2,275

1,343

685

–

2,063

1,485

605

421

2,562

Information prior to 31 March 2004 was reported under UK GAAP which may differ materially from IFRS. The main differences relate to
the treatment of infrastructure assets, retirement benefits, goodwill and intangibles, deferred tax, dividends payable and financial
instruments. An explanation of the impact of these changes is given in note 42.

S E P A R A T E F I N A N C I A L S T A T E M E N T S
F O R P E N N O N G R O U P P L C

INDEPENDENT AUDITORS’ REPORT TO THE SHAREHOLDERS OF PENNON GROUP PLC
We have audited the parent company financial statements of Pennon Group Plc for the year ended 31 March 2006 which comprise the
balance sheet and the related notes. These parent company financial statements have been prepared under the accounting policies set
out therein. We have also audited the information in the Directors’ remuneration report that is described as having been audited.

We have reported separately on the Group financial statements of Pennon Group Plc for the year ended 31 March 2006.

RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS
The Directors’ responsibilities for preparing the Annual Report, the Directors’ remuneration report and the parent company financial
statements in accordance with applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted
Accounting Practice) are set out in the Directors’ responsibilities statement.

Our responsibility is to audit the parent company financial statements and the part of the Directors’ remuneration report to be audited
in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland). 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 parent company financial statements give a true and fair view and whether the parent
company financial statements and the part of the Directors’ remuneration report to be audited have been properly prepared in
accordance with the Companies Act 1985. We report to you whether in our opinion the information given in the Directors’ report is
consistent with the parent company financial statements. We also report to you if, in our opinion, 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 other transactions is not disclosed.

We read the other information contained in the Annual Report and consider whether it is consistent with the audited parent company
financial statements. The other information comprises only the Chairman’s statement, the Chief Executives’ overviews, the unaudited
part of the Directors’ remuneration report, the statements of compliance on corporate governance and internal control and the
Directors’ report. We consider the implications for our report if we become aware of any apparent misstatements or material
inconsistencies with the parent company financial statements. Our responsibilities do not extend to any other information.

BASIS OF AUDIT OPINION
We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices
Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the parent company
financial statements and the part of the Directors’ remuneration report to be audited. It also includes an assessment of the significant
estimates and judgements made by the Directors in the preparation of the parent company 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 parent company financial statements and the part of the
Directors’ remuneration report to be audited 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 parent company financial
statements and the part of the Directors’ remuneration report to be audited.

OPINION
In our opinion, the parent company financial statements give a true and fair view, in accordance with United Kingdom Generally
Accepted Accounting Practice, of the Company’s affairs at 31 March 2006, the parent company financial statements and the part of the
Directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985 and the
information given in the Directors’ report is consistent with the parent company financial statements.

PRICEWATERHOUSECOOPERS LLP
Chartered Accountants and Registered Auditors
Bristol
22 June 2006

Notes

2006

£m

2005
Restated
(note Q)
£m

D
E

F
G
H
I

0.1
943.8

0.2
931.8

943.9

932.0

0.6
129.2
45.2
40.0
20.8

235.8

–
239.7
32.7
57.5
–

329.9

(308.3)

(303.0)

N
O
P
Q

(72.5)

26.9

871.4
(166.1)

958.9
(293.6)

705.3
(2.3)

665.3
(4.5)

703.0

660.8

184.2
10.2
98.4
410.2

142.0
153.7
–
365.1

703.0

660.8

C O M P A N Y B A L A N C E S H E E T – U K G A A P
at 31 March 2006

Fixed assets
Tangible assets
Investment in subsidiary companies

Current assets
Financial assets

Derivative financial instruments

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

Net current (liabilities)/assets

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

Net assets excluding pension deficit
Pension deficit

Net assets including pension deficit

Capital and reserves
Called-up share capital
Share premium account
Capital redemption reserve
Profit and loss account and other reserves

Shareholders’ funds

The notes on pages 95 to 106 form part of these financial statements.

Approved by the Board on 22 June 2006 and signed on its behalf by:

K G HARVEY, Chairman

N O T E S T O T H E C O M P A N Y
F I N A N C I A L S T A T E M E N T S – U K G A A P

A 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 UK accounting
standards, the requirements of the Financial Services Authority and with the Companies Act 1985. The principal accounting policies
adopted in the preparation of these financial statements are set out below.

(b) Changes in accounting policies

The Company has adopted FRS 17 “Retirement Benefits”, FRS 20 “Share-based Payment”, FRS 21 “Events After the Balance Sheet Date”,
FRS 25 “Financial Instruments: Disclosure and Presentation”, FRS 26 “Financial Instruments: Measurement” and FRS 28 “Corresponding
Amounts” in these financial statements. The adoption of each of these standards represents a change in accounting policy and the
comparative figures have been restated accordingly except where the exemption to restate comparatives has been taken. Details of the
effect of the prior year adjustments are given in note Q.

Vehicles, mobile plant and computers are depreciated evenly over their estimated economic lives on a straight-line basis, which are
principally 3–10 years.

(d) 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.

(e) Investments

Investments in subsidiaries are initially recorded at cost, being the fair value of the consideration paid, including associated acquisition
costs. Subsequently, investments are reviewed for impairment on an individual basis, if events or changes in circumstances indicate
that the carrying value may not be fully recoverable.

(f) Share-based payment

Share-based compensation
The Company operates a number of equity settled, share-based compensation plans for employees. The fair value of the employee
services required in exchange for the grant is recognised as an expense over the vesting period of the grant.

Fair values are calculated using an appropriate pricing model. Non-market based vesting conditions are adjusted for in assumptions as
to the number of awards which are expected to vest.

Employee share ownership plan
The Company balance sheet incorporates the shares held by the Pennon Employee Share Trust to meet the awards of share-based
compensation and which have not vested by the balance sheet date. The consideration paid for the shares is shown as a deduction from
shareholders’ funds until such time as they vest.

The application of FRS 20 “Share-based Payment”, has resulted in a change in the method of accounting for share-based payments.
The effect of this change in accounting policy is disclosed in note Q.

N O T E S T O T H E C O M P A N Y F I N A N C I A L S T A T E M E N T S – U K G A A P

(g) Pension obligations

The company operates a defined benefit pension scheme for its employees.

Defined benefit pension scheme assets are measured at their fair value at the balance sheet date. Defined benefit pension scheme
liabilities are measured by an independent actuary using the projected unit method and discounted at the current rate of return on high
quality corporate bonds of equivalent term to the liability. The increase in the present value of the liabilities of the Company’s defined
benefit pension scheme expected to arise from employee service in the period is charged to operating profit. The expected return on
scheme assets and the increase during the period in the present value of scheme liabilities, arising from the passage of time, are
included in other finance income or cost. Past service costs are recognised immediately in the profit and loss account.

Actuarial gains and losses arising from experience adjustments, changes in actuarial assumptions and amendments to pension plans
are charged or credited to equity and recorded in the statement of total recognised gains and losses.

The application of FRS 17 “Retirement Benefits”, has resulted in a change in the method of accounting for pension obligations.
The effect of this change in accounting policy is disclosed in note Q.

(h) 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.

(i) Dividend distributions

Dividend distributions are recognised as a liability in the Group’s financial statements in the period in which the dividends are
approved by the Company’s shareholders. Interim dividends are recognised when paid; final dividends when authorised in general
meeting by shareholders.

The application of FRS 21 “Events After the Balance Sheet Date”, has resulted in a change in the method of accounting for dividend
distributions. The effect of this change in accounting policy is disclosed in note Q.

(j) Derivative financial instruments

The Company uses derivative financial instruments, principally interest rate swaps, to hedge its risk associated with interest
rate fluctuations. Such derivative instruments are initially recorded at cost and subsequently re-measured at fair value for the reported
balance sheet.

The gain or loss on re-measurement is taken to profits, except for cash flow hedges which meet the conditions for hedge accounting,
when the portion of the gain or loss on the hedging instruments, which is determined to be an effective hedge, is recognised directly in
equity, and the ineffective portion in the profit and loss account. The gains or losses deferred in equity in this way are subsequently
recognised in the profit and loss account in the same period in which the hedged underlying transaction or firm commitment is
recognised in the profit and loss account.

In order to qualify for hedge accounting, the Company is required to document in advance the relationship between the item being
hedged and the hedging instrument. The Company is also required to document and demonstrate an assessment of the relationship
between the hedged item and the hedging instrument, which shows that the hedge will be highly effective on an on-going basis. This
effectiveness testing is re-performed at the end of each reporting period to ensure that the hedge remains highly effective.

The Company has taken advantage of the exemption allowed in applying FRS 25 “Financial Instruments: Disclosure and Presentation”,
and FRS 26 “Financial Instruments: Measurement”, and has applied these standards from 1 April 2005. Accordingly, the 2005
comparative information has not been restated. However, if FRS 25 and FRS 26 had been adopted there would have been no fair value
gains or losses to be recognised at 31 March 2005.

B PROFIT FOR THE YEAR

As permitted by section 230 of the Companies Act 1985, no profit and loss account, statement of total recognised gains and losses and
cash flow are presented for the Company.

Profit on ordinary activities after taxation

Fees payable to the Company’s auditors in the year were as follows:

Audit services

–

Statutory audit

Other assurance services

Tax services

–

Compliance services

Advisory services

2006

£m

2005
Restated
(note Q)
£m

215.6

86.0

2006
£000

2005
£000

273

447

217

105

392

Other assurance services and tax advisory services in 2006 include costs relating to the transition to IFRS and the financial restructuring
in the Company. 2005 includes costs relating to the abortive acquisition of the UK landfill operations of Shanks Group Plc.

The Company has taken advantage of the exemption in SSAP25 ‘Segmental Reporting’, and no geographical or segmental analysis of
results is provided, as this analysis is contained in note 5 to the consolidated financial statements.

C DIRECTORS AND EMPLOYEES

The average number of persons (including Directors) employed by the Company was 35 (2005 37).

Employment costs comprise:

Wages and salaries

Social security costs

Pension costs

Share-based payments

2006
£m

2005
£m

2,199

2,299

322

661

358

317

748

389

3,540

3,753

For details of the Company’s share-based payment schemes, refer to note 30 of the Group financial statements.

The remuneration of the Company’s Directors is disclosed on pages 29 to 35.

N O T E S T O T H E C O M P A N Y F I N A N C I A L S T A T E M E N T S – U K G A A P

D TANGIBLE FIXED ASSETS

Fixed and mobile plant, vehicles and computers.

Cost:
At 1 April 2005
Disposals

At 31 March 2006

Depreciation:
At 1 April 2005
Charge for year
Disposals

At 31 March 2006

Net book value:
At 31 March 2005

At 31 March 2006

INVESTMENTS IN SUBSIDIARY COMPANIES

At 1 April 2005

Additions

Disposals

At 31 March 2006

£m

0.3
(0.1)

0.2

0.1
0.1
(0.1)

0.1

0.2

0.1

£m

931.8

207.2

(195.2)

943.8

Details of the Company’s principal subsidiaries are set out in note 37 of the Group accounts.

F DERIVATIVE FINANCIAL INSTRUMENTS

Interest rate swaps – cash flow hedges:

Assets

2006
£m

2005
£m

0.6

–

Interest rate swaps and fixed rate borrowings are used to manage the mix of fixed and floating rates to ensure at least 50% of Group net
borrowings is at fixed rate. At 31 March 2006, 68% of Group net borrowings was at fixed rate (2005 69%).

At 31 March 2006, interest rate swaps to hedge financial liabilities of the Company with a notional principal value of £50.0 million
existed, with a weighted average maturity of 4.0 years (2005 nil) to swap from floating to fixed rates. The weighted average interest
rate of the swaps was 4.5%.

G DEBTORS: AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR

Amounts owed by subsidiary undertakings

Other debtors

Deferred tax (note L)

H DEBTORS: AMOUNTS FALLING DUE WITHIN ONE YEAR

Amounts owed by subsidiary undertakings

Other debtors

Other prepayments and accrued income

CURRENT ASSET INVESTMENTS

Other investments:

Overnight deposits

Other

CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR

Loans:

Bank loans and overdrafts

Unsecured loan stock

Trade creditors

Amounts owed to subsidiary undertakings

Other creditors

Other taxation and social security

Accruals and deferred income

2006

£m

2005
Restated
(note Q)
£m

127.4

238.4

1.0

0.8

1.1

0.2

129.2

239.7

2006

£m

44.8

0.3

0.1

45.2

2006

£m

40.0

–

40.0

2006

£m

–

3.9

0.5

2005
Restated
(note Q)
£m

32.6

0.1

–

32.7

2005
Restated
(note Q)
£m

29.4

28.1

57.5

2005
Restated
(note Q)
£m

1.6

5.6

7.2

0.1

293.3

288.7

8.8

0.2

1.6

6.4

0.2

0.4

308.3

303.0

N O T E S T O T H E C O M P A N Y F I N A N C I A L S T A T E M E N T S – U K G A A P

K CREDITORS: AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR

Loans:

Sterling bond

Other bank loans

Amounts owed to subsidiary undertakings

The Sterling bond, due for repayment in February 2012, was retired in January 2006.

L DEFERRED TAXATION

Share-based payment

Other timing differences

Asset for deferred tax

Asset at 1 April 2005

Credited to profit and loss account

Credited to equity (note Q)

Asset at 31 March 2006

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

2006
£m

2005
£m

–

157.4

8.7

150.0

134.9

284.9

8.7

166.1

293.6

2005
Restated
(note Q)
£m

(0.1)

(0.2)

2006

£m

(0.8)

–

(0.8)

(0.2)

(0.4)

(0.2)

(0.8)

100

M PENSIONS

The full actuarial valuation at 1 April 2004 was updated at 31 March 2006 by the independent qualified actuary. The financial
assumptions used by the actuary were:

2006

2005

2004

Rate of increase in pensionable pay

Rate of increase for present and future pensions

Rate used to discount schemes’ liabilities

Inflation

3.8

2.8

5.0

2.8

3.7

2.7

5.5

2.7

The Company’s share of the assets in the schemes and the expected long-term rates of return at the year end were:

Equities

Property

Bonds

Other

Total market value of assets

Present value of schemes’ liabilities

Deficit in schemes

Related deferred tax asset

Net pension liabilities

2006

2005

2004

2003

Return

7.8

4.8

Return

7.5

4.5

Value

£m

15.9

1.2

7.3

1.0

25.4

(28.7)

(3.3)

1.0

(2.3)

Return

7.0

–

4.5

3.5

Return

7.7

–

4.7

4.3

Value

£m

13.8

0.4

3.4

0.3

17.9

(24.3)

(6.4)

1.9

(4.5)

Value

£m

12.3

–

3.1

0.7

16.1

(22.3)

(6.2)

1.9

(4.3)

3.7

2.7

5.5

2.7

Value

£m

9.5

–

2.5

0.7

12.7

(19.5)

(6.8)

2.0

(4.8)

2006
£m

2005
£m

0.4

0.3

2.4

(1.4)

1.0

3.9

(0.3)

(2.9)

0.7

1.1

(1.2)

(0.1)

0.9

(1.1)

–

(0.2)

Analysis of amounts charged to operating profit of the Company
Current service cost

Analysis of amounts charged to other finance income of the Company
Expected return on pension schemes’ assets

Interest on pension schemes’ liabilities

Net income/(cost)

Analysis of amounts recognised in statement of total

recognised gains and losses (STRGL) of the Company
Actual return less expected return on pension schemes’ assets

Experience losses arising on schemes’ liabilities

Changes in assumptions underlying the present value of schemes’ liabilities

Actuarial gain/(loss) to be recognised in STRGL

101

N O T E S T O T H E C O M P A N Y F I N A N C I A L S T A T E M E N T S – U K G A A P

M PENSIONS (continued)

Movement in the Company’s share of the deficit in schemes during the year
Deficit at 1 April
Movement in year:

Current service cost
Contributions
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 total recognised gains and losses:

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

N CALLED-UP SHARE CAPITAL

Authorised
143,325,090 Ordinary shares of £1.22 1/10 each
131,818,190 B Shares of £1.10 each (35,858,521 converted to Deferred Shares of £1.10 each)

(2005 157,657,600 Ordinary shares of £1.11 each)

Allotted, called-up and fully paid
118,608,847 Ordinary shares of £1.22 1/10 each
35,858,521 Deferred Shares of £1.10 each

(2005 127,944,340 Ordinary shares of £1.11 each)

2006
£m

(6.4)

(0.4)
1.8
1.0
0.7

(3.3)

2005
£m

(6.2)

(0.3)
0.4
(0.1)
(0.2)

(6.4)

2006

2005

2004

2003

3.9
15.4%

0.9
5.0%

2.6
16.5%

(4.9)
(38.3)%

(0.3)
(1.0)%

(1.1)
(4.5)%

0.7
2.4%

(0.2)
(0.8)%

0.3
1.5%

1.0
4.4%

(0.1)
(0.6)%

(6.0)
(30.7)%

2006
£m

2005
£m

175.0

145.0

–

144.8

39.4

–

175.0

–

142.0

184.2

142.0

2006
number

(Ordinary
shares of

(Ordinary
shares of
£1.11 each) £1.22 1/10 each)

2005
number
(Ordinary
shares of
£1.11 each)

In lieu of £21.0 million (2005 £22.8 million) cash under scrip dividend alternative

2,087,293

–

3,151,305

For consideration of £1.6 million under the Company’s Sharesave Scheme (2005 £0.8 million)

314,962

5,683

163,276

Issued in respect of share options granted

116,886

–

344,980

2,519,141

5,683

3,659,561

102

N CALLED-UP SHARE CAPITAL (continued)

Shareholders approved a £200 million return of share capital, by way of a B Share Scheme and an on-market buy back programme,
at the Company’s Extraordinary General Meeting on 15 February 2006. Shareholders were given the options of receiving an initial
dividend payment of 110 pence for each B Share held or redeem the B Shares on 27 February 2006, the Initial Redemption Date,
or on 6 April 2006, the Final Redemption Date, or a combination of these options.

The total capital return to shareholders by way of the B Share Scheme amounted to £143.5 million, of which £39.4 million was by way of
the initial dividend payment and £104.1 million was through share redemption. The B Shares which received the initial dividend were
subsequently converted into Deferred Shares, redeemed at the close of business on 6 April 2006 for a total aggregate consideration of
one pence and then were cancelled. At 31 March 2006, £39.4 million of the capital return via the B Share Scheme was outstanding and
held in Share Capital and £5.7 million of the B Shares not redeemed until 6 April 2006 were held within other creditors note J.

O SHARE PREMIUM ACCOUNT

At 1 April 2004

Adjustment for shares issued under the scrip dividend alternative

Premium on shares issued for cash consideration

At 31 March 2005

Adjustment for shares issued under the scrip dividend alternative

Premium on shares issued

Utilised on creation of 130,463,483 B Shares of £1.10 each

At 31 March 2006

P CAPITAL REDEMPTION RESERVE

At 1 April 2004

At 31 March 2005

Transferred from retained earnings on redemption of 89,404,091 B Shares of £1.10 each

At 31 March 2006

£m

154.2

(3.5)

3.0

153.7

(2.3)

2.3

(143.5)

10.2

£m

–

98.4

103

N O T E S T O T H E C O M P A N Y F I N A N C I A L S T A T E M E N T S – U K G A A P

Q PROFIT AND LOSS ACCOUNT AND OTHER RESERVES

At 1 April 2005 as previously reported

Prior year adjustments

FRS 17

FRS 20

FRS 21

At 1 April 2005 restated now reported

Adjustments on adoption of FRS 25/26 1 April 2005

Profit for the year

Fair value gains on derivative financial instalments

Actuarial loss on pension schemes

Adjustment for shares issued under the scrip dividend alternative

Dividends paid

Adjustment in respect of share-based payment

Deferred tax in respect of share-based payment

Own shares issued to the Pennon Employee Share Trust

in respect of share options granted

Adjustment in respect of share options vesting

Receipt on allocation of shares in the

Pennon Employee Share Trust to subsidiaries

B Share payments

At 31 March 2006

Hedging

reserve

£m

–

0.6

–

Own

£m

–

(1.2)

–

(1.2)

–

(0.8)

0.3

1.2

–

Profit and

loss account

£m

Total

£m

314.6

(4.7)

1.3

55.1

(4.7)

0.1

55.1

366.3

365.1

–

215.6

–

(0.2)

21.0

(55.1)

0.4

0.2

–

(0.3)

–

215.6

0.6

(0.2)

21.0

(55.1)

0.4

0.2

(0.8)

–

(137.8)

1.2

(137.8)

0.6

(0.5)

410.1

410.2

The B Share payments of £137.8 million comprise £98.4 million for shares redeemed and £39.4 million for amounts paid as dividend.

Prior year adjustments
The prior year adjustments relate to the implementation of FRS17, FRS20 and FRS21, while FRS25 and FRS26 do not affect comparatives
and are only applied in the current period.

The adoption of FRS17 has resulted in a decrease in staff costs of £0.1 million (2005 £0.4 million) and a decrease in net finance costs
of £1.0 million (2005 £0.1 million increase), resulting in an increase in profit for the year of £1.1 million (2005 0.3 million). Total
recognised gains have increased by £0.7 million (2005 £0.2 million increased losses).

The increase in staff costs as a result of the adoption of FRS20 is offset by the reversal of the change under UITF17 (revised 2003)
in both 2006 and 2005. The deferred tax asset arising from the adoption of FRS20 has resulted in a reduction to the tax charge of
£0.5 million (2005 nil).

The adoption of FRS21 has resulted in an increase in shareholders funds of £55.1 million at 1 April 2005 (2004 £51.1 million) due to
the write-back of the proposed dividend at 31 March 2005.

This restatement of the profit and loss reserve at 31 March 2005 includes a prior year adjustment of £47.5 million.

104

Q PROFIT AND LOSS ACCOUNT AND OTHER RESERVES (continued)

Prior year adjustments (continued)

Adjustment to the profit and loss reserve funds at 31 March 2004

Adjustment to profit for the year ended 31 March 2005

Adjustment to statement of recognised gains and losses for the year ended 31 March 2005

Adjustment to amounts recognised in equity for the year ended 31 March 2005

Adjustment to the profit and loss reserve at 31 March 2005

Employee share ownership plan

FRS17

£m

(4.8)

0.3

(0.2)

–

(4.7)

FRS20

£m

1.2

–

0.1

1.3

FRS21

£m

51.1

55.1

–

(51.1)

Total

£m

47.5

55.4

(0.2)

(51.0)

55.1

51.7

During the year 117,000 of the Company’s Ordinary shares of £1.11 each were issued to the trustees of the Employee Share Ownership
Plan, financed through non-interest bearing advances made by sponsoring group companies (2005 345,000).

The market value of the 162,000 Ordinary shares of £1.22 1/10 each (2005 200,000 Ordinary shares of £1.11 each) held for the Company
by the trust at 31 March 2006 was £2.2 million (2005 £1.9 million).

R DIVIDENDS

Amounts recognised as distributions to equity holders in the year:

Interim dividend paid for the year ended

31 March 2005: 13.8p (2004: 13.2p) per share

Final dividend paid for the year ended

31 March 2005: 29.2p (2004: 27.8p) per share

Proposed dividends

Proposed interim dividend for the year ended

31 March 2006: 16.5p (2005: 13.8p) per share

Proposed final dividend for the year ended

31 March 2006: 35.1p (2005: 29.2p) per share

2006
£m

2005
£m

17.7

16.4

37.4

55.1

34.7

51.1

19.4

17.7

41.6

61.0

37.4

55.1

The proposed interim and final dividends have not been included as liabilities in these financial statements. The proposed
interim dividend was paid on 13 April 2006 and the proposed final dividend is subject to approval by shareholders at the
Annual General Meeting.

105

N O T E S T O T H E C O M P A N Y F I N A N C I A L S T A T E M E N T S – U K G A A P

S 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 K)

Falling due within one year (note J)

2006
£m

2005
£m

–

157.4

–

157.4

3.9

150.0

114.9

20.0

284.9

7.2

161.3

292.1

£0.1 million floating rate unsecured loan stock notes were issued in the year, repayable at par in 2009 or on notice being given by the
noteholders to satisfy further consideration payable in connection with the December 1997 acquisition of Terry Adams Limited.

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

Sterling bond

2006
£m

–

2005
£m

150.0

The rate of interest on the Sterling bond, outstanding at March 2005 and repayable in 2012, was 10.6%. The bond was retired in
January 2006.

T COMMITMENTS AND CONTINGENT LIABILITIES

Contingent liabilities:

Guarantees

Other

2006
£m

2005
£m

738.7

6.9

745.6

623.8

6.9

630.7

Guarantees by the Company are principally in respect of borrowing facilities of subsidiary undertakings. 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.

U RELATED PARTY TRANSACTIONS

The Company has taken advantage of the exemption allowed by FRS 8, not to disclose transactions with entities which form part of
the Group.

106

S H A R E H O L D E R I N F O R M A T I O N

FINANCIAL CALENDAR

Financial year end

Seventeenth Annual General Meeting

2006 Final dividend payable

2006 Interim results announcement

2007 Interim dividend payable

2007 Preliminary results announcement

Eighteenth Annual General Meeting

2007 Final dividend payable

31 March

27 July 2006

3 October 2006

November 2006

April 2007

May 2007

July 2007

October 2007

SHAREHOLDER ANALYSIS AT 31 MARCH 2006

SUBSTANTIAL SHAREHOLDINGS

Range

1 – 100

101 – 1,000

1,001 – 5,000

5,001 – 50,000

50,001 – 100,000

100,001 – HIGHEST

Holder

Individuals

Companies

Trust companies (pension funds, etc)

Banks and nominees

Insurance companies

Number of
shareholders

Percentage of
total shareholders

Percentage of
ordinary shares

4,894

15,101

2,745

373

122

21.02

64.85

11.79

1.60

0.22

0.52

23,287

100.0

21,102

186

1995

90.62

0.80

0.01

8.57

–

0.19

5.48

4.12

4.94

3.01

82.26

100.0

8.87

1.42

–

89.71

–

23,287

100.0

At 13 June 2006, the following interests in the

issued share capital had been notified pursuant to

sections 198 to 208 of the Companies Act 1985.

Ameriprise Financial, Inc

11.05%*

Lansdowne Partners
Limited Partnership

Zurich Financial Services and
its Group companies

AXA SA and its Group companies

Legal & General Plc and its
Group companies

7.89%

5.03%*

4.53%

3.21%

* The percentage shareholding of Zurich Financial

Services is also included within the 11.05%

shareholding of Ameriprise Financial, Inc

as the Zurich Group is part of the Ameriprise

Group of companies.

Further shareholder information
may be found at:
www.pennon-group.co.uk

107

S H A R E H O L D E R I N F O R M A T I O N

SHAREHOLDER SERVICES

Share dealing service

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.

Individual Savings Accounts

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.

Dividend re-investment plan

The Company is introducing a Dividend Re-investment Plan
commencing with the next dividend, the final dividend for the
year ended 31 March 2006. The plan will provide shareholders
with the opportunity to invest the whole of the cash dividend
they receive on their Pennon Group shares to buy further shares
in the Company at favourable commission rates. Full details of
the Plan, including how to join, will be sent out to shareholders
on 21 August 2006.

Details of the above shareholder services are available from the
Company Secretary's Department, telephone: 01392 443024.

Online portfolio service

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

Shareholders can elect to receive shareholder communications
electronically by signing up through www.shareview.co.uk – a
website operated by Lloyds TSB Registrars. Shareholders need
only their ‘shareholder reference’ printed on the proxy form
enclosed with this Annual Report. There is no charge to register
and shareholders will also have access to information about
their shareholding.

ANNUAL GENERAL MEETING

The 2006 Annual General Meeting will be held on Thursday 27
July 2006. Further details are set out in the Notice of Annual
General Meeting sent to all shareholders.

Appointing a proxy

A Form of Proxy is enclosed with the Notice of Annual General
Meeting and instructions for its use are shown on the form.

Electronic proxy voting

Shareholders also have the opportunity to register the
appointment of a proxy for any general meeting of the
Company once notice of the meeting has been given and may
do so for the 2006 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

CREST members who wish to appoint a proxy or proxies through
the CREST electronic proxy appointment service may do so for the
2006 Annual General Meeting and any adjournment(s) thereof by
following the procedures described in the CREST manual.

THE PENNON WEBSITE

The Pennon website at www.pennon-group.co.uk provides news
and details of the Company’s activities plus links to Group
websites. The investor information section contains up-to-date
information including dividend payment dates and amounts.
It also holds historical details and a comprehensive share price
information section.

Visit: www.pennon-group.co.uk/investorInfo

108