SECTION 5 SEVERN TRENT/1

The phrase the "General Section" in this Section 5 is a reference to the information in Section 1 forming part of the listing particulars for the Ordinary Shares of Severn Trent Plc, as described on page 1 of that Section 1. This Section should be read in conjunction with the General Section which contains information relevant to Severn Trent Plc as well as to other Water Holding Companies. This Section and the General Section (as defined above) constitute the listing particulars of Severn Trent Pic. The listing particulars of Severn Trent Plc should be read independently of, and without reference to, the listing particulars of any other company contained in this document. In particular, no inferences should be drawn in relation to Severn Trent Plc from any statement-in, or the absence of any statement in, the listing particulars of any other company or companies included in this document and no assumption should be made as to consistency between Severn Trent Plc's listing particulars and any such other company's or companies' listing particulars in relation to the bases and assumptions on which information contained therein has been prepared.

Severn TrentPlc

Under the UK Offer for Sale and Overseas Offers in Canada, Continental Europe, Japan and the US 353,646,000 Ordinary Sharesof £1 each are being offered at 240p per Ordinary Share of which 100p is payable now, 70p is payable on 31st July, 1990 and 70p is payable on 30th July,1991

255

SECTION 5 SEVERN TRENT/2 SHARE CAPITAL AND INDEBTEDNESS AND PRO F =ORMA NET ASSETS

SHARE CAPITAL AND INDEBTEDNESS SHARE CAPITAL The share capital of Severn Trent following the Severn Trent Combined Offer will be as follows:

Authorised issued and credited as fully paid '' f475,000 000 Orcliriary Shares qf£1 each £353,646,000 £1 Special Rights Redeemable Preference Share £1

The Ordinary Shares now offered for sale rank in full for all dividends and other distributions hereafter declared, paid or made on the ordinary share capital of Severn Trent. Special arrangements apply to any capitalisation issues, rights issues or non-cash dividends during the period when the instalment arrangements apply and are described in Part 5 of Chapter IV of the General Section. Further details relating to the Special Rights Redeemable Preference Share are included in Part 1 of Chapter IV of the General Section.

INDEBTEDNESS As at the close of business on 6th October, 1989 (and save for any sums borrowed or treated as borrowed by the Predecessor Water Authority from the Secretary of State or the Public Works Loan Commissioners, the liability to repay which was vested in Severn Trent on 1st September, 1989 ("relevant loans")) the Group had outstanding secured loans of £0.2 million, unsecured loans of £17.9 million and obligations under finance leases of £35.1 million. At that date the Group had cash and bank balances including short term deposits of £49.6 million. As part of the capital restructuring more fully described in Chapter I of this Section, on 15th November, 1989 all of the Group's indebtedness in respect of relevant loans was written off and on 20th November, 1989 the Secretary of State entered into a conditional agreement to subscribe for Ordinary Shares in Severn Trent; it is expected that Severn Trent will receive £361.0 million in cash under the terms of the subscription agreement on 29th December, 1989. On the basis of the capital restructuring and taking account of £35.2 million paid on 15th November, 1989 in respect of accrued interest on relevant loans, the pro forma indebtedness of the Group as at 6th October, 1989 would have been £53.2 million and the Group's pro forma cash resources at that date would have been £375,4 million. Save as disclosed above (and apart from any intra-Group indebtedness and relevant loans), as at 6th October, 1989 the Group did not have any loan capital outstanding or created but unissued, term loans or other borrowings or indebtedness in the nature of borrowings, including bank overdrafts and liabilities under acceptances (other than normal trade bills) or acceptance credits or hire purchase or finance lease commitments, mortgages, charges or any material guarantees or other material contingent liabilities.

PRO FORMA NET ASSETS The pro forma net assets of the Group as at 31st March, 1989, after adjusting for the capital restructuring, as described in Chapter I of this Section, would have been £1,606.4 million.

256

SECTION 5 SEVERN TRENT/3 CONTENTS

CONTENTS Page

DEFINITIONS Severn Trent/4

KEY INFORMATION Severn Trent/5

DIRECTORS AND ADVISERS Severn Trent/7

CHAPTER I THE BUSINESS OF SEVERN TRENT Introduction Severn Trent/8 History Severn Trent/8 Review of activities Severn Trent/10 Directors, management and employees Severn Trent/22 Financial summary Severn Trent/25 Capital structure Severn Trent/27 Investment expenditure Severn Trent/27 Regulation - K Severn Trent/28 Current trading and profit forecasts Severn Trent/29 Dividends Severn Trent/29 Financing Severn Trent/30 Prospects Severn Trent/30

CHAPTER II ACCOUNTANTS' REPORT Severn Trent/32

CHAPTER III INFORMATION RELATING TO THE PROFIT FORECASTS Severn Trent/40

CHAPTER IV INFORMATION RELATING TO THE K INVESTMENT PROGRAMME Severn Trent/42

CHAPTER V ADDITIONAL INFORMATION Severn Trent/44

257

SECTION 5 SEVERN TRENTj4 DEFINITIONS

DEFINITIONS

The definitions set out below and those set out under "Definitions and Glossary of Terms" in the General Section apply in this Section.

Company Severn Trent Plc

Group the Company and its subsidiaries

Severn Trent Water Authority the predecessor body to Severn Trent Water

Severn Trent the Company and/or, where the context requires, the Group or Severn Trent Water Authority

Severn Trent Water Severn Trent Water Limited, a wholly owned subsidiary of Severn Trent and/or, where the context requires, Severn Trent Water Authority

Severn Trent Industries Severn Trent Industries Limited, a wholly owned subsidiary of .the Company

Water Region the geographical area for which Severn Trent Water has been appointed water undertaker pursuant to the Water Act

Sewerage Region the geographical area for which Severn Trent Water has been appointed sewerage undertaker pursuant to the Water Act

Region the geographical area encompassing the Water Region and the Sewerage Region

Directors the directors of the Company

Local Statutory Water Companies East Worcestershire Waterworks Company and South Staffordshire Waterworks Company which operate wholly within the Region

Ordinary Shares the ordinary shares of £1 each in the capital of the Company

Severn Trent Offer the offer for sale in the UK of up to 288,221,328 Ordinary Shares being made by Schroders on behalf of the Secretary of State and described herein

Severn Trent Overseas Offers the separate offerings of Ordinary Shares in Canada, Continental Europe, japan and the US referred to herein of up to 65,424,672 Ordinary Shares

Severn Trent Combined Offer the Severn Trent Offer and the Severn Trent Overseas Offers

General Section Section 1 of the Prospectus, to the extent that it forms part of the listing particulars for the Ordinary Shares of Severn Trent, as therein described

K Investment Programme the programme of work relating to the assets of the Group of which account was taken in the initial setting of K, as described in Chapter 1 of this Section

Specific K Adjustment a change to K other than at a Periodic Review in respect of a Notified Item or a Relevant Change of Circumstance, as described in Chapter II of the General Section.

258

SECTION 5 SEVERN TRENT/5 KEY INFORMATION

KEY INFORMATION

The following information is derived from the full text of this Section and should be read in conjunction with that text and the General Section, Further Key Information appears in the General Section. BUSINESS Severn Trent Water, the principal subsidiary of Severn Trent, is one of the largest of the ten Water Service Companies. It provides water and sewerage services in the East and West Midlands. Severn Trent's management has been strengthened in recent years and the Chairman, Chief Executive and Finance Director all have private sector experience. In addition, the senior managers of Severn Trent Water, most of whom have spent the majority of their careers in the water industry, have a broad range of experience in a variety of managerial positions. Severn Trent Water provides sewerage services to a population of over eight million and water services to a population of nearly seven million. Two Local Statutory Water Companies operate within the Region. The Region has a diversified economy and Severn Trent Water has a large customer base. The Directors have prepared demand forecasts to the year 2011, Based on experience during 1989 and assuming, inter alia, the completion of the reservoir at Carsington in 1993, the Directors do not expect to require major new water resources. The capacity and flexibility of the distribution networks have helped to minimise supply interruptions and the imposition of restrictions on water use, although due to the exceptionally dry weather conditions in 1989 hosepipe bans were necessary and a number of drought orders were obtained. With no coastline, nor easy access to the sea, Severn Trent Water does not dispose of sewage or sludge to sea. It has accordingly developed extensive facilities for, and considerable experience in, sewage treatment and sludge disposal. TRADING RECORD

Years ended -31st March, -1985 19867- 1987 ,'. 1988 1989 Em, £rn Em £m 1- urriover 334 369 402 43.4 -476 Operating profit before exceptional items 116 134 154°_- 161, 178, Operating profit 73 132 140 -180 172 Profit/(loss) on ordinary activities (after interest) (1,8) 39 52 97 98 These results do not indicate what the- results of Severn°Trerit would have been had iebecn in the private sector operaling in the -new regulatory environment; nor are they-necessarily indicative of The future performance of Severn Trent. The results are extracted from the Accountants' Report in Chapter II of.this Section and are based on HC audited accounts asreported, ad1usted as described in the Accountants' Report

REGULATION The Directors believe that in all material instances where Severn Trent Water does not meet the standards in the Water Quality Regulations, Section 20 Undertakings have been entered into or Relaxations granted to allow Severn Trent Water to carry out the work to secure or facilitate compliance. However, the Directors believe that, in the future, occasional breaches of standards cannot be precluded. Consents are in place for the vast majority of known discharges of polluting matter. Although most sewage treatment works are able to comply with the conditions of their consents, the Directors recognise that it is inevitable that some breaches will occur but believe that they have taken reasonable steps with a view to minimising these risks. Severn Trent Water will be allowed to increase the average of its principal charges by the percentage change in RPI plus an adjustment factor K of 5.5 per cent, in each of the five years ending 31st March, 1995 and a factor of 2 per cent. in each of the five years ending 31st March, 2000. K may be reviewed or adjusted by the Director General. Had the system of economic regulation been in place throughout the year ending 31st March, 1990 the Directors estimate that approximately 94 per cent. of the Group's turnover would be within the K price limitation formula and a further 3 per cent. would, or could in certain circumstances, be otherwise regulated. INVESTMENT EXPENDITURE Severn Trent Water is committed to improving the quality of service to its customers for which investment has already been made and further improvements are planned. The Group will need to make substantial investments in order to secure or facilitate compliance with regulatory requirements and the achievement of service objectives, and to maintain and extend the operating capability of its relevant assets. With certain minor exceptions, this work, some of which extends to the year 2000 and

259

SECTION 5 SEVERN TRENT/6 KEY INFORMATION

beyond, is included in the K Investment Programme of which account was taken by the Secretary of State in setting the initial level of K. The Directors estimate that the K Investment Programme will require expenditure of approximately £2,330 million for the five years ending 31st March, 1995 and a further £1,750 million for the five years ending 31st March, 2000 (both estimates at November 1989 prices). Given the purpose, size and timescale of the work included in the K Investment Programme, these estimates are inevitably subject to significant uncertainty. Substantial additional expenditure may be required within this ten year period, either because new obligations arise which were not anticipated in the initial setting of K, or because some existing obligations have not been taken fully into account. Much of this expenditure would be eligible for consideration for Specific K Adjustment. It is expected that Severn Trent Water's investment expenditure requirements will lead to a rising level of indebtedness in the medium term. As at 6th October, 1989 the Group had pro forma net cash of £322.2 million. Borrowing facilities of £1,500 million have been arranged for the period to 14th September, 1995. On the basis of the provisions of the Water Act and the Appointments, the Directors believe that Severn Trent Water should be able to continue to finance its operations. PROFIT FORECASTS, DIVIDENDS AND PROSPECTS On the basis of the principal assumptions set out in Chapter III of the General Section, the Directors forecast that, in the absence of unforeseen circumstances, the profit on ordinary activities of the Group (stated after interest but before taxation and extraordinary items) for the year ending 31st March, 1990 will be not less than £121 million; based on this forecast, the corresponding pro forma forecast profit, adjusted for interest on the basis that the new capital structure had been in place since 1st April, 1989, would be not less than £208 million. The profit forecast incorporates a number of significant changes to prior periods in respect of turnover, operating costs and interest, Turnover is expected to reflect principally an average increase in charges of 9.1 per cent. and the recharge of certain operating costs to the NRA. It is expected that the increase in operating costs, which includes additional charges in respect of infrastructure renewals, will adversely affect operating profit in the.current year. Interest payable is expected to be significantly reduced as a result of the capital restructuring. The Directors believe that the prospects of the Group depend principally on the efficient management of its core water and sewerage businesses. The successful development of Severn Trent Water is central to the Directors' plans. They intend to maximise the potential of Severn Trent Water from turnover growth, by control of operating costs and the effective management of the large investment programme. Whilst there can be no absolute safeguard against adverse regulatory decisions, the Directors believe that they can further develop the strong core water and sewerage businesses, The rising level of indebtedness referred to above will result in interest becoming payable which, in the short term, will offset the anticipated strength of operating profits. This will inevitably put pressure on earnings in the short term. However, the Directors have confidence in the longer term prospects of Severn Trent and, in the absence of unforeseen circumstances, they therefore intend to pursue a progressive dividend policy. The Directors intend that Severn Trent, founded on its strong home base, will develop a significant earnings stream from other appropriate businesses both in the UK and overseas. On the basis of the Group's management experience, technical abilities and financial resources, the Directors look forward to the future with confidence and welcome the opportunities provided by the private sector.

OFFER FOR SALE STATISTICS

Market capitalisation at the Offer Price based on 353,646,000 Ordinary Shares in issue £848.8 million Price earnings multiple at the Offer Price based on pro forma HC earnings per Ordinary Share of 53.7p forecast for the year ending 31st March, 1990 4.5 times Dividends (net) per Ordinary Share for the year ending 31st March, 1990: forecast final dividend (expected to be paid in October 1990) 9.90p notional annual dividends 14.85p Gross dividend cover on a full distribution basis for the year ending 31st March,1990 3.0 times Gross dividend yield at the Offer Price based on notional annual dividends 8.25% The pro forma HC earnings per Ordinary Share forecast for the year ending 31st March, 1990 are stated after a notional taxation charge reflecting advance corporation tax on the notional dividends. The notional dividends above reflect the dividends that the Directors consider they would have recommended for the year ending 31st March, 1990 if the Severn Trent Combined Offer had taken place at the beginning of the.current financial year arid the new capital structure had been in place throughout the year. Gross dividend cover is based on notional annual dividends, plus associated tax credit, and on pro forma HC earnings per Ordinary Share forecast for the year ending 31st March, 1990, adjusted in respect of advance corporation tax.

260

SECTION 5 SEVERN TRENT/7 DIRECTORS AND ADVISERS

DIRECTORS AND ADVISERS

DIRECTORS AND SECRETARY OF THE COMPANY

Chairman John George Bellak MA

Non-executive Deputy Chairman Timothy Claud Heywood-Lonsdale MA

Chief Executive Roderick Sayers Paul MA, FCA

Director of Business Planning Victor Cocker BA, MIWEM and Marketing

Director of Operations Frank Earnshaw CEng, FICE, MI MechE, FIWEM

Director of Finance Stuart Martin Larnder FCA

Director of Government Relations Colin George McMillan BCom, IPFA and Company Secretary

Non-executive Directors Sir Richard Baker Wilbraham Bt Roger Humphrey Boissier Alan Wesley Henn Richard Ireland FCIS Andrew Henry Simon BSc, MBA

All of 2297 Coventry Road, Birmingham B26 3PU (the registered office of the Company).

ADVISERS Financial advisers Lloyds Merchant Bank Limited, 40-66 Queen Victoria Street, London EC4P 4EL Solicitors Herbert Smith, Watling House, 35 Cannon Street, London EC4M 5SD Brokers James Capel & Co., James Capel House, 6 Bevis Marks, London EC3A 7JQ Auditors and reporting accountants Price Waterhouse, Chartered Accountants, Livery House, 169 Edmund Street, Birmingham B3 2JB Principal bankers Lloyds Bank Plc, 121 Colmore Row, Birmingham 133 3AD Registrars Lloyds Bank Plc, Registrar's Department, Goring-by-Sea, Worthing, West Sussex BN12 6DA Engineering consultants Sir William Halcrow & Partners Ltd., Consulting Engineers, Vineyard House, 44 Brook Green, London W6 7BY

Details of advisers to HM Government and the WSA appear in the General Section.

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SECTION 5 SEVERN TRENT/8 CHAPTER I

CHAPTER 1 THE BUSINESS OF SEVERN TRENT

INTRODUCTION Severn Trent, through its wholly owned subsidiary Severn Trent Water, is principally engaged in the provision of water supply and sewerage services in the East and West Midlands. Severn Trent Water is one of the largest of the ten Water Service Companies in terms of area and turnover. The Region broadly covers the catchment areas for the Rivers Severn and Trent and their tributaries, and stretches from the Humber Estuary in the north to the Bristol Channel in the south, from Llyn Clywedog in Wales in the west to Lincolnshire in the east. The Region includes the cities of Birmingham, Coventry, Derby, Leicester, Nottingham, Stoke-on-Trent, Worcester and Gloucester. The maps opposite show details of the approximate areas of operation of Severn Trent Water and the areas within the Sewerage Region served by the Local Statutory Water Companies. Most of Severn Trent Water's major water resources are located in the west and north of the Region. This water is then supplied locally and to the centre and east of the Region. Water resources are significantly influenced by transfers of water, both into and out of the Region. Severn Trent Water's inland position does not provide easy access to the sea and, accordingly, extensive facilities have been developed for the treatment of sewage and sludge, and their subsequent disposal to rivers and land. The Water Region covers an area of some 18,960 square kilometres with a resident population of some 6.9 million, representing over 13 per cent. of the population of England and Wales. The Sewerage Region covers an area of some 21,650 square kilometres and has a resident population of some 8.3 million (over 16 per cent. of the population of England and Wales), of whom some 1.4 million are supplied with water bythe Local Statutory Water Companies and other Water Service Companies. Severn Trent Water supplies unmetered water to some 2.7 million premises, most of which are domestic, and metered water to over 200,000 premises, most of which are non-domestic, Sewerage services are provided to 3.5 million premises and Severn Trent Water has issued and has currently in force over 5,000 trade effluent consents for discharges into the sewerage system, Severn Trent Water supplies water to over 99 per cent. of the resident population in its Water Region and receives sewage from over 96 per cent. of the resident population in its Sewerage Region. The economy of the East and West Midlands has changed significantly since the late 1970s. Traditional engineering and manufacturing industries have declined while industries such as retailing and financial services have grown. Major industries in the Region include car manufacturing, engineering, textiles, food processing, pharmaceuticals and brewing.

HISTORY A brief history of the water industry in England and Wales is contained in Chapter I of the General Section. Severn Trent Water Authority assumed responsibility on 1st April, 1974 pursuant to the Water Act 1973 for, inter alia, the water and sewerage functions of 234 local authorities, water boards and other undertakings. Responsibility for water supply was discharged through the Local Statutory Water Companies in certain areas. The 1974 reorganisation provided opportunities to consolidate and rationalise the previously fragmented management of the water supply and sewerage services, and to develop regional strategies for the key elements of these services. Water resources, treatment and distribution are now based on three distinct areas. Service to customers has been improved by significant investment in the refurbishment and extension of treatment facilities at a third of the major water treatment works, the laying of some 6,000 kilometres of new mains and the rehabilitation of some 4,750 kilometres of existing mains. Sewerage services in some areas of the Region have also been rationalised, with a number of inadequate or inefficient sewage treatment works being replaced by larger and more modern works. For example, the Black Country scheme in the West Midlands involves the closure of 11 sewage treatment works and the diversion of the flows by a trunk sewer to the Minworth sewage treatment works, which has the ability to treat sewage to a higher standard. This scheme has contributed to the cleaning up of the Rivers Tame and Trent, and salmon have now returned to the middle reaches of the River Trent. This is one of a number of schemes which have contributed to an increase in efficiency and an improvement in compliance with consents. A series of organisational changes has progressively rationalised the business, resulting in operating cost savings, including manpower reductions of approximately 3,400 (30 per cent.) since

262 SECTION 5 SEVERN TRENT/9 CHAPTER I

The maps below show details of the approximate areas of operation of Severn Trent Water and the areas within the Sewerage Region served by Local Statutory Water Companies.

KEY

Severn Trent Water Headquarters

i. District Offices

Local Statutory Water Companies

Sewerage Region Boundary

mow. Water Region Boundary

Principal Reservoirs

Carsington Reservoir (under construction)

Note: The maps shown above are for illustrative purposes and are not to scale. The large map shows the approximate Water Region and Sewerage Region of Severn Trent Water. The small map shows the approximate location of the Sewerage Region within England and Wales.

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SECTION 5 SEVERN TRENT/10 CHAPTER I

1979. In addition, tiers of management have been reduced, accountability has been increased and communications and policy development have been streamlined. Other savings have resulted from the introduction of productivity initiatives associated. with improved methods of working, greater use of contractors and a more vigorous cost control regime. The structure of the operating activities has been extensively revised since 1974 and, in the last two years, the 15 operating districts have strengthened their local links with a view to providing customers with a more direct and effective service. Severn Trent has recently established Severn Trent Industries which carries on business through a number of trading divisions comprising Severn Trent International, Severn Trent Laboratories, Severn Trent Process Plant, Severn Trent Systems and Severn Trent Waste Disposal. On 1st September, 1989 the functions of Severn Trent Water Authority relating to water supply (except in areas where Severn Trent Water Authority's duties were carried out through the Local Statutory Water Companies and subject to minor boundary changes) and relating to the provision of sewerage services, and the majority of its property, rights and liabilities were transferred to Severn Trent Water. REVIEW OF ACTIVITIES Overview Analysis of turnover and profit An analysis of turnover and HC operating profit by activity for Severn Trent for the financial year ended 31st March, 1989 is set out below:

Other Water Sewerage trading supply* services activities Total £nn £m £m £m Turnover Unmetered 119.4 221.3 340.7 Metered 70.0 23.8 93.8 Trade effluent 23.9 23.9 189.4 269.0 Other 12.3 4.9 . Total turnover 201.7 Operating profit 39.7

*Includes turnover of £0.2 million from recreation and leisure.

The analysis of total turnover and operating profit between activities has been extracted from the Accountants' Report in Chapter II of this Section. The analysis of turnover by type of charge is based on Severn Trent's reported audited financial statements for the year ended 31st March, 1989 after making adjustment for the activities which have since been transferred to the NRA. Investment expenditure In respect of its functions as a water undertaker and a sewerage undertaker, the Group will need to make substantial investments in order to secure or facilitate compliance with regulatory requirements and the achievement of service objectives, and to maintain and extend the operating capability of its relevant assets. With certain minor exceptions, the work associated with these obligations has been included in the K Investment Programme of which account was taken in setting the initial level of K. The work excluded from the K Investment Programme relates to items where the Secretary of State considered, on the basis of available estimates of the extent of the relevant obligations or the extent and cost of the associated work, that it was not appropriate to take account of such work in setting the initial level of K. The K Investment Programme, some of which extends beyond the year 2000, is based on an assessment of the extent, capacity, condition and performance of the Group's relevant assets and has been prepared as described in Chapter IV of this Section. The Directors currently estimate that the K Investment Programme will require expenditure of approximately £4,080 million (at November 1989 prices) over the ten years ending 31st March, 2000. An analysis of estimated expenditure is included under "Investment Expenditure" in this Chapter. Substantial additional expenditure may be required over this period and thereafter in respect of existing or future legal and regulatory obligations where the work required is not included

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SECTION 5 SEVERN TRENT/11 CHAPTER I

in the K Investment Programme. Much of this expenditure would be eligible for consideration for Specific K Adjustment. All expenditure in respect of functions as a water undertaker and a sewerage undertaker can be considered at the next Periodic Review. Further discussion of the investment programmes in the individual areas of Severn Trent Water's business is included in this Chapter below.

Water supply In the year ended 31st March, 1989 Severn Trent Water put into supply an average of 1,902 Ml/d of water. Of the total amount, approximately 27 per cent, was to metered customers, The balance was unmetered and included water which was unaccounted for, principally as a result of leakage. In the last ten years, the volume of water put into supply has largely remained constant and the Directors consider that this has resulted from three principal factors: on the basis of surveys described under "Water distribution" in this Chapter, water used for domestic purposes has increased as a consequence of new housing, a small growth in the resident population of the Water Region and the increased. ownership of automatic domestic appliances; with respect to unmetered supplies, unaccounted for water has, on the basis of those surveys, reduced as a result of Severn Trent Water's leakage control strategy, which is also referred to under "Water distribution" in this Chapter; and although metered non-domestic demand for water reduced significantly during the 1970s and early 1980s, a recovery in demand has been evident in the last four years. Under the present charging arrangements the Directors believe that there are unlikely to be any further significant reductions in unaccounted for water beyond their objective set for the year ending 31st March, 1992 of 22 per cent, of the water put into supply. The Directors have forecast that over the next 20 years there will be a small overall increase of water put into supply. The demand for water services is growing from a number of existing industries, including car manufacturing and the food processing and drinks industries. In addition, a number of companies have developed or expanded plants in the Region, including Laura Ashley Industries, Birds Eye Wall's and CMB Packaging. Demand from service industries in the Water Region has increased. In addition, based on recent trends, housing developments in the Water Region are anticipated to continue at the rate of approximately 23,000 new properties per annum. There are significant variations in peak demands throughout the Water Region. Peak weekly demand can exceed the average weekly demand by over 20 per cent., but short term peaks can be substantially higher.

Water resources The Water Region is an area of contrasting climate and geology. The Welsh mountains in the west and the Pennine Hills in the north have high annual rainfall, whilst the Vale of Evesham and the lower Trent Valley are amongst the driest parts of England and Wales. Resources are organised into three distinct areas: the Severn area, the East Midlands and the Stoke district. Underground sources, river derived sources and impounding reservoirs each account for approximately one third of the total volume of water put into supply throughout the Water Region, although the significance of each differs between the three resource areas. The Severn area is predominantly supplied from the Elan Valley Reservoirs in Wales and by abstraction from a number of river intakes located along the River Severn. The Elan Valley Reservoirs provide the majority of Birmingham's water and, in the year ended 31st March, 1989, represented 16 per cent. of water put into supply in the Water Region. Water from the Elan Valley Reservoirs is transported by aqueduct some 118 kilometres under gravity to Birmingham. Natural flows in the River Severn are supported by releases from the Clywedog Reservoir and, to a limited extent, from the Vyrnwy Reservoir, in accordance with arrangements with the NRA. The Shropshire Groundwater Scheme, comprising a number of deep borehole sources, is also available to augment flows in the River Severn. The East Midlands is supplied from major reservoirs in Leicestershire and the Derwent Valley in Derbyshire, by abstraction from the Rivers Derwent and Dove and from groundwater sources in Nottinghamshire. Water from the Derwent Valley Reservoirs travels approximately 90 kilometres under gravity in aqueducts which serve Derby, Nottingham and Leicester. Another aqueduct conveys water under gravity to Yorkshire Water. Although the River Trent is the principal river in the East Midlands area, it is not used for water supply purposes by Severn Trent Water. The Stoke district is supplied from a number of boreholes and from the Tittesworth Reservoir, north east of Stoke-on-Trent.

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Each of the three resource areas has flexible operating arrangements with a view to maximising the use of low cost, high quality resources. There are limited facilities to transfer water between the three areas, the only significant one being the trunk main link between Leicester and Coventry, which provides a reinforcement capability between the Severn and East Midlands areas in the event of high demand or systems failure. The effective management of resources, together with the flexibility and capacity of the distribution networks, has helped to minimise supply interruptions and the imposition of restrictions on water use, Severn Trent Water owns 40 raw water reservoirs, with a total capacity of approximately 235,000 megalitres, most of which is utilised by Severn Trent Water. However, the great majority of water from the Vyrnwy Reservoir is abstracted by North West Water and approximately 24 per cent. of water from the Derwent Valley Reservoirs is exported to Yorkshire Water. The Elan Valley Reservoirs, which are owned by Dwr Cymru, have a capacity of approximately 100,000 megalitres, the majority of which is available to Severn Trent Water. About 75 per cent, of Severn Trent Water's raw water reservoirs are of the impounding type, whilst the remainder are filled totally or in part by pumping. Some 80 per cent. are of earth embankment construction, the rest being of concrete or masonry. Although approximately half of all these reservoirs were constructed in the Victorian era, with the oldest dating from 1854, the Directors consider that adequate provision has been made in the K Investment Programme for their maintenance. The Shropshire Groundwater Scheme is capable of future extension by developing further boreholes to augment overall resources from the River Severn. The responsibility for such development lies with the NRA and any extension of the scheme may be reflected in higher abstraction charges. The resources in the Derwent Valley are to be supplemented by the Carsington Reservoir, now scheduled for completion in 1993. Following the discovery of a major fault in the embankment, work stopped on the original Carsington Reservoir scheme in 1984. An independent review by consulting engineers confirmed that the construction of a reservoir on this site was viable and earlier this year work restarted. The scheme provides for a pumped storage reservoir which, it is expected, will add over 200 MI/d to the East Midlands resources. Until it is completed there is a possibility of supply restrictions during prolonged dry periods in the East Midlands. Exceptionally dry weather conditions have been experienced this year. This has resulted in the lowest run off of water into some of Severn Trent Water's major reservoirs during the summer months for over 50 years. The East Midlands' reservoirs were particularly affected. Despite this, supplies were maintained in the Water Region, apart from minor localised problems during periods of peak demand in early summer. Hosepipe bans affecting around 50 per cent. of the resident population were in force by the autumn, and these were supplemented by a number of drought orders to conserve water resources and, where appropriate, to prohibit the non-essential use of water. The Directors have prepared demand forecasts to the year 2011. Based on experience during 1989 and these forecasts, and assuming the completion of the Carsington Reservoir, the continuation of existing abstraction licences, some limited additional abstraction arrangements and no material changes to the climate, the Directors do not expect to require major new water resources. Water transfer arrangements There are significant bulk transfers of water, both into and out of the Water Region, which are subject to long term supply or abstraction arrangements. In the year ended 31st March, 1989 the average imports and exports of water amounted to 326 Ml/d and 286 Ml/d respectively, most of which was untreated. The principal water transfer arrangements relate to the Elan Valley, Derwent and Vyrnwy Reservoirs, further details of which are provided in Chapter V of this Section, There are also agreements or arrangements for small supplies and purchases with neighbouring water undertakers, including the local Statutory Water Companies. Water treatment As described in Chapter 1 of the General Section, abstracted water is treated at water treatment works prior to being distributed through water mains and service pipes to customers. All water put into supply by Severn Trent Water is treated, other than the supply to some 170 isolated premises in respect of which Severn Trent Water has entered into a Section 20 Undertaking to put in place appropriate treatment or alternative supplies by the end of 1990. The degree of treatment required depends on the quality of the water in the source and its intended use, and typical treatment processes are described in Chapter I of the General Section. Severn Trent Water operates 205 water treatment works. The average volumes treated at treatment works range from over 300 MI/d at Frankley, which supplies Birmingham, to small plants which treat less than 1 MI/d.

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The quality of water from most of the underground sources is such that only disinfection is required. However, in some cases blending or additional treatment is necessary, in particular where nitrate levels are above those permitted by the Water Quality Regulations. Currently just over 1 per cent. of water put into supply is blended. This process is relatively cheap and to date has enabled Severn Trent Water to contain the impact of increasing nitrate levels. However, nitrate levels in certain underground sources are likely to increase as existing nitrate in the ground permeates the aquifer, possibly requiring additional blending and, where necessary, the provision of additional treatment facilities. The associated costs have been included in the K Investment Programme or will be eligible for consideration for Specific K Adjustment. Severn Trent Water relies significantly on abstraction from lowland river sources which require more treatment than reservoir and underground sources. At a number of works Severn Trent Water is introducing additional treatment processes, one of which is the adsorption method using GAC to remove taste, odour and organic compounds. In addition, the first full scale ozone treatment plant in the Water Region, providing improved disinfection, is under construction and Severn Trent Water is considering the introduction of this process at a further 11 locations. The K Investment Programme provides for the future use of both of these processes, principally at the larger lowland river treatment works. In recognition of the increased need for regenerated GAC and potential cost savings, Severn Trent Water and Anglian Water have jointly established a company, Grafham Carbons Limited, to undertake regeneration of GAC. The reservoirs in the Peak District and Wales collect water which contains naturally occurring iron and manganese. The recently completed refurbishment of the Bamford treatment plant, which treats water from the Derwent Valley Reservoirs, and the major part of the scheme for the refurbishment of the Frankley treatment works, which treats water from the Elan Valley Reservoirs, were both designed to ensure that the water from those works complies with the iron and manganese standards of the Water Quality Regulations. All river sources, with minor exceptions, have intake protection systems which operate 24 hours a day to monitor the quality of abstracted water. The majority of large treatment works are continuously manned to keep a check on water quality and plant performance. Where such works are not continuously manned, automatic control of the processes and remote monitoring systems are used.

Water distribution Water is distributed through networks of trunk and local distribution mains of over 38,000 kilometres in aggregate and there are over 700 service reservoirs in the Water Region. Over 80 per cent. of the water in the distribution system is pumped, the remainder flowing under gravity. As a result of surveys of parts of the distribution system, Severn Trent Water has estimated that over 70 per cent. of distribution mains are of iron, the majority of which are unlined. Other materials used comprise uPVC, asbestos cement, MDPE, steel, prestressed concrete, glass reinforced plastic and galvanised iron. Over the last five years Severn Trent Water has increasingly used small diameter MDPE pipes instead of iron pipes and in the future expects to use an increasing proportion of MDPE and uPVC, both for large and small diameter pipes. Unlined iron mains are particularly vulnerable to corrosion, externally from the nature of the soils and internally from the water carried, Corrosion deposits can affect both the quality and quantity of the water conveyed in the pipes. As part of its K Investment Programme, Severn Trent Water has recently accelerated its mains rehabilitation programme and now plans to scrape and line or replace all unlined iron mains by 2007, together with some mains where the original coal tar lining is causing problems. Pipes are replaced where lining or relining is not practical. Severn Trent Water has established a number of discrete district meter areas in order to improve the management and control of its distribution networks. This policy has improved Severn Trent Water's ability to identify leakage as part of an active leakage control strategy. Measures to reduce leakage have included pressure reduction and the repair of leaking mains and service pipes. These measures have reduced unaccounted for water from an estimated 30 per cent. of the total volume put into supply in the year ended 31st March, 1984 to some 25 per cent. in the year ended 31st March, 1989. This strategy has enabled Severn Trent Water to preserve water resources and to make material operating cost savings, including general rates, treatment chemicals and electricity. Based on surveys of the district meter areas, the Directors estimate that a significant proportion of leakage is attributable to defective pipes and fittings on customers' premises. In the absence of metering there may be little incentive for most customers to identify leakage from their own pipework and the Directors consider that it is unlikely to be cost effective for Severn Trent Water to reduce leakage much further below its objective of 22 per cent. by 31st March, 1992.

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Water quality Severn Trent Water's current arrangements for monitoring the quality of water put into supply have been developed over a number of years. District managers are responsible for maintaining compliance with water quality targets and standards, and on site testing and automatic quality monitoring facilities are used. Independent of the district managers, the quality assurance department has a wide ranging role involving sampling, analysis and reporting. The monitoring process, from water abstraction through the various treatment processes and distribution to the customers' taps, has involved taking some 170,000 samples of water each year both for regulatory and operational purposes. Severn Trent Water's system of analysing, assessing and reporting on these samples facilitates the early detection of water quality problems, enabling remedial action to be taken. As described in Chapters I and II of the General Section, Severn Trent Water has significant statutory obligations under the Water Act and the Water Quality Regulations with regard to the quality of treated water, most of which derive from the EC Drinking Water Directive. Under the Water Quality Regulations revised sampling arrangements come into effect on 1st January, 1990 requiring significant changes in sampling frequency and location, and in the number of parameters to be monitored at those locations. For the purpose of determining compliance with the standards in the Water Quality Regulations, Severn Trent Water has designated a total of 320 zones with the estimated number in each zone varying between 20 persons and 50,000 persons. Compliance is determined by comparing the results of sample analysis with the prescribed limit for the relevant parameter, as described in Chapter II of the General Section. For the majority of parameters the standards are absolute, that is, a single failed sample will be evidence of a possible breach by a Water Service Company of its obligations. In the past, Severn Trent Water designed its sampling programme to give priority to monitoring areas of known or potential problems and their resolution. On the basis of this programme, most of the previously applying quality criteria were met. The changes in sampling, including the requirement for analysis to be based on the new zones, make it impractical to assess with accuracy the extent to which Severn Trent Water will meet the standards set by the Water Quality Regulations. The Directors believe that at some works or in some areas there are a number of standards with which Severn Trent Water will have difficulty in complying. These are described below and reflect in many cases the stricter interpretation of the standards of the EC Drinking Water Directive since the start of 1988 rather than any change in the quality of water put into supply. In each case, either Relaxations to the standard set out in the Water Quality Regulations have been granted or Section 20 Undertakings have been given, both as described in Chapter II of the General Section. If the revised sampling arrangements described above reveal that Severn Trent Water is having difficulty in meeting standards in other areas or for other parameters, the Directors intend to offer further Section 20 Undertakings or seek Relaxations to carry out appropriate remedial work. Where failures to meet the microbiological standards are detected at water treatment works or service reservoirs, remedial action is taken where it is considered appropriate; such action may include improvement to disinfection procedures or other measures. Section 20 Undertakings have been entered into for microbiological parameters in respect of 21 service reservoirs out of over 700. The work set out in these Section 20 Undertakings is expected to be completed by March 1992. Section 20 Undertakings have been given in relation to the failure to meet theTHM standard at six works, in relation to the aluminium standard at three small works because of the treatment processes used and in one other case in relation to residual aluminium in the distribution system. The work set out in these Section 20 Undertakings is expected to be completed by June 1994 for THM and September 1993 for aluminium. Section 20 Undertakings have also been given in respect of the nitrate standard at 15 out of a total of 175 borehole sources; remedial work should be completed by the end of 1992. As described under "Application of existing EC requirements" in Chapter II of the General Section, legal proceedings have been brought by the Commission against the UK before the EC Court. The application initiating these proceedings cites the UK's alleged failure to ensure compliance with the Directive's nitrate standard and refers, inter alia, to five of the 15 sources referred to above. All of the work necessary to secure or facilitate compliance at these five sources is due to be completed by the end of 1991. Severn Trent Water has also entered into a general Section 20 Undertaking, expiring in 1994, for iron and turbidity, arising from the reduction in water quality caused by the age and condition of the water distribution system. The work set out in this Section 20 Undertaking is included within the programme described in "Water distribution" in this Chapter. Severn Trent Water will offer a further Section 20 Undertaking in 1994, if appropriate, having regard to the amount of work then to be completed. Because of the nature and structure of the ground from which the water derives, Severn Trent Water has been granted time limited Relaxations in respect of iron and/or manganese for water

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supplied from 15 of its water treatment works and in two cases for associated turbidity. In addition, a time limited Relaxation has been granted in respect of naturally occurring aluminium at one works. The Relaxations expire on or before 31st December, 1994 by which time programmes of work should be completed with the objective of ensuring the water supplied complies with the standards in the Water Quality Regulations. Relaxations have also been granted for naturally occurring magnesium, sodium and sulphate in respect of six works. In two cases permanent Relaxations have been granted and the remaining four works are subject to time limited Relaxations with programmes of work designed to achieve compliance by December 1993. Severn Trent Water also has four permanent Relaxations and one time limited Relaxation relating to imported water and minor supplies to isolated properties in respect of taste and odour, or high levels of iron and/or manganese, or high levels of sulphate. Severn Trent Water has entered into a Section 20 Undertaking to notify the NRA of the presence of pesticide concentrations in excess of the standard in supplies from 16 surface water sources (including one bulk supply and one shared supply), to install GAC at certain works and to investigate the efficacy of treatment methods. The installation of GAC at these works has led to, or is likely to lead to, a significant reduction in identified breaches of the pesticide standard. Severn Trent Water has monitored the incidence of PAH in some parts of the distribution network known to be lined with coal tar. Based upon surveys to date, Severn Trent Water does not consider it necessary to offer Section 20 Undertakings in respect of PAH, but the position will continue to be monitored through the regular sampling of zones, as required under the Water Quality Regulations. Where necessary, Severn Trent Water reduces the take up of lead in service pipes by pH control of water leaving its treatment works. It has given a Section 20 Undertaking to identify zones where there is a risk of exceeding the new, more stringent standard for lead, to investigate whether further treatment can achieve a significant reduction in lead concentrations and, where appropriate, to install further treatment facilities. In addition, in problem areas, Severn Trent Water has provided for the replacement of its part of lead service pipes in a programme which will take at least 20 years to complete. As described in Chapter II of the General Section, the Water Act provides that the Secretary of State has discretion not to make an enforcement order where, in respect of any particular contravention, he is satisfied that it is of a trivial nature. The "Guidance on Safeguarding the Quality of Public Water Supplies", issued by DOE and described in Chapter II of the General Section, sets out procedures to be adopted when standards are not met and when it may not be appropriate to offer Section 20 Undertakings or seek Relaxations. Severn Trent Water has had regard to this guidance in respect of specific instances where the standards of the Water Quality Regulations have not been met in the past and has not in these instances offered Section 20 Undertakings nor sought Relaxations as, in the opinion of the Directors, they fall within the terms of the guidance. Severn Trent Water will, however, continue to review the position. Except for additional work set out in the Section 20 Undertaking relating to pesticides and the Section 20 Undertaking relating to lead in respect of treatment facilities, where such expenditure will be eligible for consideration for Specific K Adjustment, the programmes of work set out in the Section 20 Undertakings and Relaxations now in place have been included in the K Investment Programme described under "Investment Expenditure" in this Chapter. One of the primary objectives of the programmes of work included in the K Investment Programme is to secure or facilitate compliance with the Water Quality Regulations. However, even with such programmes, the Directors believe that it is impossible to preclude occasional breaches of standards or breaches arising either from factors outside the reasonable control of Severn Trent Water or from other exceptional circumstances. Chapter II of the General Section gives further information both on Section 20 Undertakings and Relaxations and the potential consequences of non-compliance, together with details of the Secretary of State's policy on these matters.

Fluoridation The water supply to over 30 per cent. of the resident population of the Water Region is fluoridated at the expense of district health authorities. Some of this fluoridated water is imported from the Local Statutory Water Companies. Severn Trent Water has received an indemnity from the Secretary of State for Health in respect of the addition of fluoride to public water supplies, as described in Chapter I of the General Section. Severn Trent Water is currently reviewing its policy on fluoridation in the light of operational requirements and this indemnity.

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Sewerage services Severn Trent Water provides sewerage services to approximately 3.5 million premises, the vast majority of which are domestic, and has also issued and has currently in force over 5,000 trade effluent consents. Trade effluent charges accounted for over 8 per cent. of sewerage services turnover in the year ended 31st March, 1989. Major trade effluent customers of Severn Trent Water include Courtaulds in Derby, Birds Eye Wall's in Gloucester and the brewing industry. Over the last ten years demand for sewerage services has largely followed that of water supply and the Directors expect this to continue in the future.

The sewerage system Severn Trent Water is responsible for the operation and maintenance of some 38,000 kilometres of sewers (which figure excludes some Section 24 Sewers for which the records are incomplete), receiving foul and surface water through combined, separate and partially separate drainage systems. In recent years approximately 27,000 new connections per annum have been made to the sewerage system and, assuming this trend continues in the future, the Directors forecast that over the next five years the total sewer length in the Sewerage Region will increase by some 1,000 kilometres. Severn Trent Water will only agree to adopt sewers following a satisfactory CCTV inspection. Approximately 82 per cent. of sewers are made from clay and some 4 per cent. from brick. The remaining sewers are of a variety of materials including concrete. Most new sewers in the Sewerage Region are now made of vitrified clay. Sewers vary in size and range from 150 mm diameter pipes, serving a small number of premises, to four metre diameter sewers conveying both foul and surface water within the West Midlands to Minworth sewage treatment works. Most of the sewerage system operates by gravity. However, there are currently 2,251 pumping stations in the Sewerage Region, of which 1,641 are operated and maintained by District Councils as described under "Sewerage Arrangements" in this Chapter.

Asset condition Much of the data used to determine current asset condition has been derived from drainage area studies. These studies provide a detailed analysis of the sewerage network for areas with resident populations over 10,000; to date 84 out of approximately 260 studies have been completed. Computer simulation is used to model the hydraulics of the system and CCTV is used for the internal inspection of sewers, Information derived from these studies is used to assess the structural condition of sewers and identify any maintenance problems. Severn Trent Water classifies sewers as strategic and non-strategic and does not use the description of Critical Sewers provided in Chapter I of the General Section. Severn Trent Water defines strategic as any length of pipe, other than rising mains, which is worthy of preventive maintenance due to a number of factors including its depth, material of construction, age or location. Severn Trent Water has a programme of inspection of strategic sewers in order to assess condition and the possible need for maintenance or further investment. Of the total length of sewers in the Sewerage Region some 5,750 kilometres have been classified as strategic. Severn Trent Water repairs rising mains and non-strategic sewers as and when necessary. The Directors estimate that approximately 95 per cent. of the strategic sewers are of an acceptable structural condition; the remainder may require additional investment to restore operating capability. In addition, Severn Trent Water estimates that as at 31st March, 1989 there were some 2,600 premises at risk from foul flooding. The K Investment Programme provides for measures to resolve all currently known problems. These measures may involve the lining or replacement of some existing sewers, or increasing the hydraulic capacity of the system by constructing balancing or retention tanks.

Overflows and surface water outfails Severn Trent Water has 2,284 known storm sewage overflows and 1,181 emergency overflows from pumping stations. Full consents have been granted for 1,006 of the storm sewage overflows and 609 of the emergency overflows. Temporary consents have been granted in respect of the remainder, with the exception of 56 overflows the consent applications for which are in the process of determination by HMIP or the NRA. The temporary consents have been granted in advance of substantive consideration by the NRA, as described in Chapter II of the General Section. To help protect against pollution from storm sewage and emergency overflows, Severn Trent Water is currently assessing whether these overflows operate satisfactorily. Severn Trent Water has installed telemetry alarms in over 60 per cent. of pumping stations and it is proposed to extend this coverage. These alarms give prompt warning of pump failure and the likely operation of emergency overflows,

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Severn Trent Water has carried out an exercise in conjunction with District Councils to identify storm and emergency overflows. In addition, Severn Trent Water is compiling new sewer records and studying the performance of the sewerage system, including overflows, As a result, overflows have been identified which did not have consents but which have now been consented. The Directors consider that further storm overflows may be discovered and in these circumstances any necessary consents will be applied for. In addition, the sewerage networks include approximately 7,000 surface water outfalls. The Directors consider that discharges from most of these outfalls are exempt from any consent requirement. Of the remainder, those outfalls known to contain polluting matter have been consented. However, the nature of surface waters collected by Severn Trent Water's sewerage system is such that some discharges are likely, on occasions, to contain polluting matter, Severn Trent Water plans to make applications for consents as appropriate. Causing or knowingly permitting discharges of polluting matter in breach of a discharge consent, or which are unconsented and otherwise unauthorised, is a criminal offence under the Water Act. This matter is discussed in further detail under "Duties of sewerage undertakers" in Chapter II of the General Section.

Sewer records Severn Trent Water has adopted a standard specification for sewer records. The process of compiling all records to this specification commenced prior to 1983; and approximately 60 per cent. of these records have been completed. The Directors believe the exercise will be finished by 1997, in advance of the requirement imposed by the Water Act to complete mapping of sewers by 1st September, 1999. Until this exercise is completed, the Directors will not be able to establish accurately the total length of sewers in the Sewerage Region, particularly in relation to Section 24 Sewers which are described in Chapter 1 of the General Section. The additional costs.associated with maintaining and repairing Section 24 Sewers are not considered by the Directors to be material.

Sewerage Arrangements Sewerage Arrangements with District Councils are described in more detail in Chapter I of the General Section. The vast majority of the sewerage system is maintained by 74 of the 80 District Councils in the Sewerage Region which undertake operational activities on behalf of Severn Trent Water. Of these District Councils, 71 also incur expenditure on behalf of Severn Trent Water on the design and construction of new sewers and pumping stations and remedial work to the existing system. Such work requires prior approval from Severn Trent Water, Operating costs and capital investment by District Councils in the year ended 31st March, 1989 amounted to some £50 million. Sewerage Arrangements are subject to detailed financial and technical reviews of operating budgets and investment procedures by Severn Trent Water in order to identify potential cost savings and effective operational practices. Between 12 and 18 such reviews have been carried out each year since 1983. Despite a steady increase in the length of sewers maintained and the number of pumping stations in operation, Severn Trent Water has been able to achieve efficiency savings since 1984. The Directors will continue to monitor the performance of District Councils in respect of the Sewerage Arrangements with the aim of ensuring that customers receive a cost effective and acceptable level of service.

Sewage treatment and disposal With no coastline, nor easy access to the sea, Severn Trent Water does not dispose of sewage or sludge to sea. It has accordingly developed extensive facilities for, and considerable experience in, sewage treatment and sludge disposal. Severn Trent Water operates a total of 1,063 sewage treatment works, and in the year ended 31st March, 1989 these works treated in aggregate an average of 2,810 Ml/d. The works range in size from Minworth, serving Birmingham and parts of the Black Country and treating over 500 Ml/d on average, to small plants serving just a few premises. All sludge is disposed of to land or is incinerated.

Sewage treatment works The extent of treatment at sewage treatment works is dependent on the strength and nature of the sewage and the consent standard required of the treated effluent. A typical sewage treatment process is described in Chapter I of the General Section. As the vast majority of the sewage treatment works in the Sewerage Region discharge to rivers, consents for such works are generally granted with stricter conditions than those granted in the case of sewage treatment works which discharge into estuaries. The table on the following page shows the extent of treatment facilities operated by Severn Trent Water and demonstrates that the great majority of sewage treatment works provide both primary and secondary treatment.

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Number of Volumes sewage treatment works treated % . 2 Primary only 63 Primary and secondary 745 70 Primary, secondary and tertiary 255 28 1,063 .100

All sewage treatment works have discharge consents, other than four works where the applications for consents are awaiting determination by HMIP or the NRA and 13 works discharging to soakaways which the Directors consider do not require consents. In assessing compliance in the past, Severn Trent Water interpreted look up tables on a determinand by determinand basis in accordance with DOE requirements but, as explained below, the NRA may now adopt a more stringent interpretation. On the previous basis most sewage treatment works were able to comply with the conditions of their discharge consents. However, given the nature and variability of sewage flows, the nature of sewage treatment processes, the design of sewage treatment works and the statistical basis of determining compliance with numerical consents, full compliance with consent conditions at all times cannot be assured. As at 1st September, 1989 Severn Trent Water had 771 works with numerical consents with both quality and volume conditions. In the year ended 31st August, 1989 the great majority of all works complied with the quality conditions in their consents. However, as a result of the risk of failure in the future, Severn Trent Water has applied for consents with time limited conditions in respect of 99 works. These works, serving less than 7 per cent. of the resident population of the Sewerage Region, have experienced difficulty, or are considered likely to experience difficulty, to a greater or lesser degree, in complying with the quality conditions of their consents. Temporary consents for these works were granted in September 1989 pending consideration of applications for consents with time limited conditions by the Secretary of State. In the majority of these cases, consents with time limited conditions have now been issued. In respect of the remainder, it is expected that the Secretary of State will determine the applications shortly. Whilst Severn Trent Water has discussed these applications with HMIP, it is possible that some of these consents will be issued with conditions which Severn Trent Water considers could give rise to an increased risk of non-compliance. In such cases additional expenditure could arise which would be eligible for consideration for Specific K Adjustment. Those consents with time limited conditions which have already been granted incorporate two sets of standards as described in Chapter II of the General Section. The first set remain in force until varying dates no later than March 1992 and are subject to upper tier quality conditions. The second set of standards automatically replace the first set once the specified period has expired. These reflect the standards in previous consents or, in some cases, tighter standards. Consents with time limited conditions which are granted in respect of the outstanding applications are expected to incorporate similar sets of standards. Severn Trent Water attempts to arrange construction work so as not to disrupt significantly treatment processes or affect effluent quality, thereby reducing the risk of the works failing to meet their consents, However, where disruption is unavoidable, consents with time limited conditions are applied for. Severn Trent Water has applied for a number of such consents. In a few cases, works have failed to meet their consents due to overloading as a result of trade effluent discharges. Short term remedial action has been undertaken either by Severn Trent Water or the trade effluent discharger. The Directors consider that these works should now be able to comply with their consents. As a result of the trade effluent consents issued to engineering and other industries in the Sewerage Region, Severn Trent Water is required to comply with discharge consents containing limits on non- sanitary determinands (metals and organic compounds) at 62 of its sewage treatment works. Consent standards for non-sanitary determinands are such that a single failure in a year causes non-compliance. Severn Trent Water has varied 108 trade effluent consents for discharges to 12 sewage treatment works. The Directors consider that this action should enable all these works to comply with their consents. A temporary consent has been issued in respect of one works which does not comply with the colour parameter in its existing consent. At a second works Severn Trent Water is currently awaiting the resolution of appeals by trade effluent dischargers against notices issued by Severn Trent Water to vary the terms of their trade effluent consents. This works will not complywith a pesticide condition in its discharge consent unless the appeals are dismissed by the Secretary of State and the pesticide condition in the discharge consent for the works is varied. Severn Trent Water will consider what action is appropriate if the appeals are allowed or if the consent is not varied.

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Based on the measurement of flows or, where appropriate, estimates of flows treated at works where flows are not regularly measured, the Directors believe that 170 works have difficulty complying with the volume conditions in their original consents. Severn Trent Water has received temporary consent variations of volume conditions in respect of these works, pending substantive consideration by the NRA in due course. Severn Trent Water has 261 works with descriptive consents, all of which have been able to comply with the conditions of their discharge consents. Temporary consents have also been issued in respect of 18 previously unconsented small works, pending substantive consideration by the N RA. Considerable improvements at certain sewage treatment works have been made over recent years by Severn Trent Water, principally to ensure compliance with consents. This progress will continue with the implementation of Severn Trent Water's K Investment Programme and modifications to operational procedures. In particular, programmes are included in the K Investment Programme which envisage that, by the dates by which the first set of standards in consents with time limited conditions expire or are expected to expire, the relevant works will comply with the second set of standards in such consents, other than in exceptional circumstances. In the past, Severn Trent Water has assessed compliance with respect to samples taken within a restricted daily period and at certain frequencies; at some sewage treatment works composite samples were also taken. The NRA statement of policy (set out in Chapter 11 of the General Section) indicates that the NRA aims to increase substantially the frequency of sampling and to sample whenever and with whatever frequency it considers necessary. A change by the NRA of the sampling period or sampling frequency could give rise to an increased risk of non-compliance at some works and any resulting expenditure would be eligible for consideration for Specific K Adjustment. As stated above, Severn Trent Water's practice in assessing compliance in the past has been to interpret look up tables on a determinand by determinand basis, in accordance with DOI= requirements. However, consent conditions in many cases could be interpreted to require assessment by reference to the aggregate of failed samples taken over the relevant 12 month period. As set out in Chapter II of the General Section, the NRA has stated that it will judge compliance with each consent against the exact wording of the consent. The Directors believe that, if there were to be a change in the interpretation of the relevant discharge consents from a determinand by determinand basis to an aggregate basis, this may result in a small number of works being at increased risk of breach of their discharge consents. Expenditure arising from any such revised consent interpretation would be eligible for consideration for Specific K Adjustment. The Directors recognise that it is inevitable that breaches of consents will occur at certain works, but they believe that they have taken reasonable steps with a view to minimising these risks. Causing or knowingly permitting discharges of polluting matter in breach of a discharge consent, or which are unconsented and otherwise unauthorised, is a criminal offence under the Water Act. This could lead to prosecution either by the NRA or another party. This matter and the policy of the NRA are discussed in further detail under "Duties of sewerage undertakers" and "The NRA" in Chapter 11 of the General Section. The NRA is carrying out an urgent review of the way in which discharge consents are set and the way in which compliance is assessed. Further details are given in Chapter II of the General Section. Should this review give rise to changes in consent conditions, any expenditure would be eligible for consideration for Specific K Adjustment.

Sludge disposal Severn Trent Water disposes of sludge containing approximately 175,000 tonnes of dry solids per annum from its sewage treatment works. The approximate percentages disposed of in the year ended 31st March, 1989, by the means described in Chapter I of the General Section, are shown in the table below:

Primary method of disposal Approximate total dry solids % Agricultural land 47 Landfill . 19 Dedicated land 17 Incineration 17 Sea -- 100

Note: The liquid content of sludge disposed of varies according to the method of disposal.

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As a result of Severn Trent Water's inland position, the disposal of sludge at sea is neither practicable nor cost effective. It has therefore invested in sludge digestion, which is described in Chapter I of the General Section, and now has the capacity to digest an estimated 85 per cent. of sludge produced. One of the by products of this process, methane gas, is used to generate electricity for on site use at six of Severn Trent Water's largest sewage treatment works. Severn Trent Water has pioneered a method of continuous sub soil injection of sludge which received a pollution abatement award from the Royal Society of Arts. This process is generally cheaper than traditional methods of surface spreading and ensures more efficient sludge application on appropriate soils. About one sixth of the total sludge production is incinerated at Severn Trent Water's Coleshill plant. Although relatively expensive, and only practicable on a large scale, incineration is the most cost effective method of sludge disposal in the Birmingham area; incineration leaves a residue of ash for disposal to landfill sites. The position regarding the deposit or disposal of sludge at sewage treatment works or on land for agricultural purposes is described under "Disposal of sewage sludge" in Chapter II of the General Section. Severn Trent Water is considering its position and will take such action as it is advised to be necessary.

Estuarial out falls Sewage received from two small communities with a total estimated population of less than 1,100 is discharged into the Severn Estuary after partial treatment.

Technological developments The provision of water supply and sewerage services involves a range of plant and equipment using both traditional and new technology systems. Severn Trent Water invests in new technology where economies of scale, operational savings or enhanced quality and service levels can be achieved. The examples referred to in Chapter I of the General Section are all employed in the Region, as follows: all operating districts have some form of telemetry; digital mapping of the distribution system is being developed in one district; computer systems have been developed for network analysis of both the distribution and sewerage systems; data logging equipment, developed by Severn Trent Water, is now used to collect and store data relating to customer demand and operational activities; and various techniques are used to replace and renew mains and sewers. Computer aided design is used in each of the principal engineering design offices. In addition, enhanced process technology involves the introduction of GAC at four water treatment works and ozonation at one of those works.

Research and development Research and development comprises a combination of locally funded and managed projects and work undertaken by the WRc, in which Severn Trent Water has a 20 per cent. holding of both "B" ordinary shares and convertible loan stock. Severn Trent Water's current policy is to encourage the research and development of technology, plant, processes and systems whenever such activity can profitably support the overall objectives of the business. Research and development expenditure in the year ended 31st March, 1989 amounted to some £2.3 million. Severn Trent Water is committed to a continuing relationship with the WRc through a common interest research agreement and a programme of "core research", both of which are described in Chapter I of the General Section. The Directors intend to place greater emphasis on innovation and development than on research. They believe that there will be opportunities to manage more effectively the significant investment in process technology programmed for the early 1990s, by using and developing special expertise through joint ventures and partnerships with the WRc, universities and other organisations, and through acquisitions.

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Customers Customer service A number of the duties of Water Service Companies in relation to customers are described in Chapter II of the General Section, Severn Trent Water is committed to improving the quality of service to its customers and, since 1984, has regularly evaluated the level of service received by its customers. Considerable investment has already been made to improve the appearance of water, the reliability and pressure of water supply and to relieve foul flooding. Severn Trent Water is projecting higher levels of investment for further improvements in the future; such expenditure has been included in the K Investment Programme.

Basis of charging and collection The vast majority of Severn Trent Water's domestic customers receive unmetered services and currently pay charges based on rateable value. In anticipation of the abolition of domestic rateable values and the introduction of the Community Charge, Severn Trent Water has examined alternative charging systems, although none has yet been selected. If widespread metering is introduced, the resulting expenditure would be eligible for consideration for Specific K Adjustment. Severn Trent Water has experience of domestic metering on a relatively large scale in the town of Malvern, where metering has formed a basis of charging for over 100 years. I n addition, optional metering for domestic premises throughout the Water Region has been available since 1982 and under these arrangements approximately 30,000 meters have been installed in domestic premises. With effect from 1st April, 1989 all new premises in the Water Region have been metered. Most non-domestic customers already receive metered services. Severn Trent Water intends to introduce infrastructure charges from April 1990 as outlined in Chapter ll of the General Section. In addition, changes in the incidence of costs borne by different classes of customers will arise when new charges are introduced to existing customers to replace rateable values as a means of recovering the costs of surface water and highway drainage. This must be completed before the year 2000 and Severn Trent Water is currently considering alternative bases of charges and the timetable for their introduction. The majority of Severn Trent Water's customers are billed directly for the services they receive. In the past, however, charges for over 1.2 million premises have been collected on an agency basis by District Councils, other water undertakers or major property owners. The Social Security Act 1988 and the introduction of the Community Charge have recently caused District Councils and certain other property owners to review these arrangements. As a result, a number of agents have given notice to terminate their agreements. Since 1st April, 1989 charges for over 140,000 of these premises have been billed directly by Severn Trent Water and it is expected that a further 385,000 will be billed directly with effect from 1st April, 1990. The revised arrangements are likely to increase operating costs by some £2 million per annum, for which provision has been included in the initial level of K.

Recreation, conservation and the community The duties of Water Service Companies concerning environmental and recreational matters are described in Chapter II of the General Section. Over the last 15 years, Severn Trent Water has developed recreational activities particularly at reservoir sites where public access is encouraged. Apart from traditional recreational activities, such as sailing and fishing, general recreational areas, nature trails, bird watching facilities and visitor centres have been developed. Severn Trent Water has received a number of environmental and conservation awards for these developments.

Other trading activities In the past, the scope for the development of other trading activities was constrained by legislation. However, Severn Trent has been able to carry out a number of other trading activities through what are now divisions of Severn Trent Industries, as follows: Severn Trent International This division undertakes institutional and organisational reviews, advises on operational and financial management, and provides training and management development facilities, predominantly overseas. Major projects have already been completed in Nairobi and Mauritius. Current projects include further work in Mauritius and two contracts in India; Severn Trent Laboratories This division comprises two laboratories, one in Birmingham and one in Coventry, which provide a wide range of analytical services to a developing customer base. In addition to Severn Trent Water, customers include Government Departments, Environmental Health Departments of District Councils, industrial effluent producers, contractors and consultants;

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Severn Trent Process Plant This division provides a process plant design and construction service for the Group and external customers. Marketing has been targeted initially at customers for both sludge digestion equipment and other aspects of sewage treatment and disposal;

Severn Trent Waste Disposal This division is engaged in waste disposal activities associated with landfill operations; and

Severn Trent Systems This division is engaged in the marketing, in conjunction with IBM, of a series of business control systems. In addition, Severn Trent Property Limited is engaged in property development activities.

DIRECTORS, MANAGEMENT AND EMPLOYEES The Group comprises a holding company and three trading subsidiaries. Severn Trent Water, the principal subsidiary, is responsible for the appointed business. Severn Trent Industries and Severn Trent Property Limited carry out the other trading activities of the Group.

The Company The board is responsible for policy and the overall direction of the Group. It comprises a Chairman, a Non-executive Deputy Chairman, a Chief Executive, and nine other Directors, five of whom are Non-executive. There is a Chairman's committee, and board committees responsible for audit and remuneration, The Group's activities are dealt with on a day to day basis by an executive committee, comprising all Executive Directors and chaired by the Chief Executive. The key functional roles of the Company include group accounting, treasury management, taxation and the Company Secretary's department.

Directors of Severn Trent John Bellak MA (59), Chairman, became a member of Severn Trent Water Authority in June 1982 and was appointed Chairman in October 1983. He has 30 years experience in exporting and in the textile and ceramic industries, latterly as managing director of Royal Doulton. Mr. Bellak is a member of the Grand Council of the CBI and a member of the Court of the University of Keele. He is non- executive chairman of Sutcliffe Speakman and a non-executive director of Control Securities.

Tim Heywood-Lonsdale MA (52), Non-executive Deputy Chairman, was appointed to the board of Severn Trent Water Authority in October 1983. He is chairman of Skilbeck Holdings and combines this with property management, farming and other directorships. He was High Sheriff of Shropshire from 1986 to 1987.

Roderick Paul MA, FCA (54), Chief Executive, was appointed to the board of Severn Trent Water Authority in October 1988. He has 30 years experience in the private sector gained with Glynwed, BOC and the Mitchell Cotts Group. He was chief executive of Mitchell Cotts from 1985 until 1987 and joined Severn Trent in February 1988. He is a council member of the CBI in both the East and West Midlands, a council member of the Birmingham Chamber of Industry and Commerce and a member of the Court of the University of Warwick.

Vic Cocker BA, MIWEM (49), Director of Business Planning and Marketing, was appointed to the board of Severn Trent Water Authority in October 1988. An economist, he spent 12 years in the gas industry before joining Severn Trent in 1974 as principal economist. He became head of policy and planning in 1983.

Frank Earnshaw CEng, FICE, MI MechE, FIWEM (61), Director of Operations, was appointed to the board of Severn Trent Water Authority in November 1985. He has 39 years water industry management experience and has been with Severn Trent since its formation. Stuart Larnder FCA (45), Director of Finance, was appointed to the board of Severn Trent Water Authority in March 1989 after joining Severn Trent in November 1988. He has held directorships and finance and financial planning positions with a number of companies, particularly in the brewing industry. His recent appointments have included managing director of McEwan Younger (1983-1985) and finance director of Alfred Preedy (1985-1988).

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Colin McMillan Bcom, IPFA (61), Director of Government Relations and Company Secretary, was appointed to the board of Severn Trent Water Authority in October 1983. He has wide financial experience in the public sector, particularly in transportation and water, and was director of finance of Severn Trent Water Authority from 1979 to 1989. He is aformer county treasurer of Warwickshire, and was president of the Chartered Institute of Public Finance and Accountancy from October 1988 to October 1989.

Sir Richard Baker Wilbraham Bt (55), Non-executive Director, was appointed to the board of Severn Trent in September 1989. He retired recently from the board of merchant bankers J. Henry Schroder Wagg for whom he worked from 1954, becoming a director in 1969. He is deputy chairman of Bibby Line Group and Grosvenor Estate Holdings and a non-executive director of Brixton Estates, Really Useful Group and Westpool Investment Trust. Roger Boissier (59), Non-executive Director, was appointed to the board of Severn Trent Water Authority in October 1986. He is deputy chairman of Pressac Holdings and a non-executive director of British Gas, Edward Lumley Holdings, T&N and a number of other companies. He was High Sheriff of Derbyshire from 1987 to 1988. Alan Henn (59), Non-executive Director, was appointed to the board of Severn Trent Water Authority in October 1986. He is chairman and managing director of a family jewellery business and is a director of a number of other companies, including Beacon Broadcasting and Communications, of which he is also chairman. He was appointed a Justice of the Peace in 1959, and is currently president of the National Association of Goldsmiths.

Richard Ireland FCIS (55), Non-executive Director, was appointed to the board of Severn Trent in September 1989. He is the group finance director of Wolseley, with whom he has been for over 30 years in financial and company secretarial roles. He is currently a council member of the Birmingham Chamber of Industry and Commerce and is also a member of the finance committee of the University of Aston.

Andrew Simon Bsc, MBA (44), Non-executive Director, was appointed to the board of Severn Trent Water Authority in October 1986, He is the executive chairman of the Evode Group, which he joined in 1971, and a director of the Birmingham Region of Barclays Bank and Lichfield Cathedral Arts. He is also a council member of the University of Keele.

Severn Trent Water The organisation of Severn Trent Water comprises a two tier structure of corporate headquarters in Birmingham and 15 operating districts which provide day to day services to customers. The headquarters' functions include policy determination and monitoring and a number of functions which have been centralised to achieve standardisation of practices and increased productivity. These include data management, legal services, land management, accounting services, customer billing and debt collection. Other headquarters' departments provide support to the operating districts and include quality assurance, engineering design and project management, operational planning and technical support. The fifteen district managers are responsible through two general managers to the Director of Operations. The general managers are involved in policy formulation and the coordination of all district activities. Individual districts differ in their characteristics; some districts have a concentration of bulk water supply activities, other districts have a higher incidence of sewerage services. Of the 15 districts, all but two provide both water supply and sewerage services. The two Birmingham districts provide a single service only; one provides water supply, the other provides sewerage services.

Directors of Severn Trent Water The board of Severn Trent Water comprises Messrs. Bellak, Paul, Cocker and Earnshaw, who are also on the board of Severn Trent, and the following other directors: Brian Duckworth BA, FCCA (40), Director of Finance, After four years in the electricity industry he joined Severn Trent Water Authority in 1974 where he has held a number of financial and managerial posts. He became assistant director of finance in 1988, and Director of Finance in August 1989; and

Ged Fisher BSc, AMIPM (47), Director of Personnel. Following personnel positions in the electricity and brewing industries, he joined Severn Trent Water Authority in 1974 as industrial relations coordinator, becoming head of manpower services in 1980.

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The day to day operations are managed through an executive management committee comprising Messrs. Paul (Chairman), Cocker, Duckworth, Earnshaw, Fisher and the two general managers.

Senior management of Severn Trent Water The senior managers, most of whom have spent the majority of their careers in the water industry, have a broad range of experience in a variety of managerial positions.

Severn Trent Industries Roderick Paul is the Chief Executive of Severn Trent Industries.

Employees The average number of permanent full time equivalent employees for the five years ended 31st March, 1989 is shown in the following table:

Years ended 31st March, 1985 1986 1987 1988 1989. Craft and manual 4,446 4,167 3,937 3,739 3,541 Management and staff 4,818 4,625 - 4,412 4,254 4,216 Total. 9,264 8,792.. 8,349 . 7,993 7,757

Note: All figures include employees previously engaged on activities since transferred to the NRA, but exclude employees engaged in the administration of the Water Authorities Superannuation Fund ("WASF"), for which Severn Trent Water Authority was the administering authority.

On 1st September, 1989 following the transfer of 738 employees to the NRA, the Group had 7,148 permanent full time equivalent employees of whom 3,206 were craft and manual, and 3,942 were management and staff. Severn Trent Water has well established industrial relations arrangements. Three separate regional councils cover staff, manual employees and craftsmen. These councils were previously linked to national negotiating machinery which, prior to 31st August, 1989, was responsible for the principal terms and conditions of employment for the majority of employees. From 1st September, 1989 the responsibility for negotiations in respect of pay, terms and conditions transferred to Severn Trent Water. Based on payroll deduction records, 93 per cent, of craft and manual employees and 78 per cent. of management and staff are union members. Since the national water strike in 1983, there have been only four minor local disputes. Severn Trent Water places significant emphasis on the training and development needs of employees. A management development programme has been in place for a number of years comprising in-house and residential courses for management, supervisory and technical skills, and long term management development schemes. In addition, Severn Trent Water places emphasis on process knowledge training for relevant employees.

Employee share schemes Severn Trent has established a Trust Scheme as part of the arrangements for employees to acquire Ordinary Shares in the Severn Trent Offer. This scheme can also be used in future years if the Directors so determine. It has also adopted a Sharesave Scheme and an Executive Scheme. Details of these schemes are set out in Part 2 of Chapter IV of the General Section.

Pensions Severn Trent operates two principal pension schemes, the Severn Trent Water Mirror Image Pension Scheme and the Severn Trent Water Pension Scheme. Details of these schemes are set out in Chapter V of this Section. Until 30th September, 1988 the majority of employees contributed to WASF, a fund within the Local Government Superannuation Scheme, which is described in Part 7 of Chapter IV of the General Section. From 1983, Severn Trent Water Authority was the administering authority for WASF, but this role was discontinued at Vesting.

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FINANCIAL SUMMARY Trading record The HC trading record of Severn Trent for the five years ended 31st March, 1989 is set out in the table below:

Years ended 31st March, 1985 1986 1987 1988 1989 £m £m £m £m £m Turnover 334.2 369,4 402.5 434.5 476:4. Operating costs before exceptional items (218.1) (234.9) (248.9) (273.8) (298.8) Exceptional items (42.7) (2.1) (13:1) 19,8 (5.5)

Operating profit 73.4 132.4 140.5 • 180.5 172.1 Other income 1.8 1.5 3.1 2.5 6.3 Profit before interest 75.2 133.9 143.6 183.0. 178.4 Net interest payable (93.0) (94.9) (91.6) .. , (86.4) (80.9) Profit/(loss) on ordinary activities (17..8) 39.0 52.0 96.6 97.5 Extraordinary items - (33.8) 3.2 (2.8) Retained profit/(loss) for the period (17.8) 39.0 18.2 99.8 94.7

The financial information in the table above has been extracted from the Accountants' Report in Chapter II of this Section. This information reflects adjustments principally as a consequence of the adoption of a new policy of accounting for infrastructure assets and the transfer of activities to the NRA. Accordingly, the results stated differ from the reported audited results of Severn Trent during that period. They do not indicate what the results of Severn Trent would have been had the NRA and the new regulatory environment been in existence during that period or had Severn Trent been in the private sector throughout that period. The financial record is not necessarily indicative of the future performance of Severn Trent in the private sector under the regulatory arrangements which now apply. Severn Trent was exempt from corporation tax during the five years ended 31st March, 1989. As a Water Authority, Severn Trent was subject to significant influence by HM Government on its financial affairs. In recent years, the level of profits has been affected by the application of financial performance criteria agreed with HM Government and explained in Part 7 of Chapter IV of the General Section. The pricing policy adopted by Severn Trent was determined by these criteria. For the five years ended 31st March, 1989 Severn Trent achieved its Financial Targets and Performance Aims. On three occasions Severn Trent exceeded its External Financing Limit by amounts which were not considered material in the context of its finances. The requirement to meet these financial performance criteria has resulted in Severn Trent financing increasing investment expenditure through higher charges. Whilst turnover has increased significantly over this period, it largely reflects the annual increases in charges. Efficiency savings have been achieved over the five year period due principally to significant savings in manpower. Tiers of management have been removed, productivity has increased and, where cost effective, direct labour has been replaced by hired services. Energy costs- have also been reduced, principally as a result of better tariff management, including greater use of off peak tariffs and energy efficient equipment. Over the five year period, expenditure on infrastructure assets has increased mainly as a result of the programme of mains rehabilitation. The increase in depreciation charges in the same period reflects an increased investment programme and the effects of inflation. interest payable represents interest on loans used principally to finance investment in previous years. Interest payable has been reduced as a result of lower interest rates, the early redemption of loans, savings resulting from interest rate swaps and, latterly, a small reduction in borrowings. The exceptional items arose as follows: in each of the five years redundancy costs have been included; in the years ended 31st March, 1985, 1988 and 1989 premiums were paid on early repayment of loans; and in the year ended 31st March, 1988 a £26.5 million refund of general rates was included as a result of the "Cakebread" case, as described in Part 7 of Chapter IV of the General Section.

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The extraordinary items in the years ended 31st March, 1987 and 1988 relate to the Carsington dam and reservoir scheme. The extraordinary charge in the year ended 31st March, 1987 relates to costs written off following construction problems, and the extraordinary credit in the year ended 31st March, 1988 arises from the recovery of costs from the advising consulting engineers. In the year ended 31st March, 1989 an extraordinary charge was made relating to costs associated with the preparation for Vesting.

Cash flow and capital expenditure During the five years ended 31st March, 1989 the Financial Target has been consistently exceeded to finance the growing investment programme which comprised both capital expenditure and infrastructure renewals expenditure. In the year ended 31st March, 1985 capital expenditure was £71 million and infrastructure renewals expenditure was £19 million. Of the total of £90 million, some £43 million was met from external loans. In the year ended 31st March, 1988 with investment expenditure still rising, Severn Trent was no longer permitted to increase borrowings in order to finance investment expenditure and had become a net repayer of borrowings. In the year ended 31st March, 1989 capital expenditure was £155 million and infrastructure renewals expenditure was £50 million. During the same period Severn Trent met its External Financing Limit which included a reduction in debt of some £17 million. Since 1984 Severn Trent Water has received ERDF grants of over £13 million. In the future, the Directors believe that Severn Trent Water is unlikely to receive the same level of funding from this source.

Assets As at 31st March, 1989 the HC balance sheet principally comprised tangible fixed assets amounting to £1,356 million. The Group's principal tangible fixed assets by value are the underground networks of trunk and local distribution mains and sewer pipes. These account for some 50 per cent. of the total fixed asset value. The principal assets which are built above ground comprise reservoirs, water treatment works and sewage treatment works.

Land and buildings The Group has freehold and/or leasehold interests in properties covering over 50,000 acres of land in total, substantially all of which are in operational use. The operational properties of the Group can be divided into three principal categories: (a) specialised properties covering approximately 22,000 acres, which consist chiefly of treatment works, reservoirs and pumping stations; (b) non-specialised properties covering over 1,000 acres, which are predominantly offices, depots, workshops and residential properties held for purposes directly connected with water supply and sewerage services; and (c) catchment land of approximately 26,000 acres which is held for the purpose of protecting water supplies. A summary of the principal operating establishments of the Group is included in Chapter V of this Section. The Directors have identified certain properties which are surplus to current operational requirements or are likely to become surplus to requirements over the next five years. This [and totals approximately 1,500 acres, the majority of which has little development potential. The Directors believe that the value or potential value of these properties is immaterial in the context of the Group. In addition to those properties which the Directors have identified as surplus to the requirements of the business of Severn Trent Water and which are likely to become surplus over the next five years, the Directors believe that there may be further scope for the realisation of development potential in other operational properties, both specialised and non-specialised. The benefits arising from any such redevelopment will depend, inter alia, on the costs of relocating operational plant and the obtaining of appropriate planning consents. Any such benefits have not been taken into account in setting the initial level of K but may be taken into account in subsequent reviews or interim adjustments of K. Chapter II of the Genera[ Section describes the regulatory provisions relating to certain disposals of land.

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Taxation As explained in Chapter III of the General Section, the Group is entitled to capital allowances on qualifying assets transferred from Severn Trent Water Authority. The amount of expenditure at Vesting qualifying for plant and machinery writing down allowances at 25 per cent. per annum on the reducing balance basis was £1,018 million. The amount of expenditure at that date qualifying for industrial buildings allowances was £44 million which will be relieved over the remaining tax life of the relevant buildings, which was at least ten years as at Vesting.

Until such time as a liability to mainstream corporation tax or deferred tax arises, it is expected that the only tax charge to the profit and loss account will be the write off of irrecoverable advance corporation tax.

CAPITAL STRUCTURE On 15th November, 1989 all of the Group's indebtedness in respect of relevant loans amounting to £831.4 million was written off and, on 20th November, 1989 the Secretary of State entered into a conditional agreement to subscribe (361.0 million for Ordinary Shares in Severn Trent, as more fully described in Chapter V of this Section. The effect of this capital restructuring on the Group, based on the financial position at 31st March, 1989 (as derived from the Accountants' Report in Chapter I I of this Section) is set out in the pro forma HC balance sheet below:

As at 31st March, 1989 Unadjusted Pro forma Net assets excluding net cash and current £m fm asset investments or net debt 1,293.6 1,293.6 Net cash and current asset investments 312.8 1;293.6 1,606.4

Shareholders' funds 414.0 1,606.4 Net debt 879.6

Note: The pro forma balance sheet has been compiled on the basis of the following adjustments: (i) write off of 1831.4 million of relevant loans as at 15th November, 1989; and (ii) cash subscription of £361.0 million. .

INVESTMENT EXPENDITURE Investment expenditure which will or maybe incurred by the Group includes both expenditure in respect of the K Investment Programme and substantial additional expenditure.

K Investment Programme Summarised in the table on the following page are the Directors' current estimates of the expenditure required by the K Investment Programme in respect of the ten years ending 31st March, 2000. Some of the K Investment Programme extends beyond the year 2000. Given the purpose, size and timescale of the work included in the K Investment Programme, these estimates, which lie within a range of possible outcomes, are inevitably subject to significant uncertainty and will be periodically reassessed and revised, as appropriate, by the Directors. The bases and principal assumptions relating to the estimates are set out in Chapter 111 of the General Section and Chapter IV of this Section. A letter from Sir William Halcrow & Partners Ltd., Consulting Engineers, in respect of the estimates of expenditure on water supply and sewerage services, is also set out in Chapter IV of this Section, The estimates are presented at November 1989 prices and will be subject to inflation at a rate which may differ from changes in RPI.

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Estimated expenditure required by the KInvestment Programme in respect of the ten years . ending 31st March, 2000 Five years ending 31stMarch, .;. 1995 . ,: 2000:. : (November 1989 prices) Water supply fin €m Resources 50 40 Treatment 450 300 Distribution 550 460 :. Sewerage services Sewerage network 420 390 Sewage treatment works 630 370 :2,100 1,560.: Other 230 '190 2,33,1 1.,750; analysed as follows: Infrastructure assets* 1,030 890 Non-infrastructure assets 1,300 ..._ 860 2,330 . 1,75.0 "Including both capital and renewals expenditure.

The expenditure on infrastructure assets shown in the table above comprises both expenditure which will be capitalised and renewals expenditure which will be charged to the profit and loss account, Further information on the accounting treatment of infrastructure expenditure is included in Chapter III of the General Section. The Directors estimate that the charge to the profit and loss account for renewals expenditure will be approximately £71 million in the year ending 31st March, 1990. On the basis of the Directors' current estimates of renewals expenditure contained in the K Investment Programme, it is expected that the annual charge will remain at approximately the current level in real terms up to the first Periodic Review. However, adjustments will be necessary arising from the revaluation to prevailing prices of the related accrual. In view of the profile of infrastructure renewals expenditure, the accrual is expected to increase and remain at a significant level in the ten years ending 31st March, 2000. For the year ending 31st March, 1990 the Directors estimate that investment expenditure on infrastructure assets and non-infrastructure assets will be approximately £101 million and f166 million respectively. The estimated expenditure relating to "Other" principally comprises expenditure on office accommodation, information technology, telemetry equipment and vehicles.

Additional expenditure In addition to the expenditure required by the K Investment Programme, substantial additional expenditure may be required over the ten years ending 31st March, 2000 and beyond in respect of existing or future legal and regulatory obligations. Much of this expenditure, including any difference in national construction cost inflation in respect of the estimates in the table above in excess of that allowed for in the initial setting of K, would be eligible for consideration for Specific K Adjustment. All expenditure in respect of functions as a water undertaker and a sewerage undertaker can be considered at the next Periodic Review of K. This is described in Chapter II of the General Section.

REGULATION --- K Under the new regulatory regime, Severn Trent Water will be allowed to increase the average of its principal charges by the percentage change in RPI plus an adjustment factor K of 5,5 per cent, in each of the five years ending 31st March, 1995 and a factor of 2 per cent, in each of the five years ending 31st March, 2000. K may be reviewed or adjusted by the Director General as described in Chapter II of the General Section.

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Had the conditions of the Appointments relating to charges applied during the year ending 31st March, 1990 the Directors estimate that approximately 94 per cent. of Group turnover would be within the K price limitation formula. A further 3 per cent. would, or could in certain circumstances, be otherwise regulated and 3 per cent. would be unregulated.

CURRENT TRADING AND PROFIT FORECASTS On the basis of the principal assumptions set out in Chapter Ill of the General Section, the Directors forecast that, in the absence of unforeseen circumstances, the HC profit on ordinary activities of the Group (stated after interest but before taxation and extraordinary items) for the year ending 31st March, 1990 will be not less than £121 million. This forecast incorporates a number of significant changes to prior periods in respect of turnover, operating costs and interest. Turnover is expected to reflect principally an average increase in charges of 9.1 per cent. and the requirement to recharge certain operating costs to the NRA. Severn Trent's operating costs are expected to increase at a rate significantly above the rate of inflation, principally as a result of changes in the operating cost base. In particular, the infrastructure renewals charge is expected to increase from £50 million to £71 million. Operating costs will also increase this year as a result of work to achieve compliance with sewage treatment works' consents and the Water Quality Regulations, and the costs associated with becoming a listed company. It is expected that the increase in operating costs will adversely affect operating profit in the current year. Severn Trent's net interest charges are expected to be significantly reduced in comparison with the year ended 31st March, 1989 as a result of the capital restructuring described in "Capital Structure" in this Chapter. The only tax charge on forecast profits is expected to be the write off of irrecoverable advance corporation tax in respect of the forecast dividend referred to under "Dividends" below. Certain costs associated with privatisation and the change of status of Severn Trent to that of a listed public company will be treated as extraordinary items. Based on the forecast profit, the pro forma forecast profit on ordinary activities (stated after interest but before taxation and extraordinary items), compiled on the basis described in Chapter III of this Section, would be not less than £208 million. The unadjusted and pro forma profit forecasts, together with the pro forma forecast earnings per Ordinary Share, are summarised below. Further information is set out in Chapter Ill of this Section.

Year ending 31st March, 1990 Unadjusted Pro forma forecast forecast' £m £m

Not less than, Not less than w Profit on ordinary activities .,12091- 208 Profit after taxation . 1:90. Earnings per Ordinary Share 53.7p Note: The pro forma forecast has been compiled on the basis of the following adjustments: (i) fee million in respect of interest, on the basis that the new capital structure had been in place since 1stApril, 1989; and (ii) fti million in respect of advance corporation tax onthe difference between forecast and notional dividends.

The pro forma profit forecast includes interest receivable as a result of the subscription of £361 million and the write off of relevant loans. The Directors expect that Severn Trent Water's investment expenditure requirements will result in the Group's cash resources being replaced by a rising level of indebtedness. Consequently, interest receivable will reduce and interest will become payable.

DIVIDENDS For the year ending 31st March, 1990, based on the forecast of profit for the year referred to above, the Directors expect, in the absence of unforeseen circumstances, to recommend a single dividend of 9.90p net per Ordinary Share (approximately £35.0 million in aggregate), payable in October 1990. If the Severn Trent Combined Offer had taken place on 1st April, 1989 and the new capital structure had been in place since that date, the Directors consider that they would have recommended dividends totalling 14.85p net per Ordinary Share (approximately £52.5 million in

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aggregate and equivalent to 19.80p per Ordinary Share inclusive of the associated tax credit at the current tax rate). Such notional net dividends would be covered 3.6 times by the HC pro forma earnings per Ordinary Share of 53.7p; this is equivalent to a gross dividend cover, on a full distribution basis, of 3.0 times. The gross notional dividends represent a gross yield, at the Offer Price, of approximately 8.25 per cent. In respect of subsequent financial years, the normal policy of the Directors will be to pay interim dividends in March and final dividends in October in proportions of approximately one third and two thirds respectively. The Directors have confidence in the longer term prospects of Severn Trent and, in the absence of unforeseen circumstances, they therefore intend to pursue a progressive dividend policy.

FINANCING As described under "Investment Expenditure" in this Chapter, Severn Trent Water will need to incur substantial investment expenditure. The pro forma net cash position of the Group as at 6th October, 1989, as referred to in "Share Capital and Indebtedness" in this Section, would have been f 322.2 million. Taking account of its cash resources and its borrowing facilities of11,500 million, the Directors consider that the Group has sufficient working capital for its present requirements. The borrowing facilities are available until 14th September, 1995 as described in Chapter V of this Section. The Directors are considering other sources of debt finance which may be utilised from time to time. The Directors expect that Severn Trent Water's investment expenditure requirements will lead to a rising level of indebtedness in the medium term. The Water Act introduced a new system of economic regulation which recognises the need to enable undertakers to finance the proper carrying out of their functions and the need to protect the interests of customers. On the basis of the provisions of the Water Act and the Appointments, the Directors believe that Severn Trent Water should be able to continue to finance its operations.

PROSPECTS The Directors believe that the prospects of the Group depend principally on the efficient management of its core water and sewerage businesses. The successful development of Severn Trent Water is therefore central to the Directors' plans. They intend to maximise the potential of Severn Trent Water from turnover growth, by control over operating costs and the effective management of the large investment programme. The Directors believe that the water and sewerage businesses will provide the Group with a firm base to pursue opportunities for future business development. The Directors consider that they have taken reasonable steps with a view to minimising the business risks arising from failure to comply with water quality and environmental standards. The Directors therefore believe that the growth prospects for Severn Trent Water largely depend on the operation of the system of economic regulation. Although the Director General has discretion in approving charges for certain water and sewerage services, his general duties recognise the need to enable Severn Trent Water to finance the proper carrying out of its functions, in particular by securing reasonable returns on capital. Whilst there can be no absolute safeguard against adverse regulatory decisions, the Directors believe that they can further develop the strong core water and sewerage businesses. The Directors expect that Severn Trent Water's investment expenditure requirements will lead to a rising level of indebtedness in the medium term. Consequently, interest will become payable and will, in the short term, offset the anticipated strength of operating profits. This will inevitably put pressure on earnings in the short term. However, the Directors have confidence in the longer term prospects of Severn Trent and, in the absence of unforeseen circumstances, they therefore intend to pursue a progressive dividend policy.

Turnover growth To enable Severn Trent Water to implement its investment programme, revenues are expected to grow substantially in real terms over the next ten years as a result of approved increases in charges. Against the background of the diversified economy of the Region and Severn Trent Water's large customer base, the Directors project a modest increase in the demand for water and sewerage services.

Cost control Severn Trent Water has significantly increased efficiency over the last ten years. The Directors consider that the scope for further efficiency savings is limited by pressures to provide improved services to customers and to meet higher quality standards. The Directors believe that Severn Trent Water has systems in place to control and monitor its extensive operations across the Region and they are therefore confident that operating costs can continue to be tightly controlled.

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Managing investment The K Investment Programme represents a major expansion of Severn Trent Water's capital and infrastructure expenditure and a major commitment in terms of management and engineering resources. The Directors have confidence in their programme. They believe that the programme can be managed effectively and will be seeking improvements in capital productivity.

Business development The Directors intend to develop substantially Severn Trent's non-regulated businesses. They believe that Severn Trent Industries is well placed to expand its commercial activities in areas related to the water and sewerage operations. They have identified Severn Trent International, Severn Trent Laboratories and Severn Trent Waste Disposal as divisions which are particularly suitable for expansion and discussions are currently in progress which may result in acquisitions. The Directors intend to seek opportunities for diversification of the Group.

The future The Directors intend that Severn Trent, founded on its strong home base, will develop a significant earnings stream from other appropriate businesses both in the UK and overseas. On the basis of the Group's management experience, technical abilities and financial resources, the Directors look forward to the future with confidence and welcome the opportunities provided by the private sector.

285

SECTION 5 SEVERN TRENT/32 CHAPTER II

CHAPTER II ACCOUNTANTS' REPORT

Price Waterhouse 19 Chartered Accountants, Livery House, 169 Edmund Street, The Secretary of State for the Environment, Birmingham B3 2JB The Directors, Severn Trent Plc, The Directors, Lloyds Merchant Bank Limited, The Directors, J. Henry Schroder Wagg & Co. Limited, 22nd November, 1989

Ladies and Gentlemen,

Severn Trent Plc (the "Company") was incorporated on 1st April, 1989. On 1st September, 1989 it acquired the entire issued share capital of Severn Trent Water Limited ("Severn Trent Water"), a company formed to continue the business of Severn Trent Water Authority, other than that part of the business which was vested in the National Rivers Authority (the "N RA"). On 1st September, 1989 the property, rights and liabilities of Severn Trent Water Authority, other than those applicable to the N RA, were vested in Severn Trent Water.

We have examined the audited financial statements of Severn Trent Water Authority for each of the five years ended 31st March, 1989. These periods are referred to collectively as the "relevant period". We were the auditors to Severn Trent Water Authority throughout the relevant period.

The financial information set out in Parts 1 and 2 below is based on the audited financial statements of Severn Trent Water Authority for the relevant period after making such adjustments as we consider necessary. The most significant adjustments are in respect of:

(i) the elimination from the financial information of the profits and losses, balance sheet items and sources and applications of funds attributable to the functions which have since been transferred to the NRA; and

(ii) the consistent application of the policy for accounting for infrastructure assets which was adopted in the year ended 31st March, 1989.

Severn Trent Water Authority was not liable to corporation tax during the relevant period.

The principal accounting policies adopted for the preparation of the financial information are set out in Chapter III of the General Section.

Our work has been carried out in accordance with the Auditing Guideline: "Prospectuses and the Reporting Accountant".

In our opinion: (i) the historical cost financial information set out in Part 1, when read in conjunction with the historical cost accounting policies as set out in Chapter 111 of the General Section, gives a true and fair view of the results and source and application of funds of that part of Severn Trent Water Authority's business vested in Severn Trent Water for each of the five years ended 31st March, 1989 and of its state of affairs at the end of each of those periods; and

(ii) the supplementary current cost financial information set out in Part 2, in respect of each of the five years ended 31st March, 1989, has been properly prepared in accordance with the current cost accounting policies as set out in Chapter III of the General Section.

Since incorporation, neither the Company nor Severn Trent Water has prepared any audited financial statements. No audited financial statements have been prepared for Severn Trent Water Authority for any period subsequent to 31st March, 1989.

28G

SECTION 5 SEVERN TRENT/33 CHAPTER II

1. HISTORICAL COST FINANCIAL INFORMATION

Profit and Toss accounts Years ended 31st March, Note 1985 1986 1987 1988 1989 £m £m £m £m £m Turnover (a) 334.2 369.4 402.5 434.5 476.4 Operating costs before exceptional items (b) (218.1) (234.9) (248.9) (273.8) (298.8) Exceptional items (c) (42.7) (2.1) (13.1) 19.8 (5.5) Operating profit (a) 73.4 132.4 140.5 180.5 172.1 Other income (d) 1.8 1.5 3.1 2.5 6.3 Profit before interest 75.2 133.9 143.6 183.0 178.4 Net interest payable (e) (93.0) (94.9) (91.6) (86.4) (80.9) Profit/(loss) on ordinary activities (17.8) 39.0 52.0 96.6 97.5 Extraordinary items (f) - (33.8) 3.2 (2.8) Retained profit/(loss) for the period (17.8) 39.0 18.2 99.8 94.7

Balance sheets As at 31st March, Note 1985 1986 1987 1988 1989 £m £m Em £m £m Fixed assets Tangible assets (g) 1,062.4 1,127.8 1,175.6 1,246.3 1,356.1 Investments (h)

1,062,4 1,127.8 1,175.6 1,246.3 1,356.1

Current assets Stores and work in progress (i) 9.1 8.5 8.5 7.7 6.4 Debtors (j) 44.3 47.4 50.8 81.1 64.0 Investments (k) 1.0 1.1

53.4 55.9 59.3 89.8 71.5 Creditors: amounts falling due within one year (1) (381.8) (159.5) (178.9) (194.1) (260.6)

Net current liabilities (328.4) (103.6) (119.6) (104.3) (189.1)

Total assets less current liabilities 734.0 1,024.2 1,056.0 1,142.0 1,167.0

Creditors: amounts falling due after more than one year (m) 562.7 814.5 821.6 810.2 744.5 Provisions for liabilities and charges (n) 9.0 8.4 14.9 12.5 8.5 Reserves and retained profits (p) 162.3 201.3 219.5 319.3 414.0

734.0 1,024.2 1,056.0 1,142.0 1,167.0

207

SECTION 5 SEVERN TRENT/34 CHAPTER II

Statements of source and application of funds Years ended 31st March, 1985 1986 1987 1988 1989 SOURCE OF FUNDS Em £m Em Em £m Profit/(loss) on ordinary activities (17.8) 39.0 52.0 96.6 97.5 Extraordinary items (33.8) 3.2 (2.8) Items not involving the movement of funds: Depreciation 21.6 24.0 24.3 27.7 33.8 Profits on sales of fixed assets (1.8) (1.5) (3.1) (2.5) (6.3) Provisions charged 9.0 - 6.5 -

11.0 61.5 45.9 125.0 122.2 Finance leases 1.3 - - - - Capital grants and contributions 6.3 7.0 12.1 11.2 9.1 Proceeds from sales of fixed assets 2.5 2.3 4.3 3.0 8.2 Loans 130.4 290.8 30.0 325.0 483.0 Creditors: amounts falling due after more than one year 2.6 (3.3) 0.4 7.8

154.1 358.3 92.7 472.0 622.5 APPLICATION OF FUNDS Capital expenditure: Tangible assets (71.0) (97.2) (85.4) (110.1) (154.6) Loan repayments (86.8) (253.8) (30.3) (321.0) (467.7) Finance lease repayments - (1.1) (2.5) (3.1) (2.9) Provisions applied - (0.6) - (2.4) (4.0) (3.7) 5.6 (25.5) 35.4 (6.7) (INCREASE)/DECREASE IN WORKING CAPITAL Stores and work in progress (1.0) 0.6 - 0.8 1.3 Debtors 1.9 (3.1) (3,4) (30.3) 17.1 Creditors: amounts falling due within one year 16.7 (21.2) 14,1 3.6 3.2

13.9 (18.1) (14.8) 9.5 14.9

INCREASE/(DECREASE) IN NET LIQUID FUNDS Current asset investments - 1.0 0.1 Short term borrowings and overdrafts 13.9 (18.1) (14.8) 8.5 14.8

13.9 (18.1) (14,8) 9.5 14.9

Notes to the historical cost financial information (a) Turnover and operating profit Years ended 31st March, Analysed by class of business: 1985 1986 1987 1988 1989 £m £m £m £m £m (I) Turnover Water supply 146.1 158.6 170.2 183.9 201.7 Sewerage services 188.1 210.8 232.0 250.2 273.9 Other trading activities - - 0.3 0.4 0.8 334.2 369.4 402.5 434.5 476.4

(ii) Operating profit Water supply 15.6 36,7 31.4 36.5 39.7 Sewerage services 58.5 95.7 109,1 144.1 132,2 Other trading activities (0.7) - - (0.1) 0.2 73.4 132,4 140,5 180.5 172.1

28a

SECTION 5 SEVERN TRENT/35 CHAPTER II

Notes to the historical cost financial information (continued) (b) Operating costs before exceptional items Years ended 31st March, Operating costs before exceptional items 1985 1986 1987 1988 1989 include: £m fm fm £m fm 1.0Hire of plant and machinery 1.3 1.6 1.1 1.3 Other operating lease costs 0.3 0.3 0,3 0.3 0.3 Auditors' remuneration 0.1 0.1 0.1 0.1 0.1 Directors' remuneration 0.2 0.2 0.2 0.2 0.4 Depreciation of owned assets 16.6 19.0 19,8 23.7 30.2 Depreciation of assets held under finance leases 4.3 4,2 3.8 3.4 3.0 Infrastructure renewals expenditure 19.5 25,8 34.7 47.3 49.9 Employment costs less amounts included in infrastructure renewals expenditure and amounts capitalised 73.9 73.6 74.8 79.6 81.8 Research and development 1.9 2.0 2.3 2.4 2.3

(c) Exceptional items Rates refund - - - (26.5) - Redundancy costs 14,6 2.1 13.1 1.0 1.0 Premium payable on early repayment of loans 28.1 5.7 4,5 42.7 2.1 13.1 (19.8) 5.5

(d) Other income Profits on sales of fixed assets 1.8 1.5 3.1 2.5 6.3

(e) Net interest payable Bank overdrafts, and other loans repayable within five years 38.5 7.2 6.9 26.8 43.1 Other loans 51.1 83.5 81.4 58.5 39.3 Finance lease obligations 4.2 4.4 4.2 3.6 4.5 93.8 95.1 92.5 88.9 86.9 Less: interest receivable (0.8) (0.2) (0.9) (2.5) (6.0) 93.0 94,9 91.6 86.4 80.9 Interest receivable includes: Income from listed investments 0.1

(f) Extraordinary items Privatisation and restructuring costs 2.8 Carsington dam and reservoir scheme 33.8 (3.2) 33,8 (3,2) 2.8

Privatisation and restructuring costs include expenditure relating to preparation for the vesting of Severn Trent Water Authority's assets and liabilities in successor bodies which took place on 1st September, 1989 under the provisions of the Water Act 1989.

289

SECTION 5 SEVERN TRENT/36 CHAPTER II

Notes to the historical cost financial information (continued) Water Sewerage (g) Tangible assets supply services other Total As at 31st March, 1989 fm fm fm £m Cost 619.0 883.2 170.3 1,672.5 Depreciation (108.7) (148.6) (59.1) (316.4) Net book value 510.3 734.6 111.2 1,356.1

Tangible fixed assets as at 31st March, 1989 include £133.7 million of assets in the course of construction. The above includes assets not subject to depreciation as follows: Infra- structure Land assets Total £m £m fm 8.7 743.4 752.1

The net book value of tangible fixed assets held under finance leases at 31st March, 1989 was £36 million. (h) Fixed asset investments This note does not apply to the Company As at 31st March, 1988 1989 fm fm (i) Stores and work in progress Stores 6.7 5.9 Work in progress 1.0 0.5 7.7 6.4

(j) Debtors Trade debtors 26.0 29.7 Other debtors 36.9 12.9 Prepayments and accrued income 18,2 21.4 81.1 64.0

Included in the above are amounts due after more than one year as follows: Other debtors 0.5 2.1

(k) Current asset investments These include: Investments listed on a recognised investment exchange 1.0 1.1

The market value of listed investments held on 31st March, 1989 was £1.1 million.

(I) Creditors: amounts falling due within one year Bank loans, overdrafts and temporary borrowings 33.2 18.4 Current portion of long term loans 45.3 123.3 Obligations under finance leases 3.0 3.1 Trade creditors 30.4 41.7 Other creditors 17.6 24.8 Taxation and social security 2.4 3.2 Accruals and deferred income 62.2 46.1 194.1 260.6

(m) Creditors: amounts falling due after more than one year Loans 763.3 700.6 Obligations under finance leases 38.3 35.3 Other creditors 8.6 8.6 810.2 744.5

(n) Provisions for liabilities and charges Reorganisation and other provisions 12.5 8.5

290

SECTION 5 SEVERN TRENT/37 CHAPTER II

Notes to the historical cost financial information (continued) (o) Long term debt Long term loans As at 31st March, 1989: other than Repayable: by instalments by instalments wholly partly within after within after five five five five Finance years years years years leases Total fm £m fm fm £m fm Within one year 62.8 25.5 35.0 8.6 131.9 Between one and two years 17.2 32.0 --- 6,3 55.5 Between two and five years 10.0 95.9 35.0 - 21.3 162.2 After more than five years 335.4 175,1 17.9 528.4 90.0 488,8 70.0 175.1 54.1 878.0 Less future finance charges payable in respect of finance leases (15.7) (15,7) 90.0 488.8 70.0 175.1 38.4 862.3

Of the above total, E806 million related to sums borrowed or treated as borrowed by Severn Trent Water Authority from the Secretary of State for the Environment or the Public Works Loan Commissioners ("relevant loans") as discussed further in note (t) below, and to sums borrowed from the European Investment Bank which were refinanced by relevant loans subsequent to the end of the relevant period. Borrowings from the Public Works Loan Commissioners were secured on the revenues of Severn Trent Water Authority.

(p) Reserves and retained profits Years ended 31st March, 1985 1986 1987 1988 1989 £m fm fm £m Em Beginning of period 180.1 162.3 201.3 219.5 319.3 Retained profit/(loss) for the period (17.8) 39.0 18.2 99.8 94.7 End of period 162.3 201.3 219.5 319.3 414.0

(q) Capita! commitments At 31st March, 1989: £m Contracted but not provided for 76.0

Authorised but not yet contracted for 56.0

In addition to these commitments, at 31st March, 1989 Severn Trent Water Authority had longer term investment expenditure plans which included expenditure to meet shortfalls in performance and condition and to provide for new demand and growth,

(r) Operating lease commitments At 31st March, 1989 Severn Trent Water Authority was committed to making the following payments during the next 12 months: Land and buildings Other Leases which expire: fm fm Within one year 0.4 Between two and five years 1.5 After five years 0.3 0.3 1.9

(s) Contingent liabilities This note does not apply to the Company.

291

SECTION 5 SEVERN TRENT/38 CHAPTER II

Notes to the historical cost financial information (continued)

(t) Post balance sheet events (i) Since 31st March, 1989 there have been major changes in the capital structure of Severn Trent Water Authority and the Company, which was incorporated on 1st April, 1989. These changes include the vesting of the property, rights and liabilities of Severn Trent Water Authority, other than those applicable to the NRA, in Severn Trent Water and the acquisition of Severn Trent Water by the Company, the write off of £831 million relevant loans, and the conditional agreement by the Secretary of State for the Environment to subscribe for Ordinary Shares in the Company. Under the terms of this agreement, it is expected that the Company will receive £361 million in cash on 29th December, 1989. (ii) After Vesting Severn Trent Water became liable to corporation tax. However, capital allowances are sufficient to ensure that no provision for deferred taxation is currently required.

(u) Earnings per Ordinary Share Earnings per Ordinary Share have not been included in the financial information as Severn Trent Water Authority had no Ordinary Shares in issue during the relevant period.

2. CURRENT COST FINANCIAL INFORMATION

Profit and loss accounts Years ended 31st March, 1985 1986 1987 1988 1989 fm £m £m £m fm Operating profit on historical cost basis 73.4 132.4 140.5 1803 172.1 Current cost adjustment: Depreciation (32.6) (34.8) (36.9) (39.0) (38.4) Current cost operating profit 40.8 97.6 103.6 141.5 133.7 Other income 1.8 1.5 3.1 2.5 6.3 Current cost adjustment: Disposal of fixed assets (1.2) (0.8) (1,4) (0.8) (0.3) Current cost profit before interest 41.4 98.3 105.3 143.2 139.7 Net interest payable (93.0) (94.9) (91.6) (86.4) (80.9) Current cost profit/(loss) on ordinary activities (51.6) 3.4 13.7 56.8 58.8 Extraordinary items _ (33.8) 3.2 (2.8) Current cost profit/(loss) for the period (51.6) 3.4 (20,1) 60.0 56.0

Balance sheets As at 31st March, Note 1985 1986 1987 1988 1989 fm fm fm £m £m Tangible fixed assets (a) 4,575.1 4,793.6 4,828.4 5,134.1 5,509.5 Net current liabilities (328,4) (103.6) (119.6) (104.3) (189,1) Total assets less current liabilities 4,246.7 4,690,0 4,708.8 5,029.8 5,320.4

Creditors: amounts falling due after more than one year 562.7 814.5 821.6 810.2 744.5 Provisions for liabilities and charges 9.0 8.4 14.9 12.5 8.5 Reserves (b) 3,675.0 3,867.1 3,872.3 4,207.1 4,567,4 4,246.7 4,690.0 4,708,8 5,029.8 5,320.4

292

SECTION 5 SEVERN TRENT/39 CHAPTER II

Notes to the current cost financial information (a) Tangible assets As at 31st March, 1989: (i) Analysis by service Water Sewerage supply services Other Total Em fm fm Em Gross replacement cost 2,281,7 4,470.2 243.0 6,994.9 Depreciation (535,0) (841.1) (109.3) (1,485.4) Net book value 1,746.7 3,629.1 133.7 5,509.5

(ii) Analysis by asset type Specialised operational Non- Plant, properties specialised Infra- machinery and operational structure and structures properties assets vehicles Other Total fm fm Em fm fm fm Gross replacement cost 2,198.7 159,2 3,861.6 697.5 77.9 6,994.9 Depreciation (916.9) (57.4) - (475.1) (36.0) (1,485.4) Net book value 1,281.8 101.8 3,861.6 222.4 41.9 5,509.5

(b) Reserves Years ended 31st March, 1985 1986 1987 1988 1989 fm Em £m fm fm Current cost reserve: Beginning of period 3,593.5 3,771.3 3,960,0 3,985.3 4,260.1 Revaluation surpluses reflecting price changes 177.8 188.7 25.3 274.8 304,3 End of period 3,771.3 3,960.0 3,985.3 4,260,1 4,564.4 Profit and loss account: Beginning of period (44.7) (96.3) (92.9) (113.0) (53.0) Current cost profit/(loss) for period (51.6) 3.4 (20.1) 60,0 56.0 End of period (96.3) (92.9) (113,0) (53.0) 3.0

Total 3,675,0 3,867.1 3,872.3 4,207.1 4,567.4

Yours faithfully,

Price Waterhouse

Chartered Accountants

293

SECTION 5 SEVERN TRENT/40 CHAPTER III

CHAPTER III INFORMATION RELATING TO THE PROFIT FORECASTS

PROFIT FORECAST The profit forecast for the year ending 31st March, 1990 set out in Chapter I of this Section is made on the basis of the results shown by the unaudited management accounts for the six months ended 30th September, 1989 and the principal assumptions for the remainder of the year ending 31st March, 1990 which are set out in Chapter III of the General Section.

PRO FORMA PROFIT FORECAST The pro forma profit forecast for the year ending 31st March, 1990 set out in Chapter I of this Section is compiled on a basis which reflects the position of the Group as if the new capital structure had been in place since 1st April, 1989. Account has been taken of the following adjustments: (i) £87 million in respect of interest (including the elimination of £48 million of interest paid in the period 1st April, 1989 to 15th November, 1989 in respect of relevant loans and the inclusion of £39 million of notional interest receivable for the period 1st April, 1989 to 29th December, 1989 in respect of the cash consideration for the Ordinary Shares to be subscribed by the Secretary of State); and (ii) £6 million of advance corporation tax payable on the difference between the forecast dividend for the year ending 31st March, 1990 and the notional dividend in respect of that year,

PRO FORMA EARNINGS PER ORDINARY SHARE Pro forma earnings per Ordinary Share have been calculated on the basis of pro forma profit after taxation of £190 million and by reference to 353,646,000 Ordinary Shares, being the number of Ordinary Shares in issue following the Severn Trent Combined Offer. For the purposes of the calculation it has been assumed that this number of Ordinary Shares was in issue throughout the year.

LETTERS The following letters relate to the profit forecast and the pro forma profit forecast for the year ending 31st March, 1990:

The Secretary of State for the Environment, The Directors, Severn Trent Plc, The Directors, Lloyds Merchant Bank Limited, The Directors, j. Henry Schroder Wagg & Co. Limited, 22nd November, 1989 Ladies and Gentlemen, We have reviewed the accounting policies and calculations for the profit forecast and the pro forma profit forecast of Severn Trent Plc and its subsidiaries (together the "Group") for the year ending 31st March, 1990 set out in Chapter 1 of Section 5 of the prospectus dated 22nd November, 1989 (the "Prospectus"). The profit forecast and the pro forma profit forecast, for which the Directors of Severn Trent Plc are solely responsible, take account of the results shown by the unaudited management accounts for the six months ended 30th September, 1989. In our opinion, (i) the profit forecast, so far as the accounting policies and calculations are concerned, has been properly compiled on the basis of the principal assumptions made by the Directors of Severn Trent Plc set out in Chapter III of Section 1 of the Prospectus and is presented on a basis consistent with the accounting policies previously adopted by Severn Trent Water Authority and now adopted by the Group, and (ii) the pro forma profit forecast has been properly compiled on the basis set out in Chapter Ill of Section 5 of the Prospectus.

Yours faithfully, Price Waterhouse Chartered Accountants

294

SECTION 5 SEVERN TRENT/41 CHAPTER III

The Directors, Severn Trent Plc, 22nd November, 1989

Gentlemen,

We refer to the profit forecast and to the pro forma profit forecast for the year ending 31st March, 1990, which are set out in Chapter 1 of Section 5 of the prospectus dated 22nd November, 1989.

We have discussed the profit forecast and the pro forma profit forecast, together with the bases and assumptions upon which the profit forecast is made, with Directors of Severn Trent Plc and with Price Waterhouse. We have also considered the letter dated 22nd November, 1989 from Price Waterhouse, regarding the accounting policies and calculations underlying the profit forecast and the compilation of the pro forma profit forecast.

On the basis of the foregoing, we consider that the profit forecast and the pro forma profit forecast, for which you as Directors are solely responsible, have been made after due and careful enquiry.

Yours faithfully, Yours faithfully, For and on behalf of For and on behalf of J. Henry Schroder Wagg & Co. Limited Lloyds Merchant Bank Limited

David Challen Richard Fortin Andrew Shaw Director Directors

295

SECTION 5 SEVERN TRENT/42 CHAPTER IV

CHAPTER IV INFORMATION RELATING TO THE K INVESTMENT PROGRAMME

BASES AND ASSUMPTIONS The estimates of investment expenditure required for each of the five year periods ending 31st March, 1995 and 31st March, 2000, set out in Chapter I of this Section, relate to the K Investment Programme prepared by the Group. The K Investment Programme is based on a comprehensive reappraisal of the extent, capacity, condition and performance of the relevant operational assets and future requirements. For underground assets the appraisal has included an assessment based on data relating to a sample of the types of assets within the Region. The investment needs relating to major dams and aqueducts have been assessed on an individual basis and those for other operational assets have been derived from reviews of the long term strategies for the water supply and sewerage services. Chapter 1 of this Section describes the principal objectives to be achieved which will ensure that the operational capability of the water supply and sewerage systems will be maintained. The Directors believe that the K Investment Programme will ensure that the principal obligations and service objectives are achieved. The principal general assumptions made by the Group in respect of these estimates of expenditure for the K Investment Programme, set out in Chapter I of this Section, are set out in Chapter Ill of the General Section.

296

SECTION 5 SEVERN TRENT/43 CHAPTER IV

LETTER The Directors have appointed independent consulting engineers to examine the Group ' s investment programme, which is described more fully in Chapter 1 of this Section. The following letter relates to the estimates of expenditure required on water supply and sewerage services for the first ten years ending 31st March, 2000 of the K Investment Programme:

The Directors, Severn Trent Plc, The Directors, Lloyds Merchant Bank Limited, The Directors, J. Henry Schroder Wagg & Co. Limited, 22nd November, 1989

Ladies and Gentlemen, We refer to the investment programme of Severn Trent Plc and its subsidiaries (the "Group") of which account was taken by the Secretary of State for the Environment in setting the initial level of K (the "K Investment Programme"). We have examined the estimates of expenditure set out in Chapter I of Section 5 of the prospectus dated 22nd November, 1989 (the "Prospectus") on water supply and sewerage services of the Group of £2,100 million and £1,560 million for the respective five year periods ending 31st March, 1995 and 31st March, 2000 in respect of the K Investment Programme.

Our work in respect of the estimates of expenditure has comprised an assessment of the policies, targets, bases and assumptions used by the Group together with an assessment (based on samples of the work of the Group and that of Severn Trent Water Authority) of the application of the methods and procedures adopted by them in compiling the K Investment Programme and the estimates of expenditure relating thereto. The samples of the Group's and Severn Trent Water Authority's work may not necessarily have been representative of the whole of their work but, in the unusual circumstances where there are no established procedures or codes of practice for such sampling, appeared to us to be sufficient. On the basis of the foregoing, in our opinion: :.

(i) the estimates, for which the Directors of Severn Trent Plc are solely responsible, have been properly compiled on the bases and assumptions made by the Group set out in Chapter HI of Section 1 and Chapter IV of Section 5 of the Prospectus and in accordance with methods and procedures that are adequate for providing estimates of expenditure required to enable the Group, in carrying out the functions of a water undertaker and of a sewerage undertaker in respect of the appointed areas of the Group:

(a) to secure compliance with those regulatory requirements to be met by 31st March, 2000 insofar as they relate to the K Investment Programme; (b) to facilitate compliance with those regulatory requirements which are to be met after 31st March, 2000 insofar as they relate to the K Investment Programme;

(c) to secure or facilitate the achievement of service objectives; and (d) to maintain and extend the operating capability of the Group's relevant assets

as referred to in Chapter III of Section 1 and Chapter IV of Section 5 of the Prospectus; and

(ii) the estimates have been prepared after due and careful enquiry.

Yours faithfully, For and on behalf of Sir William Halcrow & Partners Ltd. J L Beaver Director

297

SECTION 5 SEVERN TRENT/44 CHAPTER V

CHAPTER V ADDITIONAL INFORMATION

1. INCORPORATION Severn Trent was incorporated in England and Wales on 1st April, 1989 under the Companies Act 1985 as a public limited company with registered number 2366619. On 1st September, 1989 a certificate to do business was granted to the Company under section 117 of that Act.

2. SHARE CAPITAL The Company's authorised share capital on incorporation was £50,000 divided into 50,000 shares of £1 each, of which two were subscribed at par by nominees of the Crown. On 29th August, 1989 the authorised share capital was increased to £50,001 by the creation of one Special Share of £1 and the 50,000 shares of £1 each were redesignated as ordinary shares of £1 each. On 1st September, 1989, 49,998 Ordinary Shares were issued at par to the Secretary of State credited as fully paid. On 20th November, 1989: (a) the authorised share capital of the Company was further increased to £2,216,001 by the creation of 2,166,000 additional Ordinary Shares and the Directors were authorised and empowered to allot the increased share capital; (b) in accordance with a direction made by the Secretary of State under section 83(2), (4) and (5) of the Water Act, 2,166,000 Ordinary Shares were issued at par, credited as fully paid, to the Secretary of State; and conditionally on the whole of the Ordinary Share capital being admitted to the Official List by The Stock Exchange and such admission becoming effective not later than 12th January, 1990: (c) the authorised share capital of the Company was further increased to £475,000,001 by the creation of 472,784,000 additional Ordinary Shares; (d) the Directors were generally authorised, in accordance with section 80 of the Companies Act 1985, to allot relevant securities (as defined in that section) up to an aggregate nominal amount of £469,312,000, such authority to expire on 19th November, 1994; (e) the Directors were given power, pursuant to section 95 of the Companies Act 1985, to allot equity securities (as defined in section 94 of that Act) pursuant to the authority referred to in sub-paragraph (d) above, as if section 89(1) of that Act did not apply to the allotment, but the power was limited: (i) to the allotment of equity securities to or at the direction of the Secretary of State; (ii) to the allotment otherwise than pursuant to sub-paragraph (i) above of equity securities in connection with a rights issue in favour of the holders of Ordinary Shares (subject to such exclusions or other arrangements as the Directors may deem necessary or expedient to deal with fractional entitlements, problems arising in any overseas territory or by virtue of shares being represented by depositary receipts, requirements of any regulatory body or stock exchange or any other matter whatsoever); and (iii) to the allotment (otherwise than pursuant to (i) or (ii) above) of equity securities up to an aggregate nominal value of £17,682,000; and, in addition, the power was expressed to expire at the conclusion of the first annual general meeting of the Company but the Directors were empowered, prior to such expiry, to make an offer or agreement which would or might require equity securities to be allotted after such expiry; (f) 351,430,000 Ordinary Shares were allotted, credited as fully paid, to the Secretary of State in consideration of an undertaking to pay in cash £361.0 million on the later of 29th December, 1989 and the date on which the agreement between the Secretary of State and the Company relating to the subscription pursuant to section 87 of the Water Act for such Ordinary Shares becomes unconditional in all respects; and (g) in accordance with a direction made by the Secretary of State under section 83(2), (4) and (5) of the Water Act the Special Share was allotted at par, credited as fully paid, to the Secretary of State.

29B

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Save for the issue of shares pursuant to the allotments described in sub-paragraphs (f) and (g) above, no material issue of shares in the Company (other than to shareholders pro rata to their existing shareholdings or pursuant to the employee share schemes described in Part 2 of Chapter IV of the General Section) will be made within one year of the date of the Severn Trent Offer without the prior sanction of shareholders of the Company in general meeting.

3. MEMORANDUM AND ARTICLES OF ASSOCIATION Details of the Company's Memorandum and Articles of Association are set out under "Memorandum and Articles of Association" in Part 1 of Chapter IV of the General Section. Until the first audited consolidated accounts of the Group are laid before the Company in general meeting, the amount of the borrowing limit will be £2,600 million.

4. DIRECTORS' AND OTHER INTERESTS None of the Directors has or has had any interest in any transactions which are or were unusual in their nature or conditions or significant to the business of the Group and which were effected by Severn Trent or Severn Trent Water Authority or any member of the Group since 31st March, 1988 or since any earlier date but which remain in any respect outstanding or unperformed. Prior to the Severn Trent Offer, the entire issued share capital of the Company was held by or on behalf of the Secretary of State. Following the admission to listing of the whole of the Ordinary Share capital, the Secretary of State will retain sufficient Ordinary Shares to satisfy entitlements under the bonus arrangements described in Part 1 of Chapter V of the General Section. Thereafter the Secretary of State will also retain such Ordinary Shares, if any, as shall have been made available but are not taken up under the Free and Matching Offers and are not subsequently disposed of under the Severn Trent Offer and such Ordinary Shares, if any, as shall have been withdrawn from the Severn Trent Overseas Offers as described in Part 3 of Chapter IV of the General Section, but are not subsequently disposed of under the Severn Trent Offer. This could involve the Secretary of State retaining more than 5 per cent. of the issued Ordinary Share capital of the Company. Save as aforesaid, the Directors are not aware of any other person who may be interested, directly or indirectly, in 5 per cent, or more of the issued share capital of the Company or of any persons who, directly or indirectly, jointly or severally, exercise or could exercise control over the Company. No Director has any interest in the share capital of Severn Trent or its subsidiaries. However, Executive Directors who are eligible may participate in the employee share schemes described in Part 2 of Chapter IV of the General Section and in the special arrangements for employees applying for Ordinary Shares, and Directors may apply like any other member of the public under the Severn Trent Offer. The aggregate emoluments (including pension contributions, bonus payments and other benefits in kind) of the Directors for the year ended 31st March, 1989 amounted to £375,838. It is estimated that the corresponding figure for the year ending 31st March, 1990 under arrangements in force at the date of the Severn Trent Offer would be approximately £500,000. This increase is largely due to a change in the composition of the board. There is no arrangement under which a Director has agreed to waive future emoluments, nor have there been any waivers of Directors' emoluments during the year ended 31st March, 1989. Each of the Executive Directors has entered into a service agreement with Severn Trent. Mr. Bellak has a service agreement terminable by three years' notice in writing by either party expiring at any time, at a salary of £49,020, subject to annual review. Messrs. Paul, Cocker and Larnder each have service agreements terminable by the Company on three years' notice in writing and by the individual on 12 months' notice expiring at any time, at salaries of £75,250, £48,375 and £64,500 respectively, in all cases subject to annual review. Messrs. Earnshaw and McMillan have service agreements expiring on 31st October, 1991 and 30th September, 1991 respectively, both at salaries of £51,600. All the Executive Directors are eligible for such bonus payments as may be approved by the board. Following the Severn Trent Offer, the board intends to consider increases in the aggregate emoluments of each of the Directors to levels commensurate with those prevailing in the private sector. Save as aforesaid, there are no existing or proposed service agreements between any of the Directors and the Company or any of its subsidiaries. 5. PENSIONS The Severn Trent Water Mirror Image Pension Scheme ("STWMIS") conforms to the description of MIS set out in Part 7 of Chapter IV of the General Section. The Severn Trent Water Pension Scheme ("STWPS") offers members a choice of contribution and benefit levels. Members who elect to contribute 6 per cent. of pensionable pay are provided with a

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pension on retirement at age 65 of /both of their last 12 months' pensionable pay for each year of pensionable service. Lower contribution rates of 5 per cent. or 3 per cent. of pensionable pay can be chosen by members to provide lower benefit packages. Pensions from STWPS are increased in line with RPI, subject to a ceiling of 5 per cent. per annum. Increases up to the increase in RPI will be provided beyond this ceiling if, after consultation with the scheme actuary, this can be done without an increase in the employer's ordinary annual contributions as determined following the most recent actuarial valuation. As agreed with DOE, the benefits under STWPS were designed to cost no more than the benefits under LGSS and its associated pensions increase costs. At Vesting 2,420 employees were members of STWMIS, 4,400 employees were members of STWPS and 440 employees were not members of either scheme. Transfer payments will be made from WASF to STWMIS and STWPS in respect of those members who elect to transfer their accrued benefits in WASF. The transfer payments will be calculated as the value of those accrued benefits as at Vesting on the basis of actuarial assumptions specified by the Secretary of State (including allowance for future salary increases and fully index linked increases to pensions). R. Watson & Sons (as actuaries to STWMIS and STWPS) have confirmed that transfer payments calculated on this basis will be appropriate to meet the accrued liabilities assumed by each scheme (including allowance for future salary increases and increases to pensions). Pending the first actuarial valuations of STWMIS and STWPS, Severn Trent is contributing to STWMIS at the rates of 12 per cent. and 11.75 per cent. of pensionable pay for members paying contributions of 6 per cent. and 5 per cent. respectively and to STWPS at the rate of 12 per cent. of pensionable pay. Lower employer contribution rates apply in respect of members of STWPS with the lower benefit packages. R. Watson & Sons have confirmed that employer contributions at these interim rates, together with contributions payable by the members, are appropriate to meet the benefits to be earned in the future. Other pension related liabilities arise as a result of the arrangements made when the water industry was reorganised in 1974. Most of these liabilities relate to pensions increases for pre-1974 employees, payments in respect of which are made by the local authorities who are responsible for the basic pension. These payments are currently recharged to Severn Trent. The amounts payable in the year ended 31st March, 1989 totalled some £1.4 million. On 3rd May, 1989 the then Minister for Water and Planning indicated in a letter to the Chairman of the Water Authorities Association that the Water Groups would bear these pensions increase costs only until 31st March, 1990.

6. MATERIAL. OPERATING AGREEMENTS Severn Trent Water is a party to the following agreements which in the context of its water resources are material by reason of the amount of water in question and/or the geographical dependence of Severn Trent Water obtaining water under these agreements:

Dwr Cymru Agreements for the import of water from the Elan Valley Reservoirs provide for Dwr Cymru to supply water from the Elan Valley Reservoirs to Severn Trent Water for 99 years (with an option for Severn Trent Water to renew the supply agreement prior to 31st March, 2073), at an annual charge which varies from year to year by reference to the average of the water supply unit costs of the two companies. The amount of water supplied shall, save in certain circumstances, be as required by Severn Trent Water, but shall not exceed approximately 360 Ml/d. Dwr Cymru are responsible for, and bear the cost of, maintaining, operating and renewing the reservoirs and the abstraction of water. The supply agreement can be renegotiated at an earlier date in certain circumstances, with provision for the terms of the new arrangement to be determined by third parties in the absence of agreement. The agreements also provide for the sale by Dwr Cymru to Severn Trent Water of the Elan Valley aqueduct and connected land and buildings including the treatment plant (the "Elan Valley Assets") at a consideration of £31.7 million. Completion of the sale is deferred until the earlier of 31st March, 2073 and the expiration of 21 years after the death of the last survivor of the issue of the late King George V (whether children or more remote) actually born before the date of his death. The consideration is held by trustees upon terms which entitle Dwr Cymru to the income and, in certain circumstances, portions of the capital. During the term of the contract of sale, Severn Trent Water is entitled as licensee to possession and control of the Elan Valley Assets and the benefit of any income from them. Severn Trent Water is also obliged to operate and maintain them and meet all costs and liabilities relating thereto. Dwr Cymru is entitled for a consideration to take water from the aqueduct to supply certain areas in its own Water Region. If the contract of sale is completed, Dwr Cymru will become entitled to the trust fund absolutely. If the supply agreement becomes subject to renegotiation (including in circumstances where Severn Trent Water gives notice that it intends to renew the agreement for a further 99 years) the contract of sale lapses, save for certain specified provisions in the contract which continue while

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negotiations are carried out. These provisions include the right of Severn Trent Water to possession and control of the Elan Valley Assets, the right and benefit of any income therefrom, and the obligations of Severn Trent Water to operate and maintain those assets and meet all costs and liabilities relating thereto. As with the supply agreement, the terms of the new contract for sale may be imposed by a third party if Severn Trent Water and Dwr Cymru cannot reach agreement with respect to the arrangements for the use, occupation or ownership of the Elan Valley Assets. During the period that the contract of sale is being so renegotiated, the trustees hold the trust fund for Severn Trent Water absolutely. Yorkshire Water An agreement dated 3rd October, 1989 provides for the supply by Severn Trent Water to Yorkshire Water of untreated water from the Derwent Valley Reservoirs to such points of delivery as shall be agreed. The agreement expires on 31st March, 2084 subject to earlier termination by notice from either party prior to 31st March, 2030, in which case the agreement shall expire on 31st March, 2035, or in the circumstances described below. The quantity of water to be supplied in each year shall not exceed 21,550 megalitres or 24,1 per cent, of the annual quantity licensed for abstraction from these reservoirs for public water supply, whichever is the greater. The consideration for the supply is £1,052,850 for the year ending 31st March, 1990 subject to adjustment in subsequent years to reflect the mean of annual percentage changes in the average sum charged in that year per cubic metre of water supplied to metered customers by each party. Yorkshire Water is required to pay 24.1 per cent. of the costs incurred by Severn Trent Water in relation to certain major works of renewal or improvement required in the case of any of the reservoirs or their ancillary works (subject to pro rata reductions for the period by which the asset lives of the renewed or improved works exceed the remainder of the term of the agreement). In the case of major works costing more than nine times the annual payment to be made by Yorkshire Water for the year in which the works are commenced, Yorkshire Water may terminate the agreement on five years' notice and shall not then be liable for its proportion of the cost of those works.

North West Water Severn Trent Water owns the Vyrnwy Reservoir and the catchment area, the dam and associated works (the "Works"). North West Water holds the abstraction licence for Vyrnwy and owns the drawoff tower and pipeline, the aqueduct to Liverpool and a related water treatment plant. The operation and maintenance agreement between Severn Trent Water and North West Water dated 18th October, 1989 provides for the operation, management, maintenance and repair by Severn Trent Water of the Works. The agreement takes effect (in substitution for the existing "Heads of Terms" agreement dated 8th July, 1987) from 1st April, 1990 and is for a period of 100 years, subject to North West Water being able to terminate the agreement at any time on giving not less than ten years' written notice. North West Water has agreed to pay, for each financial year, 93.25 per cent. of the aggregate of Severn Trent Water's net operating costs in relation to the Works and an inflation linked amount equal to a minimum of 2 per cent. of the agreed net current cost value of the Works, adjusted (but not below 2 per cent.) in successive periods of five years by the lower of the percentage increases and/or decreases in the current cost rate of return of North West Water's water supply business or the average of the percentage increases and/or decreases in the current cost rates of return of North West Water's and Severn Trent Water's water supply businesses.

7. MATERIAL CONTRACTS The following contracts, not being contracts entered into in the ordinary course of business, have been entered into within the period of two years immediately preceding the publication of this Prospectus and are, or may be, material: (a) the agreement for warranties and indemnities and side letter, the UK underwriting agreement, the overseas underwriting agreement and the instalment agreement all of which are described in Parts 3 and 5 of Chapter IV of the General Section; (b) a multi currency revolving loan facility agreement dated 15th September, 1989 between Severn Trent as borrower, Severn Trent Water as guarantor, a syndicate of banks (the "banks") and Lloyds Bank Plc (as arranger for itself and the banks). Advances in an aggregate amount not exceeding £1,500 million (or the equivalent in other freely convertible currencies) outstanding at any one time can be drawn for periods of one week or one, two, three or six months. Interest accrues at the rate of 0.25 per cent. above LIBOR (plus certain additional costs in the case of sterling advances). A commitment fee is payable at the rate of 0.105 per cent. per annum on the daily undrawn balance of the total commitments until one month before the termination date together with certain documentation expenses and arrangement and agency fees. The facility terminates on 14th September, 1995;

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(c) an indemnity dated 22nd November, 1989 between Severn Trent and Lloyds Merchant Bank Limited whereby Severn Trent agreed to indemnify Lloyds Merchant Bank Limited against certain liabilities in connection with the Severn Trent Combined Offer; (d) an indemnity dated 22nd November, 1989 between Severn Trent and the other nine Water Holding Companies (1), the WSA (2) and N M Rothschild & Sons Limited (3) whereby Severn Trent and the other nine Water Holding Companies severally agreed to indemnify N M Rothschild & Sons Limited against certain liabilities in connection with the Combined Offers; (e) an indemnity dated 22nd November, 1989 between Severn Trent and Sir William Halcrow & Partners Ltd. whereby Severn Trent agreed to indemnify Sir William Halcrow & Partners Ltd. against any liabilities that might be incurred by it in the US or Canada arising in connection with the inclusion of its letter set out in Chapter IV of this Section in the offering documents to be distributed in the US and Canada; (f) an indemnity dated 22nd November, 1989 between Severn Trent and the Secretary of State in the terms described in paragraph (o) of Part 7 of Chapter IV of the General Section; and (g) an agreement dated 21st February, 1989 between Shephard Hill & Co. Limited and Severn Trent Water Authority whereby Shephard Hill & Co. Limited agreed for a consideration of some £17.7 million to carry out works, as more fully described in the agreement, in connection with the reconstruction of the Carsington Reservoir, as described under "Water resources" in Chapter I of this Section.

8. LITIGATION Except as disclosed in paragraph (o) of Part 7 of Chapter IV of the General Section, no member of the Group is or has been engaged in any legal or arbitration proceedings nor, as far as the Directors are aware, are any such proceedings pending or threatened against any member of the Group which may have, or have had during the previous 12 months, a significant effect on the financial position of the Group.

9. INSURANCE The Directors are of the opinion that the Group carries reasonable insurance cover for all risks facing the Group which would be expected to be subject to insurance cover.

10. INTERESTS IN SUBSIDIARIES Details of Severn Trent's principal subsidiary, which is wholly owned, are set out below:

Name of company Activity Share capital (issued and fully paid)

Severn Trent Water Limited Water supply and sewerage services 50,000 ordinary shares of f1 each

Details of other companies in which Severn Trent holds a material interest are set out below. These companies are both wholly owned.

Name of company Activity Share capital (issued and fully paid)

Severn Trent Industries Limited Various non-regulated trading activities 2 ordinary shares of El each Severn Trent Property Limited Non-regulated property development 2 ordinary shares of £1 each

Save as otherwise stated above, all of the companies, details of which are given above, are incorporated in England and Wales and have their registered office at 2297 Coventry Road, Birmingham B26 3PU.

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11. PRINCIPAL ESTABLISHMENTS The following are the principal operating establishments of the Group, all of which are freehold:

Description and location Approximate acreage

Vyrnwy Reservoir and Estate, Llanwddyn, Nr. Dswestry, Shropshire 23,500 Derwent Valley Reservoir and Estate, Bamford, Derbyshire 4,095 Minworth sewage treatment works, Minworth, Birmingham 666 Frankley/Bartley Reservoir and water treatment works, Northfield, Birmingham 540

12. MISCELLANEOUS (a) Save as disclosed in Part 2 of this Chapter: (i) no share or loan capital of the Company since its incorporation or of any of its subsidiaries within the three years before the date of the Severn Trent Offer has been issued or agreed to be issued (except, in the case of subsidiaries, to the Company) or is now proposed to be issued, fully or partly paid, either for cash or for a consideration other than cash; (ii) no commissions, discounts, brokerages or other special terms have been granted by the Company since its incorporation or by any of its subsidiaries within those three years, in connection with the issue or sale of any share or loan capital of any of those companies; and (iii) no share or loan capital of the Company or any of its subsidiaries is under option or agreed conditionally or unconditionally to be put under option. (b) Following the Severn Trent Offer, the commercial relationship between the Group, as supplier of water and sewerage services, and HM Government, as customer for those services, will continue on a normal customer and supplier basis. (c) The Directors have been advised that Severn Trent is not expected to be a close company, as defined in the Income and Corporation Taxes Act 1988, immediately following the Severn Trent Offer. (d) Save as disclosed in this Section, there has been no significant change in the financial or trading position of Severn Trent since 31st March, 1989. (e) The expenses attributable and incidental to the Severn Trent Combined Offer to be borne by Severn Trent are estimated to amount to f8,5 million (exclusive of VAT). The Secretary of State will bear other expenses, including underwriting commissions and preliminary expenses of Severn Trent, (f) Lloyds Merchant Bank Limited has given and has not withdrawn its written consent to the issue of the listing particulars of Severn Trent with the inclusion of its letter and references to its name in the form and context in which they are included. Price Waterhouse have given and have not withdrawn their written consent to the issue of the listing particulars of Severn Trent with the inclusion of their report and their letter and the references thereto and to their name in the form and context in which they are included. Sir William Halcrow & Partners Ltd. has given and has not withdrawn its written consent to the issue of the listing particulars of Severn Trent with the inclusion of its letter and the references thereto and to its name in the form and context in which it is included. R. Watson & Sons have given and have not withdrawn their written consent to the issue of the listing particulars of Severn Trent with the references to their name in the form and context in which they are included. (g) The responsibility of Severn Trent and its Directors for any information included in this Prospectus is confined to its inclusion as part of the listing particulars in respect of the Ordinary Shares of Severn Trent, and Severn Trent and such persons are not responsible for any information insofar as it is stated in this Prospectus to form part of the listing particulars for the securities of any other Water Holding Company. (h) A list of documents available for inspection is set out in Part 9 of Chapter IV of the General Section.

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