C11448_mmO2_AR_covers.qxd 10/6/04 10:09 AM Page 1 mmO 2 Annual Report and Financial Statements 2004 www.mmo2.com mmO2 plc Wellington Street Slough Berkshire SL1 1YP Registered No. 4190833 The paper used to produce this report is made from Elemental Chlorine Free Pulps sourced from fully sustainable forests. Designed and produced by Pauffley Ltd Printed in England by St Ives Burrups Limited. Annual Report and Financial Statements 2004 mmo2.com 1 Financial highlights 2004 2003 2002 Continuing operations £m £m £m Group turnover 5,646 4,611 4,076 EBITDA1 before exceptional items 1,367 858 484 Operating exceptional items (75) (8,300) (150) Group operating profit/(loss) 159 (8,658) (692) Capital expenditure 1,213 885 1,045 Year-end net debt 366 549 617 1EBITDA is our earnings before interest, tax, depreciation, amortisation and exceptional items, excluding our share of operating profits and losses of our joint ventures and associates. EBITDA is not a measure of financial performance under UK or US GAAP and may not be comparable to similarly titled measures of other companies, because EBITDA is not uniformly defined. EBITDA should not be considered by investors as an alternative to Group operating profit/(loss) or profit/(loss) on ordinary activities before taxation as an indication of operating performance, or as an alternative to cash flow from operating activities as an indication of cash flows. EBITDA is one of the key financial measures used by the Group for evaluating financial performance, and is discussed in the operating and financial review and prospects on page 23. Contents 1 Financial highlights 2 Chairman and Chief Executive Officer’s welcome statement 6 Business review 19 Corporate responsibility 21 Operating and financial review and prospects 39 Risk factors 41 Board of directors 42 Executive management team 43 Report of the directors 44 Statement of directors’ responsibility 45 Report on corporate governance 51 Report on directors’ remuneration 63 Report of the auditors 64 Financial statements 68 Notes to the financial statements 97 Non-financial metrics 98 Five year summary 99 Supplementary information for United States investors 116 Additional information for shareholders 118 Contacts 119 Glossary of terms 120 Definitions Please see cautionary statement regarding forward-looking statements on page 116. Form 20-F US information included in this Annual Report will form part of mmO2’s Annual Report on Form 20-F that will be filed with the US Securities and Exchange Commission. 2 mmo2.com Welcome to this, the third Annual Report for your Company, mmO2. In the past year we have created a genuine momentum in all the businesses that we believe can be carried forward In the year ended 31 March 2004, mmO2 passed an important We are pleased to say that O2 businesses have successfully delivered milestone, making its first ever pre-tax profit of £95 million compared in the past year against the commitments we made. Across all our with a loss of £10,203 million in the previous year. The stock market territories we have shown impressive growth in subscribers, reflecting recognised our achievement as our shares were the second best the success of our segmented and focused approach to the needs of performer in the FTSE 100 index during 2003. Total revenue from customers. This achievement has been coupled everywhere with higher continuing operations grew by 22 per cent to £5.65 billion, within profitability, driven by improvements in the quality of our customer which service revenues showed a 23 per cent increase to £5.03 billion base and greater operational efficiency. At the same time, we have and earnings before interest, tax, depreciation, amortisation and successfully developed new business opportunities. exceptional items (EBITDA) grew by 59 per cent to £1.37 billion. Excluding O2 Netherlands, operating profit before exceptional items We would like to illustrate this by highlighting just some of the and goodwill amortisation was £435 million compared with a loss of achievements made by each of the operating businesses: £18 million in the previous year but an exceptional operating charge of £75 million contributed to an operating profit of £159 million. At O2 UK, our customer base grew by 10 per cent and profitability, as A combination of stronger EBITDA, controlled capital expenditure measured by our EBITDA margin, improved to over 30 per cent. Since and improved working capital management reduced net debt by demerger, EBITDA at O2 UK has risen 55 per cent. By the end of the £183 million to £366 million, below the level at the time of demerger. year we had shown ten quarters of continuous improvements in the mix of customers and, over the period, a significant reduction in In February 2004 a proposal was received from KPN, the Dutch the rate of churn. This clearly reflects the progress we have made in telecommunications group. The Board carefully considered the proposal implementing our strategy. Our efforts to improve network quality, but rejected it as not being in the best interests of mmO2 shareholders. a vital ingredient in customer satisfaction, were recognised by Oftel, which named O2 UK as having the best ever published national call Operational review success rates. New opportunities for growth are being realised through The O2 brand goes from strength to strength in all our market Tesco Mobile, our joint venture with one of the UK’s most powerful territories, supported by interactive sponsorships including that of the retail channels, which is addressing the family market, complementing England rugby team in its successful challenge for the 2003 Rugby O2 UK’s focus on high-value customers. Tesco Mobile is already World Cup. All the businesses have shown improved performance, available in more than 500 UK outlets and the initial aim is to attract exploiting new opportunities represented by the integration of voice two million subscribers. By the beginning of May 2004, 250,000 and data services and sharpening their focus on the needs of customers had signed up to Tesco Mobile – well ahead of initial targets. their customers. In O2 Germany, we have turned a loss-maker into a business with Although we have come a long way in the two years since our convincing momentum, a rising market share, EBITDA margin in the demerger, we are not complacent. In a highly competitive environment, mid-teens and improving cash flow. O2 Germany is now the fastest we recognise that we have a great deal more to do to ensure growing mobile phone operator in Germany and has the highest ARPU continued progress. Our paramount aim is to generate sustainable and the best mix of customers of any German operator. Our market profitable growth – a challenging combination in any business. We are share by number of subscribers is 9 per cent but by subscriber revenues not chasing subscribers at any cost. A year ago we explained that our it is 10 per cent, reflecting success in attracting a high-value customer businesses would focus on improving the experience of high-value base. We have achieved annual growth in our customer base of nearly customers for O2’s voice and data products and services. Success would 25 per cent in the last two years and are closing the gap on our mean greater customer loyalty and lower rates of churn. Also, it would nearest competitor. mean a better mix of customers, with a greater emphasis on post-pay users, and higher average revenues per user (ARPU). At the same time, we committed ourselves to an improved operational performance, to tight financial discipline and to seek out and exploit new opportunities to develop our businesses. mmo2.com 3 In the case of O2 Ireland, we have taken a good business and made to download music to their mobile phones wherever they are; and we it an even better one. We were delighted that this was reflected in were the first with video streaming, making available exclusive O2 Ireland being named Telecommunications Company of the Year at highlights from the Rugby World Cup and, more recently, London ICT Expo. Growth in service revenues has continued at a strong pace Fashion Week via our O2 Active portal. We now earn revenues of more and the EBITDA margin showed a further rise to nearly 40 per cent. than £1 billion per year from non-voice services. The strong pace of growth is not reliant only on SMS text messaging, which is still O2 Airwave, with its £2.9 billion, 19-year contract to supply secure expanding and where we remain market leaders in the UK with a share communications for the UK police forces and emergency services, has of 35 per cent. Other applications, including picture messaging, games, become our fourth substantial business with positive EBITDA ahead of e-mail, internet surfing and the use of our Xda II combined phone and schedule this year. From a standing start we are now well over halfway personal digital assistant, will be an engine of continued future growth. through the national roll-out of the Airwave network to 35 police forces with over 50,000 officers using the system. Completion of the network is expected in March 2005, ushering in a rapid transformation of O2 Airwave’s financial performance. We are also in the advanced stages of bidding for the nationwide Fire and Ambulance Service contracts, and actively marketing to other Public Safety Users. Manx Telecom, which has been a pioneer in 3G technology, has been awarded a 15-year extension to its operating licence by the Manx Government and is building a GPRS network to complement its main network. Customers embrace multimedia services We continue to view non-voice services as a potentially significant source of future growth.