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Edited Transcript of UU.L earnings conference call or presentation 23-May-19 8:00am GMT

Full Year 2019 United Utilities Group PLC Earnings Call

London Jun 4, 2019 (Thomson StreetEvents) -- Edited Transcript of United Utilities Group PLC earnings conference call or presentation Thursday, May 23, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* James Bullock

United Utilities Group PLC - Strategy & Regulation Director

* John David Gibson McAdam

United Utilities Group PLC - Non-Executive Chairman

* John Russell Houlden

United Utilities Group PLC - CFO & Executive Director

* Rob Lee

United Utilities Group PLC - Head of IR

* Steven Lewis Mogford

United Utilities Group PLC - CEO & Executive Director

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Conference Call Participants

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* Dominic Charles Nash

Barclays Bank PLC, Research Division - Head of Utilities Research

* Fraser Andrew McLaren

BofA Merrill Lynch, Research Division - Director

* Iain Stewart Turner

Exane BNP Paribas, Research Division - Analyst of Utilities

* James Brand

Deutsche Bank AG, Research Division - Research Analyst

* Verity Mitchell

HSBC, Research Division - Analyst

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Presentation

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Rob Lee, United Utilities Group PLC - Head of IR [1]

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Good morning, ladies and gentlemen. I'm Robert Lee, Head of Investor Relations at United Utilities, and I'd like to welcome you to our full year results presentation.

Before handing over to the presentation proper, I'll run through a few points of housekeeping. First and foremost, there were no planned fire drills today, so if the alarm does sound, please, can you exit the auditorium using the door at the back where you first came in. Second, please, can you ensure that all mobile devices are either switched off or turned to silent. And finally, as ever, I'd ask that you view any forward-looking statements in today's presentation in the context of the cautionary statements in your presentation packs.

Thank you, and I'll now pass you over to the Chairman.

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John David Gibson McAdam, United Utilities Group PLC - Non-Executive Chairman [2]

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Good morning, and welcome to the United Utilities' full year results presentation. Before handing over to Steve, I'd like to say just a few words on behalf of the Board. During the last year, a period of extreme weather have caused unusual operational challenges for the sector as a whole, but we have maintained a resilient and high-performance service throughout. Our operational performance continued to improve, and we reinforced our position as a leading company. We continue to make substantial investment in our region, and we're doing this now more efficiently and effectively than ever before, leaving a long-lasting legacy for customers and the environment.

We've long been clear on our target to outperform the regulatory contract for the 2015 to 2020 period. We're on plan to achieve this, and we have an established track record of sharing the benefits with our customers.

In September, we submitted our plan for the next regulatory period from 2020 to 2025. We are pleased that it was 1 of only 3 to be awarded fast-track status, and we will continue to engage constructively with Ofwat as the price review process draws to its conclusion.

Overall, it's been a good year for United Utilities delivering another strong set of results. The Board is therefore pleased to propose an increase of 3.9% in the final dividend, in line with our policy. This takes the total dividend for the year to 41.28p per share.

Thank you very much. Now over to you, Steve.

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [3]

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Thanks very much, John. Well, good morning, ladies and gentlemen, and welcome to United Utilities' Full Year Results Presentation for the Final Year 2018/'19.

Before getting into the detail, there are 3 aspects of this year's performance that I want to mention. I think the first is that this has been another year in which our innovative Systems Thinking approach has been key to us going from strength to strength. The investment we've made has strengthened the resilience of our service to customers. And despite the operational challenges brought about by the weather last year, I'm proud of the UU team's performance in maintaining unrestricted service to customers and in, again, delivering year-on-year improvement in overall customer satisfaction.

Second, at the start of this regulatory period, we said that accelerating investment in the first few years of AMP6 would improve our performance against increasingly challenging ODI targets. And we've delivered on this promise with our best annual ODI result so far, reflecting good across-the-board operational performance.

And third, we were pleased to be awarded fast-track status by Ofwat for our PR19 business plan in recognition of the quality of our plans and the transformation of the business over recent years and giving us a flying start for AMP7.

We're also delighted to retain self-assured status in Ofwat's company monitoring framework for 3 years running, demonstrating that stakeholders can have the highest levels of trust and confidence in the information we report.

Here are the highlights for the full year. You can read them, so I'll just pick out a few points. Once again, we improved customer satisfaction year-on-year, and we now anticipate a GBP 16 million SIM reward for AMP6.

We beat our leakage target in a year made extremely challenging by the freeze-thaw, and then the dry weather. And this is the 13th consecutive year in which we've met or beaten our target.

We earned a net ODI reward of just over GBP 19 million for the year, and we remain confident of delivering GBP 100 million of totex outperformance in AMP6 against our final determination scope.

And finally, in view of our total anticipated outperformance over AMP6, we're announcing today an additional GBP 100 million of outperformance reinvestment in the final year of AMP6 to give us a head start against our operational targets for AMP7. This brings our total outperformance sharing in AMP6 to GBP 350 million. I'll cover a number of these points in more detail before asking Russ to take you through the financial results.

I'll start with customer satisfaction. And we now have the qualitative SIM results for the sector for the first 4 years of AMP6, and this is the period against which Ofwat will assess companies' eligibility for penalty or reward. And the slide shows our improvement journey over the AMP set against the industry average. And you can see that the industry average has improved, but we've improved faster, positioning us amongst the best of the WASCs.

This next slide shows relative positioning over the 4-year SIM measurement period. And we've delivered year-on-year improvements since the start of the AMP, ending in fourth place overall amongst the WASCs. We've calculated where we expect the reward penalty bands to fall based on the methodology Ofwat used at PR14. And assuming that Ofwat applies the same methodology, our performance position for AMP6 means we should be in line for a reward of around GBP 16 million.

And as proof that good service costs less, our cost to serve has reduced by 27% since 2014/'15, driven by our improved operational performance and a multisector best practice approach to driving down bad debt. Our ongoing focus on bad debt, through initiatives such as our innovative affordability schemes, has resulted in the bad debt performance you can see in the chart on the right, reducing from 3.6% of household revenue in 2014/'15 to 2.1% last year.

Also contributing to our reduction in cost in this area is our innovative digital strategy, through which we've developed new services that increased the speed and quality of the customer service that we provide. These include the launch of a new website, an easy-to-use mobile app and a new system that enables us to proactively keep customers informed of events on the network. Alongside these, we've increased the hours that were available for customers to contact us as well as the contact channels that customers can use, so they don't always need to call.

We expect to end the AMP in line with the PR14 allowed cost and don't anticipate the same scale of challenge in AMP7 as our business plan proposals are aligned with Ofwat's modeled costs.

Ofwat's feedback on our PR19 business plan is that we're assessed as having the most embedded innovation culture in the sector. Our strategy of Systems Thinking, underpinned by our Innovation Lab, is transforming the way that we run the business and is delivering real and material improvements in operational performance and efficiency.

Our use of advanced technology, artificial intelligence and machine learning allows us to take a much more informed and proactive approach to operations and service delivery, helping us to respond better to incidents and deliver improved service. This approach has been fundamental to the efficiency savings and performance improvements already delivered in AMP6, with scope for further improvement in AMP7.

In a more recent development, we're one of the founding members of the World Water Innovation Fund, a collaboration of leading water companies spanning 3 continents to trial innovations with the objective of improving service for customers. We'll bring to this relationship our extensive experience in sourcing innovation and in its rapid evaluation and deployment. But the attraction to us is its global reach and the multiplier effect of pooling resources to evaluate innovation once, but deploy en masse.

I reminded you in my introduction that we'd accelerated investment early in this AMP to secure the associated operational service benefit as early as possible. You'll also recall that our ODI targets get tougher with each year of the AMP. And I'm pleased to report that last year, we achieved our best ever ODI performance against those tougher targets, yielding a net reward of just over GBP 19 million, bringing the total net reward to date to just over GBP 21 million.

Of note is that we delivered improvement across the range of our ODIs reflecting good all-round operational performance. We now expect to deliver a total net ODI reward of around GBP 30 million over AMP6. This equates to performance towards the top end of our estimates, and we're building a solid foundation as we approach AMP7.

I'd like to highlight 1 investment that's been critical to improving our water service. We've previously talked about the use of machine learning to proactively manage our water network, getting ahead of problems and fixing them before customers are affected. But when we do have a major burst, we need to buy time for its repair, and we have the sector's largest fleet of tankers or water on wheels to help. These are mobile reservoirs that we can connect to the network to maintain flow and pressure in order to keep customers supplied during planned and unplanned interruptions.

Our fleet currently has the capacity of over 1 million liters of water deployable anywhere in our region, and we're adding to this capacity. And with our tanker fleet directed from our Integrated Control Centre, we'll be capable of restoring water to 95% of customers within 3 hours, 24/7, all year round.

Expansion of the fleet has made a significant impact on our ODI metric for customer minutes lost and represents sufficient use of resources when compared to network replacement.

This slide's a reminder of the Ofwat assessment of company's PR19 business plan submissions. We're pleased to have earned fast-track status in recognition of the transformation achieved by the company over AMP6 and our plans for further improvement in AMP7. We gave analysts and investors a summary of that initial assessment in our briefing in early February, and the price review process is ongoing. And as you would expect, there are a number of important issues still to be resolved, but we continue to work constructively with Ofwat on these through to the publication of final determinations in December.

An advantage of being fast-tracked more than a year ahead of the start of AMP7 is that we can refine our plans to achieve a flying start to the AMP. We've seen the benefit of early investment in AMP6. And so we've decided to reinvest a further GBP 100 million of our AMP6 outperformance in areas where we have the opportunity to deliver improved performance earlier in AMP7. This investment is in addition to the GBP 250 million we've already committed to deliver enhanced resilience, bringing the total additional investment for AMP6 to GBP 350 million.

The main priorities for this investment are shown on the slide and include 3 of our toughest performance targets for AMP7: leakage, supply interruptions and sewer flooding. I mentioned earlier that we remain on track to deliver GBP 100 million totex saving against our AMP6 final determination scope. And a key area of focus for us is to achieve a base totex run rate as we transition into AMP7 that supports our business plan submission.

And this slide shows the forecast position from our business plan submission. You can see that the efficiencies being delivered in AMP6 put us in a good position against the average run rate that we've projected for AMP7. In addition, our plans for AMP7 are well advanced. As part of our preparations, the early design work for our transition investment is underway, and we've already implemented our new supply chain arrangement for the repair and maintenance of our network. We're confident that this will generate savings in excess of GBP 100 million across AMP7. And whilst across the sector there's a degree of uncertainty as to future environmental obligations, we took advantage of our good working relationship with the Environment Agency to gain clarity of our AMP7 requirements. And therefore, we have these well defined in our plan.

We're well prepared right across the business. There's clear ownership and accountability for effective delivery of our plans for the next regulatory period.

And finally, this is a reminder of Ofwat's assessment of the trust and confidence stakeholders can have in the accuracy and completeness of company reporting. Integrity is one of our core values, and we're once again delighted to be awarded the top self-assurance rating, the only company to have achieved this for 3 consecutive years.

I'll now hand over to Russ to take you through the numbers. Thank you.

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John Russell Houlden, United Utilities Group PLC - CFO & Executive Director [4]

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Well, thank you, Steve, and good morning, everybody. Sorry I missed you at the half year results. Some of you know that I had a knee operation, but I'm now fighting fit again, and it's good to be back.

Let's start with our reported income statement. Reported profit after tax of GBP 363 million was up GBP 9 million, largely reflecting higher allowed regulatory revenue, only partly offset by one-off dry weather costs and a higher depreciation charge.

Focusing now on the underlying income statement, which we believe is more representative of business performance. Revenue of GBP 1.8 billion increased by GBP 83 million, largely reflecting our allowed regulatory revenue profile. Underlying operating profit of GBP 685 million was up GBP 40 million. This reflects the increase in revenue, partly offset by an increase in IRE and an increase in depreciation, which I'll cover on the next slide.

Underlying profit before tax of GBP 460 million increased by GBP 90 million. This is due to the increase in underlying operating profit and a decrease in the underlying net finance expense due to lower RPI inflation applied to our index-linked debt. Overall, a strong financial performance with underlying profit after tax of GBP 379 million, up GBP 74 million, giving an increase in underlying EPS of 24%.

Lastly, at our half year results, we said we were considering whether to change our calculation of the underlying profit after tax and EPS figures to exclude the impact of deferred tax. We've decided to retain our current methodology of deriving the underlying profit figures, and, therefore, retain comparability with our past performance and with most Footsie companies, but not with our listed water peers. We will reassess this position once we have visibility of Ofwat's final determination and further clarity on the direction of travel of the IASP's rate-regulated activities project, which could also have an impact on our decision.

Now let's focus on underlying operating costs. In overview, we have again maintained tight cost control on our underlying cost base despite inflationary pressures. Total underlying operating expenses increased by GBP 43 million. This reflects an GBP 18 million increase in IRE primarily due to the phasing of a large capital project with a significant element of IRE spend and an expected GBP 16 million increase in depreciation from the increase in asset base. The remaining cost base has increased by GBP 9 million as a result of small increases in employee costs, materials, bad debts and property rates, partly offset by a credit resulting from the settlement of a historical commercial claim.

Lastly, as a result of the dry weather event in summer of 2018, we expect to spend additional totex of just under GBP 80 million, and an analysis of that expenditure is included in the appendix to the presentation. For the full year, the adjusted item of GBP 36 million comprises GBP 11 million of IRE spend and GBP 26 million of operating costs.

Turning next to the statement of financial position. Property, plant and equipment was up GBP 363 million, and net debt was up GBP 199 million, reflecting expenditure on our ongoing capital program. We continue to have an IAS 19 retirement benefit surplus, which I'll talk about on the next slide.

Cash and short-term deposits reduced by GBP 171 million, mainly due to the timing of finance raised toward the end of last year. Derivative assets reduced by GBP 146 million, and derivative liabilities reduced by GBP 21 million as a result of the maturity of swaps and the movement of market rates in the period.

Gross borrowings reduced by GBP 97 million mainly because debt maturities in the current year exceeded the new debt raised. And retained earnings of around GBP 2.3 billion were up GBP 150 million, largely reflecting retained profits of GBP 363 million and posttax remeasurement gains on our DB pension schemes of GBP 73 million, partly offset by dividends of GBP 274 million.

I'd now like to update you on an important development in our pensions position. Over recent years, pension scheme funding has become a bigger issue for regulators. Ofwat will require companies to consider pensions before making dividend payments. And recognizing the limitations of IFRS and funding deficit calculations, The Pensions Regulator expects all pension schemes to calculate their deficit or surplus on a self-sufficiency basis and to have a long-term plan to achieve self-sufficiency. This means getting to a position where the pension scheme is invested in low-risk assets and funded such that it has minimal reliance on the company in order to meet all of its liabilities.

As at the 31st of March 2019, we had an IFRS surplus of GBP 484 million. In April 2019, we prepaid at a discount all of the deficit repair contributions originally planned up to 2021 for our larger scheme, the UUPS, and up to 2024 for our smaller scheme, the ESPS.

As a consequence, the only future payments we expect to make will now be our ongoing service contributions. Since our deficit repair plan was our final step to self-sufficiency, we now have no deficit on a funding basis and no deficit on a self-sufficiency basis.

This slide sets out some of the key differences between the 3 main bases on which pension surpluses and deficits are calculated. Recognizing this is a complex issue, but one that is very important in terms of differentiator of economic value, we'll happily pick up in more detail outside of today's presentation with those of you interested in understanding this further.

We believe that we are unique amongst the water companies in having achieved self-sufficiency. This means that our employees and pensioners are in a very secure position. And for our shareholders, it means that they are well protected from the risk of having to make extra payments, and they can also be reassured that our pension position means that there should be no pensions reason for either Ofwat or The Pensions Regulator to apply constraints to our dividends.

Turning next to our robust capital structure. This chart shows that RCV gearing has remained comfortably within our target range since 2011. For many years, we've maintained a consistent policy of targeting RCV gearing of 55% to 65%, which has been supportive of UUW maintaining a Moody's A3 credit rating.

This has underpinned the financial resilience of the business for the long term. Although Moody's retained its negative outlook on the sector in general, UUW had its A3 credit rating with a stable outlook, affirmed by Moody's, following Ofwat's initial assessment business plans. Taken together with our pension's position, this gives us an extremely robust capital base, providing a high degree of resilience and financial flexibility.

And now for completeness, we'll consider the cash flow statement. Net cash generated from operating activities was GBP 832 million, largely reflecting operating profit adjusted for depreciation. Net cash used in investing activities was GBP 628 million due to net capital expenditure in the regulated water and wastewater investment programs. This excludes IRE, which is treated as an operating cost under IFRS.

Cash flow CapEx is lower than the previous year, reflecting the timing of actual cash paid rather than capital work undertaken in the period. Net cash used in financing activities were GBP 377 million, largely resulting from dividends paid to shareholders and the net repayment of borrowings reflecting the timing of finance raised.

The nature of our regulatory model means that cash flow is only part of the picture with the inflation return on the RCV comprising a noncash uplift, which is reported neither as income nor as cash flow. This is why RCV gearing and its trend over time remains one of the best indicators of a sustainable business model.

Now looking at our capital spend profile over AMP6. The chart here shows how we accelerated investment in the early years of the AMP in order to deliver operational improvements. As Steve referred to earlier, we're now seeing the benefit this has had contributing to our best-ever in-year ODI performance. In 2018/'19, we invested GBP 821 million, taking our total capital investment for the first 4 years of the AMP to around GBP 3.2 billion. Our capital delivery continues to be achieved in an increasingly effective and efficient manner, as measured by our internal Time: Cost: Quality index, or TCQis, that was up at 95%, meaning that 95% of our capital expenditure in the last year was delivered to time and the budgeted cost and meeting the high level of quality required.

Now an update on our financing position. Over the 2015 to '20 regulatory period, we had a financing requirement totaling around GBP 2.5 billion, which is now fully funded with a comfortable liquidity position extending out to the end of 2020. We remain one of the sector leaders in issuance of CPI linked-debt.

In April 2019, we increased our CPI linkage in our debt portfolio to GBP 365 million through a new GBP 100 million bank loan and executing around GBP 100 million of RPI to CPI inflation swaps, matching existing RPI-linked bonds. These transactions took place subsequent to 31st of March and are not, therefore, included in the statement of financial position. We've raised a further GBP 382 million of nominal debt taking our total for AMP6 to just under GBP 1.9 billion.

Since September 2018, we've also renewed or extended GBP 150 million of committed bank facilities and signed GBP 50 million of new facilities, taking the total to GBP 800 million under our rolling bilateral program.

And finally, an update on our cost of debt and hedging. As a reminder, our inflation hedging policy is to target around 50% of net debt to be maintained in index-linked form. The average cost of our GBP 3.8 billion long-term index-linked debt portfolio is 1.3%, with the most recent issuances at lower rates, reflecting the current interest rate environment.

With regard to interest rate hedging, our policy is to fix interest rates on our nominal debt on a 10-year reducing balance basis, thereby broadly replicating a 10-year trailing average used by Ofwat. Our nominal debt portfolio of GBP 3.3 billion is virtually all fixed for the 2015 to '20 period with an average rate of around 3.2% nominal. The low cost of debt that we've locked in places us in a strong position to deliver financing outperformance up to 2020.

So to summarize, this is another good set of results in which we've continued to maintain tight cost control while delivering high-quality service. Our strong balance sheet, robust capital structure with a responsible level of gearing, and our financial risk management approach are sector leading and underpin financial resilience for the long term. The responsible stewardship of our pension schemes has eliminated our pension deficit on a funding and self-sufficiency basis, mitigating risk for pension scheme members and shareholders. The low cost of debt we've locked in places us in a strong position to deliver financing outperformance up to 2020, and our current position provides financial flexibility, so that we're well prepared for AMP7.

Thank you, and I'll now hand you back to Steve.

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [5]

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Thanks, Russ. As you've seen from today's presentation, we've had another strong year, and I'm incredibly proud of the great people we have working with us. I'm particularly pleased for them, the level of external recognition we've received from within and outside the water sector. This slide shows some of those accolades covering our leading performance in customer service, governance, the environment and people. And I'd like to draw your attention just to one of the awards in the customer space, The WOW! Awards, that helped us to embed our customer values while recognizing excellence in customer service and feeding it back directly to the relevant employees.

We've received over 32,000 individual postings of great customer feedback and that, since we started participating in the awards in 2012, has more than any other company in the scheme over that period. And we're very proud of the achievement and delighted with the recognition that it's giving our people.

So finally, this slide summarizes the year's key achievements, and I'll pick out just a couple of highlights. We put customers at the heart of everything we do, and I'm delighted that customer satisfaction has once again improved year-on-year. So we now anticipate a GBP 16 million reward for our SIM performance across the AMP, whilst bad debt and cost to serve continue to reduce.

We said, when we started the AMP, that accelerating investment would deliver performance benefits, and it has. We've delivered our best in-year ODI performance with a net reward of just over GBP 19 million against our toughest targets yet. And this performance puts us in a great position as we transition into AMP7, and I'm delighted that we're now -- that, today, we're announcing an additional GBP 100 million of AMP6 outperformance reinvestment to achieve a flying start against our operational targets for AMP7. The investment will focus on areas where we [have] stretching targets and brings our total outperformance reinvestment in AMP6 to GBP 350 million.

Our strategy is delivering, and we've again gone from strength to strength. And I'm proud of our achievements and excited about the opportunity AMP7 represents for us and our stakeholders.

So thank you. Thanks for listening. I'd now like to invite questions.

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Questions and Answers

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James Brand, Deutsche Bank AG, Research Division - Research Analyst [1]

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James Brand from Deutsche Bank. Three questions, please, all a bit different. The first, one of the interesting things from looking through the draft determinations was some of the profiling around prices. And the profile that you proposed on prices had quite a big year 1 real price cut and then some more modest real price cuts coming through the rest of the period, but Ofwat's draft determination had all of the real price cut coming through in year 1. I'm just wondering whether that impacted your thinking at all about anything in the next regulatory period. Obviously, it would imply more of an impact on year 1 profits, but whether there are any more profound implications from that. And also whether you're still trying to push back on that going in, provide more evidence going to the final determinations.

Second question is just on residential retail. It's obviously a pretty staggering improvement there compared to how the outlook was a few years ago. When you're saying you're looking for upper-quartile performance or hoping for upper-quartile performance in the next regulatory period, does that mean that you're hoping to outperform in that area? Or obviously, Ofwat is aiming for upper-quartile cost allowances itself in different areas, so should we interpret that as an aim for outperformance or just to be in line with their allowance in the next regulatory period?

And then thirdly, just on the dividend, I'm not necessarily expecting an answer to this because I know obviously we're not going to find out on the dividend until early next year. But I was just wondering whether any priorities that you could identify when thinking about the dividend that there metrics that you -- that are more important than others for you, whether it's the balance sheet or the payout ratio. But I'd understand if you don't to comment on that, but if you're willing to, that would be really interesting.

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [2]

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Okay. All right. I think just picking up the points there. As far as the price profiling's concerned, you're right that one of the things that we did was perhaps look at a softer entry into the price, so that we still achieved an overall price reduction of about 10.5% over the period. But that -- it wasn't all year 1. And traditionally, Ofwat has given us the bulk of the reduction in year 1. And then -- and that's not always been the case for all companies. I think one of the concerns we have about that is the implications for customers in that they do get that advantage. But of course, the K factor they're after in terms of the adjustment going through tends to give you above-inflation rises and sometimes quite significant as you start to see that adjustment come through. So one of the things that we will be doing in the representations, which we put forward tomorrow, James, if I'm correct, is dealing with that and actually questioning whether that's an appropriate approach.

On retail, I think, for me, it's been brilliant performance. And I put most of that down to this force of nature called Lou Beardmore. Stand up, Lou. But Lou took on the customer area for us in terms of domestic retail. And has actually made some brilliant performance really. I mean we and the Board are absolutely delighted with what she's done. I mean I think, clearly, we were pleased that the econometric modeling and the way that Ofwat looked at retail as part through their methodology took into account many of the things that we've been talking about over the years as factors on costs, things like deprivation, whether it's a dual or single service. There's a whole series of features that I think the modeling now picks up.

Clearly, if we can outperform, we will outperform. And we've got a whole series of initiatives that we're driving through in the way that we're dealing with customers who are struggling to pay whether they [have the] priority service. And so I think that's an area where we've got a lot planned, haven't we, for AMP7. And we'll keep working that area as well as trying to improve the debt position. Because what we're finding is, as you're getting better reach out to customers, it's improving debt because you're talking to people that you've never -- that would not talk to you previously. And that's been one of the big advantages of the work that Lou's done. In terms of dividend, for us, the key metric is the FFO to net debt [with S&P] isn't it effectively in terms of what we're doing. Do you want to pick up on that?

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John Russell Houlden, United Utilities Group PLC - CFO & Executive Director [3]

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I mean obviously, we look, first and foremost, to maintain our credit metrics because that's very important, opposite the debtholders. We think it's important for debt and equity to be fairly treated. And so we try to maintain our credit rating as in line with our targets. In terms of the dividend policy metrics, I think it's not appropriate to go into detail here because we'll have to give you a full explanation of whatever we decide post FD.

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [4]

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Okay. Right, sorry. Dominic was second. I didn't -- I forgot about -- I'll pick you up here.

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Dominic Charles Nash, Barclays Bank PLC, Research Division - Head of Utilities Research [5]

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It's Dominic Nash from Barclays. I was coming -- cheeky going to do 3, maybe just do 2. Firstly, on the GBP 100 million of the extra totex or outperformance you're going to be investing, can you just give us quickly tell us how much of that GBP 350 million you've got left in the final year? And what's the marginal return on investing an extra GBP 100 million sort of going into AMP7?

Secondly, on your SIM outperformance of GBP 16 million, I think you've put it into your RORE, I think it's 0.4% or 0.5% RORE. Has Ofwat actually agreed a methodology for that? Are you putting all 4 years of that into that number?

And just a quick one then for Russ. Obviously, I think you're involved in accounting methodologies. And the deferred tax issue you haven't put through this year. You said you might be waiting for the regulatory accounting standards. Realistically, how many years do you think we're going to have to wait for that? Because I think that's been ongoing now for what, a decade, maybe less?

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John Russell Houlden, United Utilities Group PLC - CFO & Executive Director [6]

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Let me take the last one first. No, it's not been going on for a decade. People might have been talking about it, but nobody was actually doing anything at the IASP until about a year or 2 ago on the rate-regulated activities project. They were originally thinking of a discussion paper, but we've been working with them, as have some of the other regulated companies, to take it further forward quicker. And it looked like we may see an exposure draft either at the back end of this year or more likely next year. So rate-regulated activities, of course, would deal with the deferred tax issue because the deferred tax issue is, that under accounting standards for a normal company, what you're doing is you're sort of smoothing the profit after tax by deferred tax because it's tax that you think you will one day pay. You're allowing for it now, and, therefore, you're not causing a volatility in your profit after tax.

Under the regulatory model, that doesn't make any sense at all because our regulatory model allows for cash tax. So if cash tax is low now, we get a low allowance in our revenue for the tax. And if that tax ever became payable, then you get a large regulatory allowance. So the current accounting standards actually create volatility rather than remove the volatility, which is the original intent. The IASP understand that. And they -- therefore, if we get a rate-regulated activities exposure draft, I'd expect that to be included, which is one of the reasons that I said earlier why I've deferred the decision on whether to adjust our results.

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [7]

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Just keep going back to front, sorry.. So as far as SIM's concerned, I think what we've done is we've put forward the calculation to Ofwat using the same methodology. I think what we've seen so far -- we've got James Bullock over there, Regulation Director. What we've seen so far would support that as being an expectation. But of course, it'll only be confirmed when we see that in the final determination because as far as Ofwat is concerned, their only -- they'll only see the final SIM figures for the sector at the end of the reporting year. But James, I think we're reasonably confident that that's the basis on which they'll calculate?

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James Bullock, United Utilities Group PLC - Strategy & Regulation Director [8]

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Yes. So I think (inaudible)

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [9]

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Yes. I think the underlying point for me, though, is I'm just delighted with where we are. I mean you'll remember back years ago, where we used to be in terms of customer satisfaction. I'm not sure that was the word customers used. And the journey that we've been on as a company is just brilliant. And we live and work in the region. So of course, you get neighbors, friends, all sorts of people talking to you. I used to have 2 people in my office dealing with complaints. Now we sometimes think there's something going wrong with the mail room because if we don't [still] get letters coming through, it's very satisfying. Or e-mails for that matter.

The other component is the GBP 100 million, the additional GBP 100 million is all last year work. And one of the things that we did was we gave the guys early notice that that's what the Board was considering, so that effectively, when we did get final Board approval for that investment, we could get a racing start to the work. So -- and it's effectively -- roughly 50-50 isn't it, water and wastewater investment that we're making, largely targeted against the more challenging ODIs in terms of things like customer minutes lost, leakage and sewer flooding. So those are the priorities in terms of the areas of investment.

Russ' chart showed you the distribution of our investment over the 5-year period. And that green section is the outperformance reinvestment. We -- there's about GBP 200 million this -- remaining this year. But again, we're confident from the work we've done. GBP 100 million of that has been long-term planning. We started outperformance reinvestment as soon as we were confident. And so you saw some expenditure in year 2, but you'll see that running through, but the bulk of that expenditure being in the last year. Nice thing about it actually is it gets -- keeps your resources on. You haven't got the feast and famine that you often see, so that's a benefit of doing it.

Key issue for me, though, it's about responsible behavior. We are outperforming. I think part of the issue for companies is to be seen to be operating responsibly. And I think we're doing that, but we're making best use of the money in giving us a racing start for next AMP.

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John Russell Houlden, United Utilities Group PLC - CFO & Executive Director [10]

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Just on Dominic's final point about returns, you can be assured that every item of that CapEx has got a return in excess of the cost of capital, and it has got a good payback. We went through a long list of projects, and that was one of the filters that we applied.

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [11]

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You've got the mic. So only you've got the power [today.]

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Iain Stewart Turner, Exane BNP Paribas, Research Division - Analyst of Utilities [12]

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Can I ask a couple of questions? On bad debt, you've got a chart on page -- on Slide 7, which shows the bad debt going down. And then on Slide 18, you've got operating cost with bad debt going up. Can you just reconcile that, please?

And then you're talking about deferred tax. And obviously, on your balance sheet, there's a big differed tax liability. But the way you're talking about cash tax, it sounds like you're effectively saying that there should be some sort of regulatory asset to offset that deferred tax or the deferred tax is actually something that's due on customers rather than on shareholders. Is that the right way to think about it?

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John Russell Houlden, United Utilities Group PLC - CFO & Executive Director [13]

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Yes to the second question. To the first question, it was a one-off benefit last year that came through as result of the cleanup of the Water Plus stuff. So it was -- nothing to do with domestic retail.

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Fraser Andrew McLaren, BofA Merrill Lynch, Research Division - Director [14]

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It's Fraser McLaren from the Bank of America. Just 2 questions, please. First of all, you mentioned there were a number of things that you were still speaking to the regulator about. On that list, which are the largest items? And how is the overall spirit of your discussions?

And then secondly, just to be clear on the extra GBP 100 million of investment that it is genuine extra spend and that none of it is simply bringing work forward from AMP7?

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [15]

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I think one of the advantages, I think, of fast-track is that, essentially, you are -- you're not in a scenario where you've got very significant challenge. If I think about where we were in PR14 and the size of the gap between us and the regulator, that is a very difficult situation to be in. I think when you get to fast-track, and you know that the vast majority of your plan is accepted. It's a very different spirit. And I think the relationship between ourselves and Ofwat and the other regulators for that matter has improved significantly over AMP6 largely as a function of performance. And I think good performance earns you the right to a good conversation. So I think I would say that all of our dialogue with Ofwat is well intended, good-spirited. And I mean I think if you look at the sort of things that we're doing, we had some overspills from the initial assessment, which were around things like some of the ODIs, where we haven't got time to resolve them.

So we've got outstanding points. We've got issues like the bill profiling that we're talking about. I suppose one of the big issues as you go forward, we've got big issues like Ofwat's view of WACC later in the year, which none of us know about. That's not a subject for conversation. I think, James, we get that around -- we get a view around the times of the draft determinations for slow-tracks in July, so that is a material point in the discussions. But I'd say that fast-track does get you to a point where it's a very constructive conversation that you have, and it gives you an environment in which to discuss different opinions, yes?

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John Russell Houlden, United Utilities Group PLC - CFO & Executive Director [16]

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Yes. I mean we did have a difference of opinion at IAP on Systems Thinking and on natural capital. We've pretty much got what we asked for on natural capital now, but we're still talking on Systems Thinking.

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [17]

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On Systems Thinking, it's an interesting one because what we've said, and this is -- and Simon is leads for that. [And] you saw Simon at the -- when we did the day talking about the company and what we're doing. Embedded within our business plan for AMP7, there is a very significant shift forward on Systems Thinking in terms of developing where we'd get to by the end of AMP6. What we did in offering up an ODI for Systems Thinking for AMP7 was to say we can see very clear advantage in actually driving this whole approach to technology application, to different process, to the way that we look at the whole system affects the way that we manage. And then if we can accelerate that, which would require further investment, then some of that investment has a much longer tail to it. We should get a contribution through an ODI. And that's the conversation effectively that we're having with Ofwat.

So it doesn't mean whether we'll do Systems Thinking or not, it's the rate of Systems Thinking implementation that we've talked about. And then the nice thing about it is that many other companies now in the sector are actually starting to talk to us and say, "Well, what is Systems Thinking? What are you doing?" And are you actually starting to emulate that. Now we've been at this for 8 years, so there's a lag in terms of implementation elsewhere. But we are now seeing other sectors starting to look and think about the way we organize the concept of operations and the way that we're applying technology to the management of our operations.

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Fraser Andrew McLaren, BofA Merrill Lynch, Research Division - Director [18]

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(inaudible)

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [19]

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It's extra. Yes. It is extra, yes. It is, yes. Okay. Any other questions? Verity?

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Verity Mitchell, HSBC, Research Division - Analyst [20]

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Verity Mitchell from HSBC. I'm just very interested in your chart on Slide 13 on the totex run rate. Just why you've presented it the way you have in terms of excluding enhancement CapEx. I mean what are you trying to tell us here?

And obviously, this just puts in the business plan submission. What does -- from what we've seen from the initial assessment, you have the glide path issue, but you also have the actual totex efficiency that Ofwat requires. So what does enhancement CapEx do to this chart? And also, what does Ofwat's initial assessment do to it?

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [21]

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Yes. I mean I think one of the points that's come up from a number of analysts and investors is a perception that effectively we still have a big challenge to get to in terms of base totex running forward. And what it will -- by using this chart, we wanted to effectively demonstrate that the work that we've been doing through AMP6 gets us into a good launch position for AMP7. So that's really the sole purpose of the chart rather than anything else.

Clearly, when you look at the overall totex challenge, the GBP 200 million that Ofwat have come through, we'll work through the areas where that will be found across the business. But I think rather than getting into the detail, it was much more a case of trying to give people a sense of where we are, what the glide slope is and the level of confidence that effectively, as we go into -- AMP7 doesn't represent a shock for us, a cost shock for us because of the work that we've been doing during AMP6. So it's a little more than that, Verity, in terms of how we've done it.

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John Russell Houlden, United Utilities Group PLC - CFO & Executive Director [22]

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Yes. The enhancement CapEx in AMP7 is going to be a bit less than in AMP6. Because in AMP6, we had 1 or 2 quite big projects which were unusual. We had the Thirlmere pipeline obviously for West Cumbria, and we had Davyhulme. Quite big projects in AMP6, but we won't have so many of those big projects in AMP7.

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [23]

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Okay. Yes? Where's the microphone?

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Iain Stewart Turner, Exane BNP Paribas, Research Division - Analyst of Utilities [24]

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Iain Turner again from Exane. Can you just remind us how the regulatory treatment of the additional investment works? And if we were to look at the draft determination, what's in there already? And then how will this change? What's in there with the extra amount you've announced today?

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [25]

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I mean and effectively, the additional investment would go through the menu arrangement. So roughly 50-50 shareholder-customer. So one would expect that this additional investment, like the GBP 250 million before it, from a regulatory perspective, would go through that menu sharing arrangement. And it is -- it's not quite 50-50, but it's roughly 50-50.

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Iain Stewart Turner, Exane BNP Paribas, Research Division - Analyst of Utilities [26]

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So this will count [as spend?]

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [27]

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Yes. I mean if you look at it from a regulatory perspective, I mean it would [still be] a spend beyond the final determination for AMP6.

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Iain Stewart Turner, Exane BNP Paribas, Research Division - Analyst of Utilities [28]

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So your RAV -- as per the 2020 RAV, as per the draft determination would be higher now?

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Steven Lewis Mogford, United Utilities Group PLC - CEO & Executive Director [29]

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Yes. Okay. Any other questions? Okay. Well, thank you very much. Thanks very much for coming. Thanks for listening.