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Executives

Jonathan D. S. Dawson - Head of Investor Relations, Executive Director, Chairman of Remuneration Committee, Member of Finance Committee and Member of Nominations Committee

Steven John Holliday - Group Chief Executive Officer, Director, Group Director of UK Gas Distribution & Business Services, Member of Finance Committee, Chief Executive of National Grid Transco and Director of National Grid Transco

Andrew R. J. Bonfield - Finance Director, Executive Director, Chairman of Disclosure Committee and Member of Finance Committee

Nicholas Paul Winser - Executive Director of Transmission, Executive Director of UK and Executive Director

Thomas B. King - Executive Director of Electircity Distribution & Generation, Executive Director of US and Executive Director

Analysts

Mark Freshney - Crédit Suisse AG, Research Division

Dominic Nash - Macquarie Research

John Musk - RBC Capital Markets, LLC, Research Division

Edmund Reid - JP Morgan Chase & Co, Research Division

Peter Atherton - Liberum Capital Limited, Research Division

Bobby Chada - Morgan Stanley, Research Division

Lakis Athanasiou

Martin Brough - Deutsche Bank AG, Research Division

Peter Bisztyga - Barclays Capital, Research Division

Iain Turner - Exane BNP Paribas, Research Division

National Grid (NGG) H1 2014 Earnings Call November 21, 2013 4:15 AM ET

Jonathan D. S. Dawson

All right. Ladies and gentlemen, I think it's time to kick off, so good morning. Welcome to King Edward's Hall for the half year results for National Grid for 2013, '14. And thank you for joining online for those of you who are joining us. My name's John Dawson, Head of Investor Relations for National Grid. And with us today, of course, are Steve and Andrew, who will go through our results presentation in a minute.

Before we start, a couple of notices, please could you ensure you turn off all your mobile phones and other electronic devices. That would be very helpful. We will have a full Q&A session at the end. Please wait for the microphone before asking a question just so we can get it recorded and your question can be heard online. We may include forward-looking statements in our presentation today so, of course, please read our cautionary statement in full, which you can see here behind me now.

With that, let me hand over to Steve.

Steven John Holliday

Thank you, John. Good morning, everybody. The running order for today begins with a few remarks from me on the highlights of the first half, then Andrew will take you through the details of our financial performance for the first 6 months, together with some comments on the financing of the group, and the reporting implications of RIIO, some of which, of course, we introduced at our seminar back in August. I'll then return to talk about the investment environment and the implications for us at National Grid as we see it today and, of course, our progress against this year's priorities and the outlook for the rest of the year. We've got with us this morning, as usual, Nick Winser and Tom King. We're also joined by John Pettigrew, who's our COO for the U.K. businesses.

We've made a solid start to the year as we begin our new regulatory arrangements in both the U.K. and the U.S. And we finalized the important foundations in the U.S. that are critical for future filings and performance improvements. I'd summarize here with we're very much on track.

In the U.K., we've made good progress managing our costs and outputs against the regulatory targets in all of our businesses. We're close to completion now of a thorough reorganization of the U.K. business, providing costs and operating efficiencies. And in addition, we started to see the benefits of cost and service improvements, resulting from negotiations with suppliers and long-term partners. More on that in a moment. In the U.S., we're on track towards a robust and satisfactory full year out-turn. The new rate plans in Rhode Island and New York are providing a secure framework for key parts of the business. And we're continuing to invest in network improvements and asset replacement required by customers but driving growth.

In addition to the normal activities, a significant amount of work is being undertaken to ensure a smooth handover of our LIPA contracting business to PSEG at the end of 2013. And I'd certainly like to take this opportunity to thank all of our staff who are involved in that activity. While that's going on, we remain focused on finalizing the important building blocks that will support further improvements in our business of which, of course, the SAP implementation remains key. You'll recall that this system went live just over a year ago and presented us with major challenges. In May, we had expected to address these during the first half of this financial year. Frustratingly, despite significant amount of focus, this now coincides and overlaps with the LIPA separation, and it will not be fully completed until the middle of 2014. But it remains an area where we can't be distracted. Our legacy systems were complicated and unintegrated and, as such, they were a major barrier to developing our business. These new systems are essential. They'll maintain and underpin the health of our regulatory discussions and improve our ability to manage the business efficiently. Despite that extra work that's been caused by this, our U.S. operations have nonetheless made good progress towards the Elevate 2015 targets, which I talked about briefly at our full year results. As a result, we're on track to deliver a strong performance on network reliability, emergency response and other important measures of performance.

Looking at the first half financial results, we're on plan, delivered a solid start to the year. Operating profit is GBP 1.57 billion, in line with our expectations. Profits before tax, GBP 970 million, reflecting the temporary cost of pre-financing our growth at attractive interest rates. Overall earnings at GBP 761 million, earnings per share at 20.4p, both down 1% on this period last year. A satisfactory performance, but a platform on which we can build in the second half of the year. And I'm pleased to confirm that the board have confirmed a dividend of 14.49p per share, unchanged at the half year, in line with the policy that we announced back in March.

We've also taken the decision to suspend the scrip dividend alternative with this year's interim, a decision that reflects strong underlying discipline around financing our growth and the high take-up last August. Andrew will talk about this in more detail. But before I hand over to him, let me just cover a few important operational highlights. Firstly, safety. Always at the heart of the way we operate. And as you know, over the last few years, we've sustained good standards, but we refocused our efforts, set ourselves a higher level of performance as an ambition. And in the U.K., we've delivered a significant improvement. In October, our benchmark employee lost time injury frequency rate improved again, and is now below 0.1 injuries per 100,000 man-hours worked, compared to an average of 0.12 over the last 3 years. We've proven we can deliver performance that's up with the very best in comparable industries. That benchmark should set the motivation to achieve even more. In the U.S., our safety performance is not yet seeing the same results, but we've redoubled our efforts, particularly in the areas of training and safety communications. We determined that we'll bring the level of performance there to a similar high standard.

Our RIIO price controls provide a great opportunity for us to drive efficiencies in our U.K. businesses, and sharing those with customers and investors alike. Measurement of the progress at the full year were focused very much on the returns that we're delivering. But let me try at the half year just to give you a little bit of a sense of the progress in the meantime. In transmission, we made excellent progress transforming the gas and electric businesses to perform optimally under RIIO. Last year's restructuring in Gas Distribution involved an 11% reduction in headcount, with a further 5% expected as the full benefits of our new structure kick in. In the transmission businesses, by the end of this year, we will likewise have reduced the headcount by a similar 11%.

Improvements are being made in many areas, not least, of course, in the area of total expenditures, in TotEx. For example, major contract renegotiations have already delivered cost benefits, particularly in some of our alliance arrangements. Let me try and give you just one small example, but typical of hundreds of projects that we do every year. An original estimate for a package of new connections was approximately GBP 40 million to improve scoping of that, making sure the scope was absolutely only what was required, and then smarter design and a different way of tendering that project, we reduced the cost to GBP 26 million, a 30% reduction on the original estimate. And we have hundreds of projects like that across the U.K. And of course, we share those efficiencies with customers, as well as investors, helping to keep bills down in the U.K.

In Gas Distribution, we've been able to lock in a number of benefits in the period, supported by our previous investment in IT systems, the reorganization of our field force and last year's renegotiations with a number of our suppliers. From a field operations perspective, with the support of our people and their unions, we're introducing changes to working practices which, over time, will have a major impact on customer service, responsiveness and efficiency. And again, under RIIO, we'll share the benefit of those changes, helping to keep bills low, but also driving up higher returns for investors.

In addition, our new Repex replacement program strategic partnership arrangements have got off to a really good start. We are well on track to deliver over 1,000 miles of replaced mains this year. The benefits of rationalizing our supply base and resetting those contracts have locked in unit efficiencies on costs and a much stronger alignment to all of the incentives under RIIO. And one of the most significant incentives in that business is the removal of risk from the gas system. And at the half-year stage, we've already delivered over 70% of that risk forecast for the whole of the year, so well ahead of our target. As a result, when we get to the full year, we expect to be able to report meaningful savings and service improvements that will markedly improve versus the allowed returns.

Of course, we're continuing to invest at significant levels in all of our regulated businesses, important investment for customers, but growing our asset base that will underpin future earnings growth. The current U.K. debate around the future cost of energy, whilst totally understandable, is creating uncertainty for potential investors, particularly in new generation. And I'll talk a little bit more about that when I return, and how we currently see that and our perspective on certainly how it affects our own investment plans over the next few years. Overall, we made a solid start and we've laid the foundations for good overall performance for the full year.

And with that, I'll hand over to you, Andrew.

Andrew R. J. Bonfield

Thank you, Steve, and good morning, everybody. Steve has highlighted our results reflect the steady progress we've made for the first half and towards our full year, meeting our full year expectations. But before I start, I'd like to discuss how financial reporting and performance measures will be impacted by RIIO.

In the new world of TotEx, measuring performance of our U.K. business requires additional information, which is only produced on an annual basis. Analysis of IFRS operating profit movements without this context doesn't give the full picture of the value we are creating. At the full year, you should expect additional more detailed disclosures around regulatory returns, regulatory revenue movements and IOUs, and regulatory asset values. All of the items our U.K. CFO, Andy Agg, discussed with you in August. In the meantime, operating profit remains the focus of our interim reporting, but as this does not include the capital efficiency and incentive benefits that will be discussed at the full year results, we've reduced the amount of commentary in the interim statement. You will have noticed a change in that we've split our U.K. transmission businesses into 2 segments, reflecting the increased differences in the 2 price controls and you should expect to see that going forward as well.

Let's look at our financial performance in the first half of the year. And unless stated, the quoted numbers will reflect business performance. Electricity Transmission operating profit was up 12% due to higher revenues from increased regulatory allowances, including the link to RPI, and increased profitability of the French interconnector, which performed very well in the first half of the year. Gas Transmission operating profit decreased by 18% compared to the same period last year. This is due to a change in the timing of permit revenues and a reduction in the allowed return and the higher gearing ratio required under RIIO. Gas Distribution profits were up 12%, reflecting increased regulatory allowances.

As expected, profitability in our U.S. operations was impacted by the loss of deferral income in Niagara Mohawk, which reduced revenues by around GBP 60 million for the first half. As a reminder, this has no impact on our U.S. GAAP returns. We also had a significant timing effect as we under-recovered revenues by GBP 57 million. This is seasonal, and we expect to reverse this by the end of the year. These headwinds in the U.S. were partially offset by revenue increases from new rate agreements, storm recoveries in Massachusetts and lower bad debt. In the Other Activities segment, our U.K. businesses were broadly unchanged from the comparable period last year. Profitability in the segment as a whole though was impacted by the U.S. system improvement costs, which Steve mentioned earlier and I'll speak more about in a moment.

At the group level, reported operating profit was slightly lower than the same period last year, driven by the lower contribution from the U.S. and U.S. system costs. Across all of our regulated activities in the U.K. and the U.S., we did see some pressure on controllable costs. Our objective remains to keep these costs flat or lower in real terms, but there were a number of one-off charges in the first half, which impacted the results. Depreciation also increased as we continued to grow the asset base. Overall performance of the group was slightly better than our internal expectations and, as I mentioned, we remain on track for the full year.

Returning to U.S. systems costs. The increased workload resulting from issues during the initial implementation of our SAP system has continued for longer than we anticipated. This has been a very complicated project, touching around 90 different systems across the whole business. Resolving the knock-on impact of each of the issues we have identified is a complex process, which has been exacerbated by the need to separate the activities of LIPA. This means that the final changes to the system are not now expected to occur until the first half of 2014, '15. We are confident that the project plan we have in place will deliver the changes we need, and we expect costs in the second half to be lower than the GBP 90 million incurred in this period. Reported financing costs were 9% higher than last year after adjusting for exchange rates. The increase was driven by the higher cost of carry on our gross debt associated with pre-financing most of our annual investment program.

Now let me just talk a little bit about the outlook for interest cost and our strategies for managing these, probably very topical after the last night's minutes. Over the last 6 months, long-term interest rates have increased by around about 100 basis points. This increase only brings us back to 2011 rates and are still a long way from the levels where they were before the 2008 financial crisis. Despite the increase in interest rates, we still expect to be able to outperform against our debt -- cost of debt allowances.

In the U.S., around 80% of our operating company debt is fixed. This reflects the way allowances are set as these typically reflect the embedded fixed cost. So maintaining fixed operating company debt matches the allowance and manages risk. The majority of this U.S. debt matures post-2015, so we have limited exposure to rising rates in the short term. If interest rates continue to increase and are higher than when we refinanced, we have the option to refile these rate cases and request more appropriate allowances.

In the U.K., our regulated debt allowances for operating companies are now reset annually using the 10 box -- the 10-year iBoxx tracker. Over the last year, the index yield has averaged real rate of about 1.5%. As we've explained before, we are able to issue a rate below that. As the tracker rolls forward, it uses today's lower rates to replace higher rates from 10 years ago. So this year's average real rate of 1.5% replaces the 2003 rate of 3.5%. As a result, the 10-year tracker allowance for next year will be 2.7%, as I've shown on the pink line. This remains higher than the average real cost of our existing U.K. debt. Much of the debt that matures over the next few years reflects rates that existed before the financial crisis. So if interest rates stay where they are, when we come to refinance, we will do so at a lower cost. As interest rates move, both the tracker and our average cost will move to reflect the new market conditions. Because of this, we do expect to outperform our cost of debt allowance. The tax rate for the first half was 400 basis points lower than last year, an effective rate of 23%. This movement reflects the lower proportion of U.S. profits in the half year and the 1% lower U.K. corporation tax rate. Reported earnings were down GBP 5 million and earnings per share decreased by 1%.

Our new dividend policy is to grow the dividend at least in line with RPI inflation for the foreseeable future. As we advised in March, when we announce the new policy, we will hold the interim dividend of 14.49p. The full effect of the new dividend policy on this year's total dividend will be seen in the final payment for the year, which is due next August. In the future, we intend interim dividends to be set at around 35% of the previous year's total payment. Our scrip program has been a popular option for many of our shareholders and the take up for the last year's final dividend was over 45%. In May, I set out our approach to financing our organic growth program. Doing this successfully should enable us to deliver attractive total shareholder returns. An important part of that is maintaining the A- credit rating. As we go through the first few years of our investment program, the transition measures on depreciation impact our revenues and cash flows. As I mentioned in May, the benefit of the scrip on our retained cash flow to debt metric is an important underpin of the rating. However, if elections are higher than expected, the additional capital provides little value. We are suspending the scrip at the interim due to the strong take-up at the final. This will limit this year's overall scrip uptake to around 30% of total dividends. However, you should expect us to offer the scrip alternative with the final dividend payable next summer.

Looking at cash flow. Our operating cash flows of just under GBP 2 billion were around 5% higher than prior year. This was partly driven by year-on-year weather impacts on working capital and recovery of last year's U.S. storm costs. Net debt remained unchanged at GBP 21.4 billion, reflecting a net cash outflow of around GBP 700 million, and offset by about GBP 800 million of favorable foreign exchange movement in our U.S. dollar denominated debt.

Finally, our technical guidance for the year, which remains largely unchanged. We updated our guidance in July for additional U.S. system costs and a number of positives, including the French interconnector. The French interconnector has performed very well in the first half of the year. We expect this to continue, but not to the extent seen in the last 6 months. As I mentioned earlier, U.S. system implementation costs will continue, albeit at a lower rate in the second half. And we are now expecting a lower full year tax rate of between 26% and 27%. At the group level, we expect CapEx to be lower than previously guided at around GBP 3.5 billion, and we also expect net debt to increase slightly less than our original forecast, and are now guiding to an increase of around GBP 1 billion, excluding foreign exchange. So overall, I'm pleased with the progress we've made, and there are no material changes for our full year outlook.

With that, I'll hand you back to Steve.

Steven John Holliday

Thank you, Andrew. And while we've been focused on execution and delivering the benefits of our new regulatory arrangement, the news flow here in the U.K. in terms of energy policy, generation margins and potential price caps has created a huge amount of uncertainty, all of which I'm sure you're very aware, in particular, around the timing of investment in new power generation. This is in contrast to the U.S. where interestingly, the focus seems to move the other way. All 3 states in which we operate are focusing on customers' needs for future investment. Net-net, we still see plenty of opportunity for organic investment. In other words, where we can invest at 100% of RAV or rate base on both sides of the Atlantic and drive sustainable value.

But let me take you through these in a little bit more detail, starting here in the U.K. And to remind you of our thinking, only last year when we're in the process of agreeing our forecast expenditure allowances for the RIIO period with Ofgem. The headline allowances for TotEx was set based on our Gone Green scenario with a number of agreed overlaid adjustments.

Broadly, this meant that over a 10-year period, the 8 years of RIIO and a further 2 years, 34,000 megawatts of new generation would connect. The 2,000 megawatts a year expected for the first 3 to 4 years of that period and the headline allowances for those early years reflected a growing amount of load-related expenditure and a relatively flat profile for non-load related investments, together, of course, with the previously agreed large strategic reinforcement projects.

Since then, unsurprisingly, we've seen a slowdown in the start of new generation construction. Currently, just under 2,500 megawatts of new generation will require connecting to the transmission system over the course of the next 2 years. We've always known from experience that not all of the contracts that we have for generators to connect ultimately leads to a connection. But compared to this time last year, we've seen a substantial change to this profile of contracted generation. This means that as things stand today, the currently low level of connections is likely in our view to continue for the next few years as many projects potentially delayed. But while that's going on, interestingly, our total contracted generation out to 2023 list has grown, showing that customers are still looking to invest but are waiting, and looking to do so when they have certainty, and certainly later than we previously expected. So it's not unreasonable for us now to plan for the scenario where our connection investments are low for the next few years. Nevertheless, we'll still be investing significantly in load-related and strategic projects. We'll be doing extensive pre-works, continuing to invest to reduce constraints and finishing our major reinforcement projects like the Western High voltage DC link from Scotland to England and, of course, the huge investment in power tunnels under London.

At the same time, our non-load CapEx continues at a material level, reflecting the underlying age of the group and the need to replace critical infrastructure. Non-load related CapEx last year was around GBP 500 million and is expected to be broadly the same this year. And this, of course, is appropriate at a much higher level than at the start of the previous price control period.

In gas, the agenda has been different for some time. Our plans for gas transmission always had our major investments loaded towards the end of the 8-year period, and this still looks like a reasonable assumption. In Gas Distribution, the focus remains on the Repex agenda, replacing or lining aging metallic pipes and removing risk from the system. In this respect, the RIIO base plan should remain unchanged, adjustments only arising from changes from the health and safety executive in the prioritization of these activities. Of course, we clearly don't have a crystal ball, so some things could even accelerate investment. What might they be? Possibly the new strike prices when they're finalized, or could it be when the second legislation for EMR is actually enacted in 2014 and therm contracts are signed. To summarize our view, though, the overall 8-year U.K. investment program still feels about right, but it's clear it's going to be phased more towards the latter years.

Importantly, when certain outputs are required, the TotEx allowance will flex. So RIIO was designed to handle exactly this sort of uncertainty. That ensures, importantly, that customers do not fund outputs that have not been delivered yet, helping to minimize any increase in bills despite what some might suggest. And we've put even further flexibility into our financing, our supplier arrangements, and indeed into our own management and engineering capabilities. Regardless of these current uncertainties, we expect to invest a significant amount in essential assets over the next 2 to 3 years. And this will afford our business the opportunity to outperform our regulatory contracts, driving growth and generating good returns for shareholders.

If I look out to the medium and the longer term, growth expectations remain strong. The chart I showed earlier demonstrated there's a strong pipeline of generation projects that have signed a connection agreement. Even in the event the U.K. Electricity Transmission CapEx remains at this level right to 2015, we'd still expect the RAV growth in that business to be between 8% and 10% per year. And overall, the U.K. to be at 6%.

Turning to the U.S. where longer-term growth opportunities continue to expand. Six years ago, we were investing $750 million a year. Since then, we've more than doubled that to around $1.8 billion. And enshrined in the existing agreed rate plans, this grows further to $2 billion next year. And we now expect, with future filings and requirements, that will progressively increase over time to around $2.5 billion a year.

What's causing that? What's behind that? Firstly, shale gas continues to drive the desire for network expansion to meet the demands of many customers who want to convert from oil to gas. Secondly, again, partly related to shale, significant changes in the mix of generation. More gas generation being built and a significant drive towards renewables, all requiring the buildout of new transmission. And lastly, and thankfully, we're not talking about a major storm today, though as I say that, I already am tempting fate. It's the first year for a while we've not had a huge storm in the first half of the year. But the last few years of recent extreme weather have undoubtedly put a real focus and a right focus on the resilience of networks and the modernization of infrastructure that has become old. In part, those drivers will be reflected in increased investment allowances in the rate bases of our electricity and gas network businesses. But in addition, our business development pipeline continues to grow. Generation in Long Island is now well-positioned to move forward with repowering. We talked about it for a number of years. We're now in advanced discussions around a possible investment of up to $1.5 billion in the Barrett facility, with a decision to proceed expected sometime during the course of 2014.

Staying in New York State for a moment. The New York Transmission consortium has been working on a superhighway to connect downstate demand with upstate generation, particularly renewable energy, and it's progressing well. This is a $1.3 billion project, of which we represent a 21% share. It's currently expected to be finalized with state support in early 2014.

And finally, the Clean Line projects, in which last year, we purchased an option to invest. And they have made good progress. Just this past month, the state of Kansas granted planning permission for 1 project, known as the Grain Belt Express Clean Line. Construction work on that $2 billion project is targeted to start in 2016, with commissioning in 2018. All in all, an exciting range of opportunities. Decisions yet to be taken, but potential for attractive, secure, long-term returns. So together with our U.K. investments, our program of organic growth options remains strong.

But let's turn back to this year. This year's priorities, unchanged. This year is and continues to be all about execution. In the U.K., we've made good progress, streamlined the organization. The focus now is on making sure we get the benefits from that, delivering the outputs and driving outperformance. In the U.S., as I said earlier, while ensuring we perform under our new rate plans, we must maintain this focus on completing the SAP implementation. Getting that system in place was the foundation for further performance improvements. It's going to drive both customer service, and importantly, it will generate more opportunities for efficiencies to drive higher returns.

As Andrew said, our expectations for the full year are unchanged with that we shared with you in May. First half is a solid start. We're confident of delivering the returns and the growth that are necessary to underpin our longer-term ambitions. And with that, we'd be delighted to take your questions. And I think there are, as Jon said, some microphones that will be available.

Question-and-Answer Session

Mark Freshney - Crédit Suisse AG, Research Division

It's Mark Freshney from Crédit Suisse. Just 2 questions for you, Steve. If a future U.K. government were to impose a price cap on retail and business builds, and you were asked to contribute towards that, what kind of legal redress would you have? And how can you be sure that your revenues really are firm? And for you, Andrew, I have a question on the one-off costs relating to restructuring and I think the gas hold provisions. Will those be included within the ROE estimates that you put out at the year end?

Steven John Holliday

Okay. Let's, if I may, Mark, just use your question -- just to talk about this issue for a second. Affordability is a real issue. It's not a joke. It's a serious issue, but it's only one of the issues that we clearly have to address. Reliable energy supplies is equally a very important issue, not just for the consumers, but also for the economy. And of course, we've got our desire to ever progressively clean up the mix of energy. I mean, that trilemma exists in the U.K., exists all over the world. Getting the debate and getting the balance and the trade-off right is something that needs to happen and happen pretty quickly. Our business, of course, has just been through, as you all know, a really rigorous review by Ofgem and by stakeholders of the costs of running our business, providing reliable, safe networks day in, day out, as well as stress testing the GBP 26 billion of investment that we need to make. So just been through that 2-year review period, and that's contributed an GBP 11 increase to the increase in bills this year. So the GBP 100-odd that we were paying as consumers extra this year if we're an average bill payer, GBP 11 of that is we're going to associate with beginning of the RIIO period. For the next 7 years, that's an increase of GBP 1 RIIO per year for the next 7 years. That's all it is, which allows us to run these businesses in the way that we have in the past and equally invest GBP 26 billion of critical investment that's required. So I think that, that's what we need people to actually focus on. But it's right there's a debate about the balance of and how quickly should we clean up our energy mix. But we clearly need to make sure, as I was remarking, that generation gets built in this country, so pretty quickly getting back to what needs to happen, get this Energy Bill through Parliament. That piece of legislation is crucial to give investors the clarity for the future. And let's not forget just how stable the U.K. has been such for a long period of time. The World Energy Council actually do a ranking on sustainable energy investment environment to deal with policy and regulation. The U.K. is in the top 5. That's not surprising. We've attracted a huge amount of investment over the past. We're now entering a phase where we need more investment than ever, so creating confidence, real stable environments, the right incentives and the confidence that our regulatory environment that have worked so well for a long period of time aren't interfered with the short-term initiatives is hugely important. Andrew, do you want to pick up?

Andrew R. J. Bonfield

Yes. Mark, on exceptionals, we have never included exceptionals within ROE calculations. That's never been part of the calculation methodology. On the gas hold, of course, part of the reason why they have been classified as exceptional is, a, the size of them. It is a one-time, because effectively, now, we are in a situation where we'll be demolishing them over a period of time, and we'll actually receive some return from Ofgem, but it'll be spread out. But because the decision has been taken to transfer them out of Gas Distribution into the property company effectively, it triggers the charge, so it's -- effectively, that's the way it – what's triggered it.

Steven John Holliday

Thanks, Mark. Dominic?

Dominic Nash - Macquarie Research

Yes. Dominic Nash, Macquarie. Two questions as well, please. First one is one is going off of Mark's question that if -- what proportion of your revenues come from retail? And if the credit ratings of U.K. retail gets cut, is there any credit impact on yourself or your ability to raise debt? And secondly, on interconnections, as the carbon tax starts to really kick in, in the U.K. power price divergence from Europe, do you see further opportunities in building interconnectors in this? Could this be quite a major profit driver for you going forward?

Steven John Holliday

Okay, let me -- hang on. Nick, you might actually pick up the complexity of the way the retail charges flow through and the surety that we have actually of who picks up those charges. But let me just take the second one first because it is an important point, in this overall context of securing the lowest possible cost, reliable energy supply as we can in the U.K. It's been very clear for a long time that the U.K. is under-interconnected against the position that it would like to be. And there were a number of projects, as you well know, that have been -- in my part, on the drawing board for a long time, a long time. And we need some of those to actually come to fruition, so certainty around the regulatory regime is important. We've just actually had a piece of independent work done by consultancy to look at if we were more interconnected. If 3 extra gigawatts of interconnection was available, what might the benefit be to the U.K.? That analysis has GBP 1 billion a year potentially for 20 years by equalizing prices and allowing customers in the U.K. access to lower-cost electricity. So we're very determined, Dominic, to try and find the right regimes around an opportunity to build more interconnectors as soon as we can. They're challenging from a technical front, but we've proven that we can do that. And I think it's a big piece of the mix in the jigsaw for the future, ensuring we get reliable supplies, but likewise, doing that at the lowest cost to customers. Nick, the way our retail charging works and the others pick up if, by implications, somebody fails, I guess, is your question, Dominic.

Nicholas Paul Winser

So the arrangements in the industry are designed to include provisions for the failure of say, a DNO, for distribution come [ph] for the special administration powers in there. That's -- they are included in that to give certainty that the industry will continue to function in that way. So ultimately, that's the assurance that sits in the whole of the regulatory structure against -- I mean, I think it's a remote possibility, but against the failure of a distribution company because of a -- or a supply company because of a price freeze of some form.

Steven John Holliday

John, go ahead. There's one question behind.

John Musk - RBC Capital Markets, LLC, Research Division

It's John Musk from RBC. Two sort of numbers questions. Firstly, on the scrip dividend and I guess related to CapEx, which is yet again coming in a bit lower than what you would have guided a few months back, for this year and for next year, how does that balance into decisions around the scrip dividend, because it would appear that the savings from CapEx are roughly equal to some of the savings on the scrip dividend or -- so does that play into your decision on maintaining the scrip dividend over longer term? And then secondly, just a simple one. On the SAP implementation cost, can you just update on what the total costs are now for the SAP implementation? And is there any way you can talk about a payback period on those costs?

Steven John Holliday

Andrew, costs overall? I'll do payback.

Andrew R. J. Bonfield

Okay. On the scrip dividend first, to start that, on the -- where we are on that is the RCF-to-debt metric is not impacted by CapEx, so it's a pre-CapEx measure. RCF-to-debt is probably the most important of the credit metrics, where scrip benefits is from. So to be honest with you, the CapEx change has no impact on decisions relating to that. As regards SAP costs, we've capitalized about $240 million of spend, which is actually going into rate, and that will be recovered through future rate -- other future rate filings, but it's already in, for example, Niagara Mohawk, and we will be recovering that. Obviously, the expenses last year was about GBP 112 million, and the GBP 90 million we've incurred this year to date will actually just be -- basically will not be recovered through rates. The quicker we get things obviously running back up and forward, the quicker we can actually move into a more regular rate filing process, so that will be the way we get the payback, John, through SAP, as well as, obviously, efficiencies from running the business better.

Steven John Holliday

Is that -- you got...

John Musk - RBC Capital Markets, LLC, Research Division

Yes. So is the total -- sorry, is the total cost, the GBP 240 million, and we can add on the GBP 112 million and the GBP 90 million as well?

Andrew R. J. Bonfield

Yes.

Steven John Holliday

Yes. And important point in there is this is not our finest hour. The costs of remediating this system are to our account. Investment in the system originally that will benefit customers and replaces systems that had to be replaced, we enshrined in loss of rate plans. But all remediation is to our cost actually. And yes, when we're through, we'll get the benefits. But as I said, we have to replace these whole systems. The systems will deliver benefits, but don't deliver any benefit until we get these problems resolved and get the system working properly. Do you want to go to Ed, and then we'll come over to Peter over here?

Edmund Reid - JP Morgan Chase & Co, Research Division

Edmund Reid from JPMorgan. Two questions. The first one is on U.S. transmission. I believe there was a ruling earlier this year about ROEs in U.S. transmission. I want to understand what that meant going forwards in terms of return? And then secondly, I don't want you to go through the entire presentation you gave earlier this year, but the impact of lower U.K. CapEx on your earnings under RIIO?

Steven John Holliday

Okay. Just first, I want to make a remark, and then Tom can pick it up. The challenge to ROEs is continuing. That has not yet run its full course actually in terms of the decision, so Tom can comment on exactly where that is. That's been going on now for 18 months plus. The -- in terms of future investments, as I talked about these things, there's opportunities intentionally. When those projects come to fruition and they go through a filing and we know the return, then we have a decision to make about whether that return, we believe, is adequate for us to invest. So that's a decision that pending for the future obviously. But the challenge to ROEs in the Northeast has been going on now for, as I said, at least 18 months and continues. Tom?

Thomas B. King

Yes. Ed, the -- it is a challenge in the Northeast. I think now, it's national. As you know, there's been other regional challenges to it. So ultimately, where the U.S. sits relative to the ROE decision is really the composition of FERC. We now have a chairman that is leaving. There was a chairman nominated, that's been withdrawn. So where the FERC finds itself, it's in a basically a 4-commissioner chairmanship -- excuse me, commission. The expectation is this issue doesn't really move forward until we get a new commissioner named and then get confirmed by the Senate, and then this issue will pick back up and be a large debate within the U.S. Ultimately, the debate gets to the broader issue of commission policy on incentives and returns to attract investment in transmission. I think that will play out in 2014, and we really won't get a decision until the second half of calendar 2014. As to the -- your term, the decision reached within our filing, that was only an administrative law judge recommended decision, so it's basically been put aside, waiting for the commissioners to be named and the commission to move forward with the overall major policy issue.

Andrew R. J. Bonfield

And even a sort of broader ruling would be less than $10 million impact on revenues, so it's very, very small.

Steven John Holliday

Okay. Peter?

Peter Atherton - Liberum Capital Limited, Research Division

Peter Atherton from Liberum. Three questions, but they're all pretty simple. [indiscernible] Firstly, on SAP, obviously, there's cost implications of a difficult implementation. But are we going to have any secondary implications around your customer service levels or regulatory information flows that could lead to other actions onto the company the future? On Labor's sort of proposals, one of their proposals is to abolish Ofgem and replace it with something else. Now I'm sure you would hope and expect that Ofgem, Mark, [ph] too, would just pick up the current regulation and carry it forward. But have you actually had specific discussions with Labor yet about that and have you received direct assurances from them that, that wouldn't be the case? And then thirdly, on the sort of hiatus in new build generation in the U.K., how long before you move from sort of -- I mean, sort of use my own words here, but sort of amber alert on security supply to red alert? And almost how long could that pause go on for before you start to get particularly concerned?

Steven John Holliday

Okay. Good questions. I'm not sure they're short questions, Peter, but nevertheless, short to ask. SAP, I mean, simple answer is no. We did have some serious issues at the beginning of last year to deal with payroll systems not working. We've worked through all of that. And in the U.S., they did lead to some challenges from outside in both New York and Massachusetts, all of those have been fully resolved and that system is now working. It's just the rest of the system we've got to continue to get implemented and then get into our rate filings. And this will, as I said, I mean one of the benefits of this systems ultimately is the amount of double, triple checking we've done on our rate filings to make sure that data is absolutely accurate. That's one of the things that when the SAP system is working, it will relieve those costs in the future. Ofgem, it's not for me to comment on the future of Ofgem. That's clearly a political decision. I guess the only observation I would make is the fact that Ofgem do quite a lot of things, don't they, and I don't think that's widely understood. Their focus on the regulation of monopoly networks, which, of course is our piece of the business. I think if you go around the world, they're held in really high esteem actually. It's the way [ph] investment is flowed to the U.K. Their introduction of incentive-based regulation is something that many others have copied elsewhere in the world, and RIIO already looks as if it looks quite sensible in terms of the mechanisms of flexibility that have been put in place and not least the fact that everything we can do to drive down costs will benefit bills in the future. But there are other duties around the operation of markets, the launching of markets and these certain things. There's a lot for others to decide. I don't think it's for us to really comment on. Red alert, amber alert, you'll follow this as closely as anybody. The position we're in as we go into this winter, and Nick can add if he wants to, is the same next winter. So if we manage through this winter, which is a 2008-'09 replica in terms of the margin, as you know, we're consulting on 2 new tools for use next year: One, to have incentives for mothballed generation to make themselves available in the peak of the winter; two, for demand side response actually. And of course, we're always talking about the peak, the worst day of the year, a few hour period around the peak. So we'll see how those go during winter '14-'15, I think, before we speculate about but what does '15-'16 look like and how tight are things getting. Unquestionably, it's tight for the next few years. And in my view and our view, getting EMR in and getting generation to begin to be constructed, clearly, is something we urgently need to get on with. We really do. Nick, you want add a comment around next winter or anything?

Nicholas Paul Winser

Yes. The only thing I'd add over the 5-year period is it sort of -- it depends on GDP. The -- and Ofgem ran a good sensitivity action in the winter outlook on GDP. I mean, broadly, the projections that we did at winter outlook that we picked up on the forecast economic growth then, you set at these sorts of type, but manageable margins right through to the end of the decade as long as all of the existing generation stays on, because basically, you've got electricity demand gradually easing away. We need to keep an eye on that and see what's happening in terms of updating those GDP growth figures and just see how that comes into play and we'll do that annually in a normal process. But I think that's the additional thing to watch.

Steven John Holliday

Yes, it is. And just FYI, demand on the Electricity Transmission system in the U.K. first half of the year on last year, on a weather-normalized basis, down 0.7%, going the right direction. Bobby, and we'll come back to Dominic.

Bobby Chada - Morgan Stanley, Research Division

It's Bobby Chada from Morgan Stanley. I just wanted to follow up on some of these investment options that you've been talking about or have highlighted in the presentation. So does the Long Island generation -- is that something that you would expect to go into rate base? The same for the transmission project, I assume that's going into rate base. And will you have to file and agree those with the state regulators in advance? And then on Clean Line, is it going to be a pure regulated transmission piece or will there be a merchant aspect to it?

Steven John Holliday

Rate base and some merchant, it'll be a PPA on Clean Line where the capacity will be bought by someone to transmit their renewable energy for a 20-year period, a bit like an interconnector actually. But notices hasn't been made on any of these yet. I just wanted to give you an update from it's quite interesting actually how some of these things are clearly accelerating in the course of the last 6 months. Our investment thesis is not changing. We like investing in regulated assets. We don't put our cash to work until we totally understand the way in which we'll collect our revenues and that those revenues are secured. It's exactly the way that we look at all 3 of those opportunities.

Bobby Chada - Morgan Stanley, Research Division

And to Dominic's -- to follow-up on Dominic's question about interconnectors and the carbon arbitrage, if you like, do you see much demand from people to sign up for -- because I assume you wouldn't do an interconnector unless you had committed effectively take-or-pay contracts just like on some of the Clean Line stuff?

Steven John Holliday

That's the whole debate that's going on to a certain extent about, do you wait for customers to come or is the benefit for the U.K. of interconnectors so much actually that we should be investing as a society in that important infrastructure and underpinning that investment somehow. So Ofgem are out thinking about the different mechanisms. They're doing the right thing, asking what's the mechanism that ensures that we get these investments made and how do we make sure the customers aren't paying too much for it. We do need a framework created pretty quickly though because as I've said, I think these are important. And then – go on then, and then pass forward to Martin.

Lakis Athanasiou

Lakis Athanasiou, Agency Partners. If I read what you're saying correctly on CapEx in the U.K. this year and next, you seem to be on a trajectory that is significantly below the baseline by a few hundreds of millions of pounds, looks to be mainly in Electricity Transmission. Could you give a flavor of why that -- what that's coming from? Is it in terms of outputs, in terms of short-term re-phasing and in terms of efficiency?

Steven John Holliday

The number that I'm -- it's -- there are 2 things going on here. So we'll talk about efficiencies at full year. That's exactly we'll talk about at the full year because we're only halfway through. So what will affect that number overall, as we've signaled before is, if we're successful, it will be lower. That's what TotEx is all about actually. Those benefits will get shared, investors and customers. But I'm identifying very clearly that the connections piece is reducing. Only last week, we announced the postponement of a project across Suffolk, Bramford to Twinstead. It's a GBP 100-plus million project. Not huge in the context of things over many years, but that's indicative of the fact that connections have gone back. So the reduction in CapEx is purely associated with connections reduction, but then our savings, and we'll cover that off very fully in the full year.

Lakis Athanasiou

So there hasn't really been any short-term re-phasing stuff? It's a mixture of connections and efficiency?

Steven John Holliday

Yes, it is. Martin?

Martin Brough - Deutsche Bank AG, Research Division

Yes. Martin Brough from Deutsche Bank. A couple of questions, one on smart meters, and the rollout timetable got pushed back a year. And obviously, it's good for the legacy gas meters. But in terms of the Gas Distribution obligations to facilitate some of the rollout and the costs that might be incurred, could you just talk about those costs over the next few years and whether you'll have to sort of go back and ask for some of that to be recovered? And then the second question was, Boris and his island -- and the Isle of Grain, have you spoken to him about that?

Steven John Holliday

Well, on the first question, we have no costs associated with the smart meter rollout at all. It's -- we're not in that business. The business -- it doesn't affect our regulated business at all. Clearly, the rundown on meters, as you rightly identified, the retirement of the old gas meters, continues to -- every year you look at it, it seems to go back slightly. But we will not be investing in anything that's associated with the implementation of smart meters. The business we have that might have been onstream, we sold 2 years ago.

Martin Brough - Deutsche Bank AG, Research Division

As I understand -- or some of the other gas distribution networks seem to think that they will have more callouts and more costs, and that there isn't a mechanism in the control [indiscernible].

Steven John Holliday

Yes. Well, if you're assuming that a contractor who does a smart meter then doesn't install it properly and there's a gas leak, we might get more callouts, I agree. It's not something that we've looked at, at all, frankly. We expect the supplier companies that are responsible for the rollout to ensure that the meters are correctly and safely installed. What's your -- the second point?

Unknown Executive

Isle of Grain.

Steven John Holliday

Isle of Grain. Yes, we have done a lot of communication for a number of years now to explain that, that airport actually is close to the Isle of Grain LNG terminal, in which we've invested just shy of GBP 1 billion, potentially imports 24% of the U.K.'s gas. So if you're thinking of building an airport there, you just have to have a broader thought process about -- that's going to need moving somewhere and it's going to cost rather a lot of money. I think some of the publicity recently has come through to sort of identify that to a few more people than perhaps have realized it before. And it's not just our facility. There were a lot of other industrial facilities, as you know, on the Isle of Grain. Peter first, and then to Iain.

Peter Bisztyga - Barclays Capital, Research Division

It's Peter Bisztyga from Barclays. Two questions. Firstly, about the U.S., as you see demand for new gas connections grow over time, is there a risk of -- is there going to be a growing risk of a mismatch between when you spend the money and when you get the returns for it? Or do you expect the regulation to evolve in the U.S. in a similar way to that which it has done in the U.K.? And then secondly, just going back to the U.K. politics, has the Labour Party engaged with National Grid at all on any of their sort of proposed policies and what the implications of delayed generation investment might be?

Steven John Holliday

On the second one, no is the answer. I don't think they've come out with a fully thought through policy yet. Actually, that's what I understand they're working on. So we've not been in debate on that. On gas, in the U.S., we're working with 2 of our rates [ph] in particular. In fact, all 3, in reality, but certainly, in New York at the moment and in Massachusetts, about how can these investments to expand the gas system get made in a strategic sense because it needs -- these aren't about connections, the simple easy connections, the ones that are being done. But there are still just under 1 million consumers in our franchise areas who today are heating their homes with oil who can use gas. But to capture them, the networks need some pretty big expansions. Of course, this happened in the U.K. a very long time ago. How do you socialize the funding of those big expansions? Those discussions are alive at this very moment to put in place the regulatory arrangements so that we are incentivized to get on with those investments. And they'll certainly be a big part of the -- of what's called KEDLY, the old KeySpan business on Long Island where there's a huge chunk of customers there, almost 450,000 who want to get a gas in count [ph] today. So it would be at the heart of that rate plan which we're expecting to file in the second half of 2014. Iain?

Iain Turner - Exane BNP Paribas, Research Division

It's Iain Turner from Exane. Just a couple of questions. Firstly, what does $0.5 billion of SAP expenditure actually look like on the ground? It seems an amazing amount of money for new IT systems, and putting them right. And then secondly, on the CapEx and the kind of slippage, you talked about how you think, over the 8-year period, you'll catch up it. And I just wonder to what extent that's a little bit of wishful thinking. Because if you look at things like gas storage, the government is not going to support that now, with a subsidy. And I think, from memory, and it's a slightly hazy memory, there was about $800 million of CapEx in your GT1 business plan for connecting up storage. And then things on the generation side of things, like new nuclear, that seems to be slipping back to the right-hand side of the screen. That's where I'm -- again, there's a lot of money in your plans for things like in East Anglia for [indiscernible] about cutting those up, and those all seem to be shifting to the right. So I just wonder to what extent that's wishful thinking, that the CapEx program will end up around about the same number as you thought it was going to be on -- for the 8-year period?

Steven John Holliday

I think if you look at that chart I showed where it's dipped and then it goes back up again -- because we've actually got today, would you believe it, 101 gigawatts of connection agreements out to 2026. We've never had that in our history actually. Question is how much of that is going to come forward. I think we need to be careful about knee jerking on 6 months' information. As I said things can change very quickly, and I hope they do actually. I hope EMR really does put an emphasis into the generation market, back to Peter's question earlier. On the gas stuff, we actually had a number of these things that weren't in our baseline plans actually, although we did apply for them, you're quite right. So our gas allowance, as I said, feel about right to us at the moment, they do. And there were some things that might be in some things that might not be an awful lot of our CapEx, is to do with compressor replacement and reinforcements around there. It's still -- it's just too early to tell. I mean, your points are well made. I don't have a huge defense. Are you right, are we right, I don't know. We need to handle this as we go forward. The important thing is this is what RIIO was designed to do though actually, to flex to make sure that customers aren't paying for things they don't need and our revenues will flex, when all of a sudden, we're investing an awful lot more in 2015 that was originally forecast, et cetera. But our job for investors is just to keep giving you the best information we got today, I think, without any question.

Andrew R. J. Bonfield

Okay. [indiscernible].

Steven John Holliday

Yes, on SAP, yes.

Andrew R. J. Bonfield

I mean, SAP is, as we said – tried to say, is incredibly complex. This is not just a financial system, SAP, that's been implemented. It goes beyond there, it goes into things like store management systems and front office systems, how we do accounting for revenue versus CapEx and OpEx and so forth. So it's a hugely complex system, which is one of the challenges. So when you had the knock-on impact of the storm and the issues around the payroll, a lot of work has had to be done about remediating, actually getting data back and corrected. So a lot of the costs actually associated, particularly on the remediation side, is unfortunately very expensive consultants who are coming in to actually do work for us because effectively, everybody was out, actually, on the storm duty at the time last year. So that's one of our challenges, which has been to get them out and get internal resource available to do that work, and that's a part of the process, which has continued to -- ongoing. As we say, it's slightly exacerbated by LIPA because at the time we did -- in May, when we actually announced results, we weren't expecting LIPA to take over the SAP -- or PSE&G to take over the LIPA -- our version of SAP for LIPA. They've actually elected to do that, so it shows its base system is good. It's just unfortunately not in the situation yet where we are -- where we actually got it stable and operating 100%. But that's delayed of the final fixes because then, you get into year end and SOX reporting and so forth. So that's all been part of the challenge we've been trying to make -- to deal with.

Steven John Holliday

We've just got to see this thing through and get it finished. Last question, Ed?

Edmund Reid - JP Morgan Chase & Co, Research Division

Two questions. One of which is exceedingly boring, so I apologize in advance. You changed your tax guidance to 26% to 27%, I believe. What's driving that, and would you expect it to continue into next year? And then my second question is sort of re-asking my second question from last time, which is the lower CapEx and when it feeds in to your earnings numbers. So from memory, I think there's a 2-year lag. So it would feed into the '15, '16 revenue numbers, but I was just wondering if you can go through that in a bit more detail?

Andrew R. J. Bonfield

On the tax guidance, the principal driver is the mix of profits, U.K., U.S. U.K. tax rate has continued to reduce obviously. That's a benefit slightly this year, although we were aware of that at the time when we did the May. But most of it really relates to purely just mix of profits, U.K. versus U.S.

Steven John Holliday

Yes. And on your other question, I'm going to be slightly cheeky, Ed, if I may. You're right about the 2-year lag. So we announced just a [ph] fixed -- we'll pay back. And one of the things that Andrew alluded to, we talked about in the seminar, we can't do it at the half year, it doesn't make any sense at all. But at the full year, we will do a reconciliation in line with the seminar in terms of these IOUs. And how much -- back to Lakis' question, how much have we actually saved this -- that our savings that we'll benefit from and customers will benefit from versus delays, and how much is therefore going to go back to customers in 2 years' time. So we'll true all those things up with our full year results. If you'd like to go through the seminar again, my chief remark is, I know Andy Agg is here. He carries those charts with him at all times. He'll be delighted to run you through them again after this, I'm sure.

Thank you. Thanks for joining us this morning. I appreciate it.

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