UK: Strong performance at Scottish & Newcastle driven by growth in UK and Russia

Scottish & Newcastle plc announced on February 21 preliminary results for the twelve months to 31 December 2005

Highlights
• Profits before tax up +9.5% at £392m
• Revenue at £3,926m up +4.1%, driven by innovation and brands focus
• Own branded beer and cider grew volumes by +6.1% and net sales by +7.0%
• UK – Sales, market share growth and cost efficiencies drive operating profit growth of
+10.2%
• BBH – continued growth with +12.3% volume and +23.7% operating profit
• International – difficult markets in Continental Europe contribute to a -4.3% fall in operating
profit. Comprehensive action plan for France; strong performance in Portugal.
• ROIC improved to +6.9% from +6.5% in 2004

Commenting on the results Sir Brian Stewart, Chairman, said: ‘I am pleased to report that Scottish & Newcastle achieved its financial objectives for the full year, showing a strong overall performance with comparable operating profit growth of +6.9% and earnings per share up +10.4% despite ongoing difficult conditions in certain local markets. As I said at the half year, economic conditions across our markets have shown considerable variability this year and our success is a reflection of both the increased breadth of our business and of our brands’ strength. As always, the objective is to perform well regardless of the prevailing market conditions, and I believe the current results show that we have achieved this goal. ’

Commenting on the results Tony Froggatt, Chief Executive, said:-
‘In 2005 we were able to show just how much value we can add to mature markets if we concentrate on the essential aspect of a consumer-led business: creating brands that people love to drink. The dual strategy of driving value in mature markets and volume in emerging markets has delivered a satisfying performance overall in what was a tough year in a number of our markets. We have made very good progress against our key financial targets, with sales up +4.1%, improved margins, strong cash generation of £266m and return on invested capital (ROIC) up to 6.9% in 2005 from 6.5% in 2004.

Our principal objective is to build top line sales growth while increasing return on invested capital, and we are achieving this through focusing the business on four strategic priorities. Firstly, we invest behind our brands and in innovation. Secondly, we strive to improve our organisation. Thirdly, we have a continued focus on operational efficiency. Lastly, we are constantly considering investment opportunities for growth in our existing and new markets. I believe that we are delivering on all four counts.

1. Investing in our brands and in innovation
We now have a dynamic business that is brand-focused and consumer-led. Our investment programme has driven organic branded beer and cider sales growth of +7.0% and volume growth of +6.1% year-on-year.

New product development (NPD) has also been a key part of our success this year and we believe that we are now leading the beer category in both new product and in technological innovation. In 2004 NPD investment was 4% of branded net sales, which we increased to 10% in 2005. The new Super Chilled technology has clearly put great momentum behind Foster’s in the UK, which has grown sales by +10% in the period. There are now over 50,000 condensation founts in the UK. We are rolling the technology out in our major markets, driving a whole new drinking experience across continental Europe. By the end of 2006, we plan to have increased this total to over 100,000 founts; 14,000 of them outside the UK.

‘Beer with food’ is another exciting category that we are driving, an initiative inspired in Portugal by Sagres Bohemia. Bohemia accounted for around half the growth of both volume and value of the overall Sagres brand.

We are also putting greater focus on low-alcohol beer. Kronenbourg Pur Malt is up +40% in France and has now been launched in Portugal and in the Middle East.

Looking at our total advertising and promotion (A&P) spend across the business, we are confident that our increased A&P investment has enabled us to grow value, which in turn represents solid return on investment.

2. Driving our organisation
We have also made good progress with our second priority, improving our organisation.
We are building our management capability in three ways. Firstly we have raised the bar on performance – a quarter of the senior managers in the business are top quality people that we have brought in from blue chip consumer goods companies in the past three years. In addition, anotherquarter of the senior management team has been promoted from within the business. And thirdly, we have mixed the pack in terms of experience, sharing best practice across the group by moving a third of the senior team across markets or functions, thereby creating a truly integrated international business. I believe that these three steps are critical to securing competitive advantage in all of the markets in which we operate.

As part of our drive to establish sales best practice across all markets, we have appointed a Group Sales Director, completing the main group functions.

3. Operational efficiency
We continue to review our cost base right across the group. Clearly a significant step in securing efficiencies is the recently announced brewery rationalisation in France, but integrating operations across other markets has also led to further savings.

In Finland we announced in September last year the movement of 400,000 hectolitres of bottling capacity from Tornio to the brewery in Lahti, realising both cost and productivity savings. While the increasing cost of energy challenges our cost base, we are taking measures to mitigate the impact in the short to medium term. We will seek to reduce cost and spread operational best practice across the group.

In addition we continue to focus on cash generation, constantly review existing assets and divest those that do not provide an acceptable return.

4. Investing in growing markets
We are committed to investing in growth. In the last year we have increased our holding in India and invested in China. In both joint ventures we bring operational and brand knowledge to our local partners, and both businesses are now contributing to the overall performance of S&N.

In BBH, the integration of Pikra, Vena and Yarpivo with Baltika is progressing. We are confident that the minority shareholders will see the benefits of the merger.’

Market summary
S&N (UK) has been successful in a year of challenging market conditions. Market share increased 1.1% points (adjusted for the brand contract restructuring in mid 2005). Within a market that declined by 2.1% our own brand net sales increased by 6.2%.

The £60m cost savings programme is on track, with £55m of initiatives now announced. An incremental £32m of these cost savings has been realised in 2005. S&N UK will continue to seek ways to reduce the cost base, which should be reflected in margin improvement. While the UK will continue to be competitive and regulations such as the planned smoking ban will bring new challenges, we believe that we can continue to outperform the market.

France remains a key focus. Six significant steps have been taken. Firstly, as reported in August, we have reorganised the on-trade sales force. This has eliminated duplication of sales effort and has achieved a refocus on the on-trade outlets that will generate the strongest growth.

Secondly, we have announced the creation of a national contact centre for the on-trade in the east of France. These two steps will transform our on-trade capability. Thirdly, we have appointed Thierry Daniel as Commercial Director to lead the sales efforts across the on and off-trade. Thierry has joined us from Procter and Gamble.

Next, to boost the top line, dedicated cross-functional teams have focused on the launch of both Kronenbourg Blanc and the Super Chilled founts to ensure high impact execution in the trade – in 4000 bars across France. In addition, the pull-through will be driven by a significant increase in A&P behind our key premium brands in 2006. And lastly, on 16 February we announced the proposed sale of the Champigneulles brewery in Nancy. As a result of this comprehensive plan, we intend to remain competitive in a difficult economic environment.

BBH has grown beer volumes by12.3%, increasing its Russian market share to 36.3% by 2.1%points. Operating profits grew by 23.7%, despite the additional £5m marketing investment by S&N behind Foster’s and Kronenbourg 1664.

In January Baltika – which is majority owned by our joint venture BBH– announced the details for the proposed merger with Pikra, Vena and Yarpivo. The merger of the Russian businesses within BBH will allow us not only to continue to spread best practice but also to achieve other savings through the management of a combined brand portfolio. The savings will allow BBH to continue to drive the top line in Russia while at the same time improve the bottom line. At the end of 2005 BBH and the joint venture partners had a combined ownership of 91% of Baltika.

Group financial summary

Comparisons with the results for the twelve months to 31 December 2004 are affected by the acquisition of a 37.5% stake in United Breweries in India in 2005, the investment of Chongqing in China in 2004, the change of Mythos from joint venture to subsidiary in 2004 and the restructuring of the Beck’s contract in 2005. On a comparable basis, excluding the positive impact of acquisitions and the impact of movements in foreign exchange rates, revenue grew by 4.1% to £3,926m and operating profit by 6.9% to £479m.

Profit before tax for 2005 was £392m, an increase of 9.5% on a comparable basis. Earnings per share was 31.9p, an increase of 10.4% on a comparable basis. On an unadjusted basis profit before tax for the twelve months to 31 December 2004 was £363m and earnings per share was 29.4p.

Current trading and outlook
Trading in the first weeks of 2006 has been in line with recent trends with the exception of
Russia, where the unusually cold weather had an adverse impact on what is quite a slow month in terms of trading.

In the UK, strong brands – driven by continued focus on innovation and the right marketing support – should continue to drive top-line growth ahead of the market, while tight cost control will help the bottom line. After the disappointing market dynamics in 2005 we expect to see slight volume growth in 2006, largely due to the football World Cup in the summer. However, the group is not immune to the very real cost pressures associated with increasing energy and commodity prices.

In continental Europe, the picture is still mixed. With the changes in France in place, the business is now in a strong position to deal with what is still a tough market and trading environment. We are confident that across the international division, the roll-out of product innovation, in many cases around premium-priced product, and the increasingly focused A&P approach will drive the top line.

It is expected that BBH will continue to show above-market growth. We expect Russian market volumes to grow at 3% to 5% in the medium term and we expect to gain share within this market, while achieving price increases just below local food and beverage price inflation. Having seen an outstanding margin improvement in 2005, it is anticipated that margins in 2006 will be stable at around 20%. Strong cashflow from operating activities will continue to support dividends at the current level or above.

In summary, 2005 has shown the power of the Scottish & Newcastle’s brand portfolio, especially when paired with a rigorous focus on the cost base and the efficient asset utilisation of our business. We believe that continuing this approach will strengthen the group’s competitive position across its markets and at the same time drive further shareholder value.

Dividend
The Board has proposed a final dividend payment of 14.09p per share for 2005, an increase of 2.5%. If approved the final dividend will be payable on 3 May to shareholders on the register at 31 March 2006.

Scottish and Newcastle UK (S&N UK) has firmly established its market leadership with 27% beer market share despite shedding 1% market share by passing the control of MGD and Beck’s back to the brand owners and despite the licensing of Kestrel. The top four brands, Foster’s, Kronenbourg 1664, John Smith’s and Strongbow continue to grow strongly ahead of the market and ahead of their respective categories.

Volume and share performance
For the UK beer and cider business, adjusting for the portfolio rationalisation, the branded beer and cider business showed strong growth with 2.8% volume increase and net sales up 6.2%. This compares with total beer and cider market volume decline of -2.1%, -3.6% in the on-trade and flat in the off-trade.

S&N UK’s top four brands continued to perform strongly with net sales +9.0% and volumes +7.0%, contributing to gross margin improvement of 2% points.

Operational efficiency
In 2005, the UK made further progress on the cost savings programme to increase operational efficiency. In total £55m of the £60m cost savings program are now announced. An incremental £32m of these cost savings have been realised in 2005.

As part of a continuing drive to improve returns on invested capital, S&N UK is reducing its overall net asset base in the UK through a combination of activities including the recent closure of breweries and disposals from the loan portfolio. Two further tranches of its trade loan book were sold in June and December and overall the loan book has reduced by some £50m over the year. The disposals improve return on invested capital, although they reduce operating profit by about £3m per annum. They are earnings neutral.

Investment in brands
In 2005 S&N UK continued to invest in its key brands with an increase in marketing of around 10% in the full year. Investment on innovation continued to be a priority; new products launched during the period included Strongbow Sirrus and packaged Kronenbourg Blanc. Foster’s Super Chilled and draft Kronenbourg Blanc have seen continued growth following launches last year. In the UK we have driven a virtual growth cycle of higher A&P spend leading to higher brand sales and margin, which in turn has allowed higher spend on A&P and technical innovation. We have achieved our initial goal of raising A&P spend to a double-digit percentage of net sales of branded beer and cider.

Excellent progress across total business portfolio
The Waverley TBS wholesale business has shown a strong performance in 2005. Revenues grew by +3.9% to £450m, while operating profits were at £15m. SNPE successfully took on the management contract of a further 320 pubs in November 2004. Beamish and Crawford grew net sales by 8.6% in a challenging Irish market, one year on from the introduction of the smoking ban.

S&N’s International division includes the group’s strong and established market positions in Continental Europe, exports to more than 60 countries including the USA and joint ventures in India and China.

The international business is facing challenging markets across continental Europe, which resulted in a decline of operating profit year-on-year of -4.3%. Importantly, though, premium brands continued to outperform the market, leading to an improved mix. Overall branded beer volumes in continental Europe decreased by -0.3%.

France
Brasseries Kronenbourg (BK) is the market leader in France with a 37% market share. Its two leading brands, Kronenbourg and Kronenbourg 1664, are the number one and three in the market. In a weak economy, branded beer market volumes fell -1.0% overall, despite the second half benefiting from easier comparables.

BK continued to gain share in the more valuable premium sector, showing the success of focused A&P behind the key brands. In total the three premium brands – Kronenbourg 1664, Grimbergen and Foster’s – gained 19 basis points market share. Grimbergen, which has received increased A&P investment of +14.4% in the period, stood out with strong volume growth of +22.1% and value growth of +23.2%.

BK lost overall market share due to increased competitor promotional activity and the growth of hard discounters. The mainstream Kronenbourg and low-priced Kanterbrau saw volumes fall by - 3.7% and -9.4% respectively. However, the two brands saw a marked improvement in the second half with volume growth of +2.1% for Kronenbourg and a slower decline of -6.2% for Kanterbrau.

BK’s net selling prices increased by +1.0% over the period through a combination of price increase, +0.7%, and mix improvement, +0.25%. In the last year BK carried out a fundamental refocusing of the business. As announced last week, the proposed sale of the Champigneulles brewery and the increased efficiency at Obernai should result in yearly cost savings of €20 million. At the same time BK has restructured its on-trade sales force eliminating duplication and increasing focus on the larger growing outlets, while continuing and improving the service to other on-trade outlets through the planned new national contact centre to be based in the east of France.

The business announced the appointment of a new Commercial Director to lead the combined on and off trade sales teams. Since the first announcement of the introduction of the Loi Dutreil, effective from the first of January 2006, BK has done a lot of work to assess how best to take advantage of the changes while minimising the risks that come with it.

It has built a comprehensive plan that has so far been well received by its customers. This plan minimises disruption for both BK and our customers in the coming year, while ensuring that any investment in pricing is made behind the right brands.

In the medium to long-term the creation of a more liberalised market should be beneficial to the strongest brands, as they will be used more as traffic builders. We are well positioned to benefit from this with the number one and three off-trade brands. There will be price challenges for all suppliers but BK is well positioned to respond. Overall BK is now better positioned to succeed in a challenging market.

Portugal
Central de Cervejas is number two brewer in Portugal with a 41% market share, led by the Sagres brand. Central de Cervejas also owns Luso, the number one mineral water brand in Portugal. Central de Cervejas was one of the best performing businesses in our international portfolio in the period, despite the current weak macro economic environment and the tough comparables.

Overall beer volumes grew +7.0% year-on-year, with underlying sales growth estimated to have been at 8.5% adjusting for the Euro 2004 Football Tournament. Central de Cervejas gained market share in both the on and the off-trade in the period. Domestic branded beer net sales increased by +6.6%. During the period, there have been outstanding results from recent innovations in Portugal, including in particular Sagres Bohemia. This premium priced extension to our mainstream lager, Sagres, is accountable for over half of the 11.5% net sales value growth of Sagres. Domestic water net sales increased by +8.3%. This was driven by Luso, which was up 11.6%, helped by new flavoured brand extensions, and the entry into the carbonated sector, both of which sell at a premium to unflavoured, still product.

Belgium
Alken-Maes is the number two brewer in Belgium with a 15% share. Its leading brands are Maes
Pils, and the fast-growing speciality abbey beer, Grimbergen. In the year to December 2005, the Belgian market declined -0.9%. While Alken-Maes branded beer volumes performed in line with the market in the first half of the year, strong discounting from competitors, in which Alken-Maes chose not to participate , led to some market share decline in the second half.

In 2005 the new management team in Belgium stripped out cost and reviewed the focus of A&P spend. Net selling price per hectolitre for branded beer was up 1.2%. Maes Pils increased net sales per hectolitre despite increased pressure on pricing from competitors. As a result volumes fell -3.7% over the period. However we are already seeing the positive impact of the current rollout of Maes Super Chilled in the on-trade, which will differentiate the brand from other mainstream brands.

Grimbergen continued to grow well with volumes up by 5.2% following an increase in A&P spend behind the brand. The roll-out of innovations like Maes Super Chilled combined with continued A&P support behind our premium brands will allow us to compete successfully.

Finland
Hartwall is one of the leading beverages companies in Finland with market share just above 40%. Approximately half of Hartwall volumes are non-beer beverages including soft drinks, water and other alcoholic drinks such as cider. Its leading brands include Lapin Kulta, the number two beer in Finland, and Hartwall Jaffa, an orange flavoured soft drink and the water brand Novelle. S&N branded beer volumes were down by -1.4% in the period, driven by on-trade decline of -6.0%. Net sales per hectolitre were down -16.0%, driven by the off-trade due to a particularly competitive retail environment. This was triggered by the duty reduction 18 months ago and the main retailers competing intensely for market share. Prices have improved somewhat in the second half, showing a lesser year-on-year decline than in the first half. Hartwall announced in September last year the movement of 400,000 hectolitres of bottling capacity from Tornio to the brewery in Lahti, realising both cost and productivity savings. In soft drinks and water Hartwall has maintained value share in very competitive markets due to the strength of its brand portfolio.

Greece
Mythos Breweries is the number two brewer in Greece with an 11% market share led by Mythos, the leading Greek national lager brand. Branded beer net sales in Greece are up 4% driven by the Mythos brand.

USA
Newcastle Brown Ale (NBA) continued its strong growth with volumes up 12.1% in the US market. We are now looking back at over a decade of double-digit growth for Newcastle Brown Ale. The import market is a growing segment in the US and NBA is outperforming within this high value segment. At the same time Kronenbourg 1664 is starting to establish its position as a premium niche brand in the US.

Venture markets
In our venture markets (Germany, Italy, Spain, Sweden, Switzerland, Nordics and ‘export’) we made good progress. Underlying volumes increased by 14% in 2005 and pricing has been firm.

Asian development markets
The Asian beer market is growing quickly and has exciting potential, based on rising consumer incomes and current low per capita consumption.

India
On 3 May 2005 we completed the acquisition of 37.5% of the shares of United Breweries Limited (UBL), India's leading brewer. The completion of this acquisition gives the group an equal stake with the group of shareholders led by Dr Vijay Mallya. S&N and the VJM Group have joint management control and appointed two directors each. A former finance officer at S&N has taken up the role of Chief Financial Officer of UBL.

This investment combined with our smaller joint venture MABL now represents around half the market and is well ahead of the nearest competitor, who has a market share of somewhat below 30%. The combined UBL and MABL business’ volumes grew 17% in 2005, while the Indian market grew by 12%.

China
Chongqing Beer Company Limited, our Chinese joint venture with Chongqing Beer Group is a public listed company and does not announce its full year half results until the end of March. However at the end of the third quarter the business has shown 20% sales growth.

Significant market share gains in Russia
BBH significantly outperformed the Russian market in 2005, on average growing at twice the market rate and in doing so growing market share in Russia by 2.1%points to 36.3%. BBH remains the clear market leader in Russia with strong positions across all market segments.

Improving trend in Ukraine
With market growth of 25%, Ukraine has further established itself as one of the largest and most vibrant European beer markets. It continues to grow strongly from a comparatively low per capita consumption level and represents an excellent growth opportunity for BBH.

In Ukraine, BBH experienced some volume and market share loss in the first half of 2005. Through the combination of continued re-organisation of the sales and distribution system and a fully operational new brewery, the second half of the year showed the reversal of the negative trend of the first half. For the full year, BBH Ukraine sales volumes grew by 13% against market growth of 25%, resulting in market share of 19.1%.

Leadership in the Baltic states maintained
All three Baltic state markets showed positive development in 2005: Estonia grew by 13%, Lithuania by 8% and Latvia by 3%. In total, Baltic markets grew by 8% compared with 2004. BBH remains the clear market leader with a combined share of 41.6%, despite a volume increase slightly below the market. Our focus on brand development and margin growth has resulted in further profitability improvement in what is already a very profitable part of BBH’s business.

Impressive growth in Kazakhstan continues
The Kazakhstan beer market continues its rapid growth, increasing 25% in 2005. BBH has significantly outperformed, at twice the market rate in 2005, and reached a market share of 25.3%. BBH has maintained and extended its leadership in the market with a strong brand portfolio, wide distribution network and capable management team. We will have doubled capacity by early summer 2006.

Price/mix
Price development was strong. BBH was able to grow prices per litre before mix by 8.2% in local currency. Mix development led to -1.5% reduction in sales driven by the growth of the PET sector ahead of other packaging segments. This effect has lessened as the year has progressed.

Margins
BBH’s operating profit margin has improved by 30 basis points across 2005 to 19.0% from 18.7%. This improvement is after the additional A&P investment of £5m by S&N behind Kronenbourg 1664 and Foster’s. Margin growth has been driven largely by purchasing synergies in production and best practice initiatives across the business. As part of our strategy to drive volume and market share gains in BBH’s markets we have chosen to invest further in sales and distribution resource. Margins are expected to be stable at around 20% in 2006, before the additional A&P investment by S&N.

Russian integration proposal
BBH announced in January 2006 plans for the proposed integration of its Russian businesses. The purpose of the integration is very clear – to create full value for all shareholders by bringing the businesses in Russia closer together to ensure we develop our unrivalled scale and geographic footprint and benefit from best practice.

The merger is expected to generate annualised synergy savings of $60m to $80m in the first full year after completion, mainly coming from best practice improvements and cost savings. Approximately one-third of this amount has already been achieved in 2005. BBH has confirmed its commitment to the Russian beer market by reiterating that it will take shares in the enlarged Baltika in exchange for its shares in each of Pikra, Vena and Yarpivo businesses, rather than cash.

International Financial Reporting Standards (IFRS)
The accounts have been prepared under IFRS and the 2004 comparative figures have been restated to comply with IFRS. In the transition to IFRS the 2004 comparative figures have not been restated for the implementation of IAS32 (Financial Instruments: Disclosure and Presentation) and IAS 39 (Financial Instruments: Recognition and Measurement). Instead IAS 32 and IAS 39 have been implemented at 1 January 2005 with an adjustment put through the Statement of Recognised Income and Expense. The main impact of this adjustment was to reduce shareholders’ funds by £28m and to increase net debt by £44m.

Exceptional Items
There were exceptional items of £57m relating to restructuring initiatives in the UK, International and BBH. In addition, there was net financial income of £6m arising from movement in the fair value of financial instruments which are held for hedging purposes, but which do not qualify for hedge accounting under IAS 39.

Interest
Net interest costs of £87m compared with £82m in 2004. In April last year we made a one-off £200m special payment to the pension scheme. Primarily as a result of this, net interest on the pension liability fell from £8m to £5m, but there was a consequent increase in the interest cost on borrowings.

For the twelve months to 31 December 2005 EBITDA interest cover (excluding net interest on the pension liability) was 8.1x compared with 8.3x in the twelve months to 31 December 2004. On a similar basis operating profit interest cover was 5.8x compared to 6.0x.

Cashflow and Net Debt
For the twelve months to 31 December 2005 free cash flow before dividends (cash flow from operating activities and investing activities, but excluding acquisitions) was an inflow of £266m. Cash flow from ordinary operating activities was £423m and £84m was spent on reorganization and onerous contracts to give a net cash flow from operations of £339m.

Net interest paid was £68m. Tax paid was only £14m as the Group continued to benefit from tax relief on the £200m special contribution paid to the pension scheme in 2004. A dividend of £34m was received from BBH.

Capital expenditure was £159m, split £86m UK and £73m International. Depreciation and amortisation was £122m. Fixed asset disposals generated proceeds of £86m mainly from the disposal of surplus properties. There was a net inflow on investments of £48m driven by further disposals of the UK loan book to Royal Bank of Scotland.

Dividends cost £186m and £113m was spent on acquisitions (primarily the investment in United Breweries Limited) to give a net cash outflow of £33m.

Net debt improved from £2107m at 1 January 2005 (after adjusting for IAS 32 and IAS 39) to £2040m at 31 December. This was primarily due to benefits from exchange rates of £72m (mainly the weakening of the euro) and changes in the fair value of interest rate swaps and loans of £18m offset by the net cash outflow of £33m.

Pensions
The pension liability improved from £397m at 31 December 2004 to £313m at 31 December 2005. Net of deferred tax, the liability at 31 December 2005 is £221m (£285m last year). The improvement was primarily driven by a strong investment performance (which more than offset the negative impact of falling bond yields) and cash contributions in excess of the annual service cost.

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