(Translation of registrant’s name into English)

 

BT Group plc
Annual Report
& Form 20-F
2009

BT Group plc is a public limited company registered in England and Wales and listed on the London and New York stock exchanges. It was incorporated in England and Wales on 30 March 2001 as Newgate Telecommunications Limited with the registered number 4190816. Its registered office address is 81 Newgate Street, London EC1A 7AJ. The company changed its name to BT Group plc on 11 September 2001. Following the demerger of O2 in November 2001, the continuing activities of BT were transferred to BT Group plc.

     British Telecommunications plc is a wholly owned subsidiary of BT Group plc and encompasses virtually all the businesses and assets of the BT group. The successor to the statutory corporation British Telecommunications, it was incorporated in England and Wales as a public limited company, wholly owned by the UK Government, as a result of the Telecommunications Act 1984. Between November 1984 and July 1993, the UK Government sold all of its shareholding in British Telecommunications plc in three public offerings.

     This is the Annual Report for the year ended 31 March 2009. It complies with UK regulations and is the Annual Report on Form 20-F for the US Securities and Exchange Commission to meet US regulations. This Annual Report has been sent to shareholders who have elected to receive a copy. A separate Summary financial statement & notice of meeting 2009 has been issued to all shareholders.

     In this Annual Report, references to ‘BT Group’, ‘BT’, ‘the group’, ‘the company’, ‘we’ or ‘our’ are to BT Group plc (which includes the continuing activities of British Telecommunications plc) and its subsidiaries and lines of business, or any of them as the context may require.

     References to a year are to the financial year ended 31 March of that year, eg ‘2009’ refers to the year ended 31 March 2009. Unless otherwise stated, all non-financial statistics are at 31 March 2009. Please see cautionary statement regarding forward-looking statements on page 148.

     A number of measures quoted in this Annual Report are ‘non-GAAP’ measures. The Directors believe these measures provide a more meaningful analysis of the trading results of the group and are consistent with the way financial performance is measured by management. These include EBITDA, adjusted EBITDA, adjusted operating profit, adjusted profit before taxation, adjusted earnings per share, net debt and free cash flow. The rationale for using non-GAAP measures and reconciliations to the most directly comparable IFRS indicator are provided on pages 33 to 35, 39, 41, 47 and 48.

 

2		Financial summary
3		Chairman’s message
4		Chief Executive’s statement
5		This is BT
6		How we are structured

 

8		Business review
26		Other matters
32		Financial review

 

50		Board of Directors and Operating Committee
52		The Board
54		Report of the Audit Committee
56		Report of the Nominating Committee
56		Report of the Committee for Responsible and Sustainable Business
57		Report on directors’ remuneration
70		Directors’ information
71		Business policies
74		Shareholders and Annual General Meeting

76		Statement of directors’ responsibilities
77		Report of the independent auditors – consolidated financial statements
79		Consolidated financial statements
136		Glossary of terms and US equivalents
137		Report of the independent auditors – parent company
138		Financial statements of BT Group plc
141		Subsidiary undertakings and associate
142		Quarterly analysis of revenue and profit
143		Selected financial data
145		Financial statistics
146		Operational statistics

148		Information for shareholders
160		Cross reference to Form 20-F
163		Glossary of terms
166		Index

 

		2009				2008
		£m				£m
Revenue			£21,390				£20,704
EBITDAa
– adjustedb,c			£5,348				£5,784
– reported			£3,301				£5,245
Profit (loss) before taxation
– adjustedb,c			£1,877				£2,506
– reported			£(134	)			£1,976
Earnings (loss) per share
– adjustedb,c			18.4p				23.9p
– reported			(1.1)p				21.5p
Full year proposed dividend			6.5p				15.8p

Key points

2     BT GROUP PLC ANNUAL REPORT & FORM 20-F

The world looks a very different place than it did a year ago. Global trade has contracted for the first time in many decades. Financial markets have been in turmoil and trading conditions worldwide remain extremely challenging. Against this background, the importance of defending free trade and fighting for regulation that promotes investment and encourages competition has never been greater.

     Our management team not only understands the challenges, but also sees the opportunities that lie ahead. Three out of our four principal divisions (BT Retail, BT Wholesale and Openreach) are delivering well. Management’s highest attention is now directed towards returning BT Global Services, our one under performing division, to profitable growth.

     We have agreed with the Trustee of the BT Pension Scheme the pension contributions for the next three years, enabling the Board to announce a sustainable dividend policy.

     The proposed final dividend of 1.1p gives a full year dividend of 6.5p which rebases dividend payments to a level which we are confident is sustainable. The Board is committed to delivering attractive returns for shareholders and believes that the operational improvements in the business will generate sufficient cash flow to allow the dividend to grow at the same time as investing in the business, reducing debt and supporting the pension scheme.

Regulation

It is clear how important the 2005 Telecommunications Strategic Review by Ofcom has been in establishing the UK as the most competitive telecommunications market in the world. While the price of other utilities has soared, the price of communications has fallen sharply. New market entrants have flourished, encouraged by low wholesale prices and incentives to invest in unbundled local loops. Britain has more companies competing in the same space than any comparator country.

     Now a healthy debate is underway about the investment needed to deliver the next generation of broadband services. These will be carried largely over fibre optic cables able to deliver speeds of up to 100Mb compared with a typical speed of 4-5Mb today. This investment will provide the UK with the world class IT infrastructure it will need to thrive as a knowledge-based society.

     It is essential that the regulatory environment encourages investment. This means that BT and others must have the potential to make a return for shareholders that is commensurate with the risk involved. We need a level playing field in the UK’s fast moving market which allows every company to compete on equal terms and makes sure that new monopolies are not allowed to emerge. We also need regulation to move at the same speed as the market is evolving.

     In our overseas markets, particularly in the rest of Europe and in North America, regulators must do more to encourage fair competition. BT should be able to invest and compete in any other country, in the same unrestricted manner that overseas companies can invest and compete in the UK.

A sustainable business

BT has a proud record of contributing to the communities in which we work and of building a sustainable business. We believe our services are an important part of the solution to climate change.

     Thousands of our people are involved in voluntary work and I am keen to build on this heritage and make sure that as a global business BT’s Better World Campaign takes a genuinely global view.

Your Board

In December 2008, we welcomed Tony Chanmugam to the Board as Group Finance Director in succession to Hanif Lalani who had become Chief Executive, BT Global Services.

     Since joining BT I have been extremely fortunate to have as my Deputy Chairman, Maarten van den Bergh who is stepping down from the Board at the conclusion of this year’s AGM in July. Maarten has been a tremendous asset to the Board having served as senior independent director since 2006 and as Chairman of both the Board’s Pension Scheme Performance Review Group and Remuneration Committee. I would like to thank him for almost nine years of distinguished service.

     I would also like to express my gratitude to Matti Alahuhta who has decided to step down at the end of May having served as a non executive director for just over three years. His telecommunications industry and international experience have been of great value to the Board and we wish him well.

     I am working with the Nominating Committee to strengthen your Board following these departures and we will announce new appointments shortly.

     My thanks also go to the rest of the Board for their extremely hard work during the last challenging months. I would also like to pay tribute to the BT staff. Everywhere I go I have been struck by their passion and commitment. I am confident in their ability to build on BT’s many strengths in the future.

The future

BT is in business for the long-term. We invest billions of pounds into the UK’s IT infrastructure for the long-term. We are seeking the regulatory certainty which will support long-term business decisions. And we want long-term relationships with our customers that are based on excellent service, and on our enduring commitment to helping them thrive in this fast changing world.

Sir Michael Rake
Chairman
13 May 2009

 

The actions we have taken will enable BT to come out of this recession a stronger and better business.

 

There’s no doubt about it, this has been a tough year. A tough year for BT Group, a tough year for the economy and a tough year for our shareholders.

     But there are good reasons to look forward with optimism. Taken together, BT Retail, BT Wholesale and Openreach have delivered a resilient performance. That despite the economic downturn. However this success was overshadowed by the performance at BT Global Services. Because of this we have had to take a number of very substantial charges. These have not been comfortable, but were necessary to establish the solid foundations from which we can now build a profitable business.

Meeting our customers’ needs

The markets in which we operate are changing fast and we need to move with them. In the UK we have the most competitive communications market in the world. Thanks largely to BT’s investment, the UK now has some of the highest broadband availability and take up in the world as well as some of the lowest prices. Speeds are improving all the time, and our new fibre based services will deliver a next generation of super-fast broadband, bringing speeds of up to 100Mb to people’s homes.

     We have made real improvements in customer service, and we are going to do much more. Let me give you a couple of examples. Three years ago you could expect a fault on your telephone line once every nine years. That’s now improved to once every 13 years. By the end of the financial year, 97% of our customers were getting through on their first call, complaints were down and customer satisfaction had improved significantly. And on Christmas Day 2008 we recorded our lowest ever number of outstanding network faults.

     When our service improves, our customers are happy, more people want to do business with us, and also we can reduce our costs. That’s because when we get our services right first time, the number of people phoning our call centres falls and the number of engineers we need to send out to fix things declines. That’s just as true for the biggest customer of BT Global Services or BT Wholesale as it is for a family buying a broadband service from us. We have made significant progress, but this is most definitely not the end of our journey to make BT a leader in customer service.

New opportunities

Even in the most difficult economic circumstances a diverse and agile business will find opportunities to grow and improve the service it delivers to its customers. A really good example is BT Conferencing which is strongly growing both revenues and profits and is now the world’s biggest provider of videoconferencing. Using the latest technology we are meeting the needs of companies all around the world. Helping customers save money by cutting travel costs and reducing their carbon footprint.

     Another example is our Business One Plan service, which is the UK’s first triple play of landline, mobile and broadband for small and medium-sized businesses. It launched three years ago and in 2009 added free calls within an organisation – even between offices and mobile workers – a significant saving. Over a million business lines are now using this service and more than 2,500 new customers sign up each week. In our consumer business the new BT Home Hub has been ordered by over 800,000 customers since its launch last June. It has the best wireless range on offer, and allows customers to save power by programming it to switch off when it’s not being used.

     These are just a few examples of BT seizing opportunities and delivering great service in the UK and around the globe. I was particularly pleased that Telemark Services, an industry analyst, has just rated BT Global Services the best operator in the world in its Customer Satisfaction Index with the highest score ever awarded.

A better business, a better future

In order to transform the company, we need to drive significant cost saving. Regretfully this has meant a reduction in our workforce. However, we have sought to retrain and redeploy permanent staff whenever we can. That has meant that in the past year only a third of the reduction came from our permanent staff, with the rest made up of contractors and third-party resource.

     So in the past year we have taken some tough decisions and we have taken some bold decisions too. Like investing £1.5bn in fibre based super-fast broadband. There are certainly plenty of challenges, but I believe that the actions we have taken will enable BT to come out of this recession a stronger and better business.

Ian Livingston
Chief Executive
13 May 2009

4     BT GROUP PLC ANNUAL REPORT & FORM 20-F

BT is one of the world’s leading communications services companies. In the UK, we are the largest communications service provider to the residential and business markets. The BT brand is one of the most trusted in the UK. Around the world, we are a major supplier of networked IT services to government departments and multinational companies.

We meet the needs of our different customer groups through four customer-facing lines of business, supported by two internal functional units. BT Retail, BT Wholesale and Openreach operate mainly in the UK. BT Global Services provides services in more than 170 countries around the world.

 

We believe that the way we are structured brings us closer to our customers, helps us get it right first time and enhances the customer experience, at the same time as helping us reduce our costs and drive value for our shareholders.

6     BT GROUP PLC ANNUAL REPORT & FORM 20-F

BT is a communications services company which operates in more than 170 countries worldwide. We are proud to serve customers that range from some of the largest multinational corporations and public sector organisations in the world, through the small business sector to millions of families and residential customers in the UK.

     We are at the heart of a communications revolution which is continuing to improve the quality of people’s lives and the effectiveness of their businesses. It is our job to bring together the best technology to create services that our customers need while offering them the very best value.

In 2009, in spite of the economic downturn, three of our lines of business – BT Retail, BT Wholesale and Openreach – have each performed well. Both BT Retail and Openreach delivered EBITDA growth while in BT Wholesale the rate of decline in revenue has slowed. This good performance was primarily due to the effective delivery of cost savings. However, these achievements were overshadowed by the unacceptable performance in BT Global Services.

The issues in BT Global Services

During the 2009 financial year, the level of profitability in BT Global Services fell significantly. This was caused by a combination of higher costs, the slow delivery of cost reduction initiatives and worsening economic conditions. This led the Board to conclude that previous estimates of profitability for some of our major contracts were no longer likely to be achieved.

     On page 10 we explain what actions the Board took as a result of these issues and how BT Global Services is being restructured to streamline and refocus the business.

We aim to make BT a better business and drive shareholder value by delivering on our current strategic priorities better, faster and cheaper.

		These are:
4		providing excellent customer service
4		building future networks
4		becoming more agile.

Providing excellent customer service

Our goal is to provide excellent service in every market in which we operate by putting our customers at the heart of everything we do.

     Every part of BT is taking action to make substantial improvements to the delivery of our services. That means getting things right first time every time, keeping our promises to our customers and meeting or exceeding their expectations.

     We continually track improvements that reflect the real experience of our customers from start to finish. We have made significant progress in the last 12 months across the whole range of our customers and we are determined to make further improvements. In the highly competitive markets in which we operate we believe that being recognised for outstanding customer service is a key differentiator for BT.

     As an example of the progress we are making in the consumer market, the time taken to get through to an adviser fell by 65% in the past year. Our customers experienced a reduction of more than 20% in the number of line faults, which means that a line will go wrong on average just once every 13 years. In the small business market, there was a 20% improvement in the average time to clear telephony network faults, while the average time to provide international multi-protocol label switching (MPLS) services to large business customers reduced by over 40%.

Building future networks

The digital revolution is opening up a world of new possibilities for all our customers. It means people can work together and collaborate more effectively than ever before. They can be entertained and informed in ways that would have been hard to imagine just a few years ago. We think this revolution has only just begun, and we are investing in our networks, systems and services to ensure that they are fit for the future.

     In July 2008, we announced plans to make Britain’s biggest ever investment in a fibre-based super-fast broadband network. We will spend £1.5bn making fibre based services available to around 40% of the UK’s homes and businesses by 2012. This will deliver a range of services with top speeds of up to 100Mb, allowing customers simultaneously to run multiple bandwidth-hungry applications, such as high-definition movies, gaming, complex graphics and videos; all with greatly improved upload as well as download speeds.

     These plans are conditional on our ability to make a proper return on our investment, and we have seen encouraging progress in establishing the right regulatory basis for this investment.

     Super-fast broadband will run on BT’s 21CN infrastructure. 21CN is our next generation global platform and has been at the heart of BT’s transformation for some years.

     We have now completed the new 21CN core network which is a unified software driven platform. It will help us meet our customers’ needs faster and more efficiently whether they are delivered over copper or fibre. It will reduce the time it takes to get new services to market, eliminating duplication and reducing costs.

     Our flagship MPLS network service provides coverage and support around the world from 875 BT managed points of presence and around 2,600 in partnership.

8     BT GROUP PLC ANNUAL REPORT & FORM 20-F

BUSINESS AND FINANCIAL REVIEWS BUSINESS REVIEW

a		Items presented as ‘adjusted’ are stated before contract and financial review charges and specific items.
b		Adjusted basic earnings per share and free cash flow are ‘non-GAAP measures’ provided in addition to disclosure requirements defined under IFRS. The rationale for using non-GAAP measures is explained on pages 33, 47 and 48, and a reconciliation of adjusted basic earnings per share and free cash flow, to the most directly comparable IFRS indicator, is provided on pages 39 and 41 respectively.

     BT GROUP PLC ANNUAL REPORT & FORM 20-F     9

We have four customer-facing lines of business: BT Global Services, BT Retail, BT Wholesale and Openreach. These are supported by two internal functional units: BT Design and BT Operate.

     BT Retail, BT Wholesale and Openreach operate mainly in the UK, where we are the largest communications services provider to the residential and business markets. BT Global Services operates in the UK and globally.

     BT is one of Europe’s largest and most successful communications wholesalers to other communications providers (CPs). In the UK we support CPs through BT Wholesale and Openreach, and internationally through Global Telecoms Markets, an operating unit of BT Global Services.

     We have integrated our networks, IT and testing facilities – which are managed by BT Design and BT Operate. Specifically, BT Design deploys platforms, IT systems and processes that support our products and services, while BT Operate is responsible for making sure they run smoothly. Neither generates external revenue.

Line of business financial performance

The financial performance of each of the lines of business for 2009, 2008 and 2007 is discussed in this Business review. We measure the financial performance of BT Retail, BT Wholesale and Openreach based on EBITDA and operating profit before specific items. For 2009, we measure the results of BT Global Services on an ‘adjusted’ basis, being before the impact of contract and financial review charges and specific items. For further discussion of these items see pages 33 and 47 to 48. A reconciliation of adjusted EBITDA to group operating profit (loss) by line of business, and for the group, is provided in the table at the foot of pages 34 to 35.

Business overview

BT Global Services is a provider of networked IT products, services and solutions. We aim to be the partner of choice for large enterprise and government customers in the UK and globally.

     We have created a powerful combination of networked IT and professional services capabilities together with strong customer partnerships, investing and innovating together to build long-term value.

     The Gartner Group’s research organisation recognises BT as a global leader in Gartner’s Magic Quadrant for Network Service Providers, and industry analyst Telemark Services has given BT its platinum award, reflecting customer satisfaction with our delivery of global data virtual private network services, regarded as best in class.

     Customer service improvements in 2009 included a reduction of more than 40% in the average time to provide international MPLS services and a 6% improvement in the delivery of international repairs within the target time.

We have more than 3,400 points of presence in more than 170 countries. We are the largest supplier of networked IT services to -UK national and local government.

     Despite these strengths, during 2009 the level of profitability in BT Global Services fell significantly.

     As explained in the Principal risks and uncertainties section in this year’s and previous years’ annual reports, our pricing, cost and profitability estimates for major contracts generally include long-term cost savings that we expect to make over the life of the contract. In 2009, a failure to achieve these anticipated savings made a number of these contracts less profitable or even loss making, adversely impacting our profits.

Actions taken

The Board changed the senior management team within BT Global Services, with a new Chief Executive for the division appointed in October 2008. The new team’s brief was to address the cost base, to bring greater focus to the profitability of new contract wins and to reduce shortfalls in delivery performance on existing contracts. The new management team undertook an extensive review of BT Global Services’ financial position, contracts and operations. The financial review covered the financial performance of BT Global Services and its balance sheet position. The contract reviews covered the largest and most complex contracts and were conducted jointly with external advisors. Having completed the contract and financial reviews, a charge of £1.6bn was recognised, which includes £1.2bn relating to the two major contracts that are the subject of ongoing commercial negotiations. These charges reflect a more cautious view of the recognition of future cost efficiencies and other changes in underlying assumptions and estimates, particularly in the light of the current economic outlook. £1.3bn of the total charge relates to contract costs which had been previously capitalised on the balance sheet.

     BT Global Services’ management team is implementing a number of process improvements. Some of these were in place by the end of 2009, the rest are being implemented in 2010. These include undertaking more regular contract reviews to assess commercial risks and opportunities as part of a strengthened contract governance process that combines operational, financial and risk reporting. Additional scrutiny of contracts and cost transformation plans have been put in place and will continue to be conducted on a rigorous and regular basis involving strong independent oversight of assumptions and estimates for new and existing contracts. We are also placing greater focus on profitable sectors, setting stringent win criteria and enhancing due diligence around our ability and readiness to meet our delivery requirements on all major contracts.

     Immediate action has also been taken to address the cost base, with particular focus on external procurement and total labour resource. We reviewed rates across our contractor base, and successfully reduced these rates by up to 35%. We have addressed spend of £450m with suppliers across seven categories of expenditure, including our contractor base, and have successfully

10     BT GROUP PLC ANNUAL REPORT & FORM 20-F

renegotiated contracts, resulting in price reductions of 12% on average, and up to 35% in some categories. In addition, we have focused on a number of areas of significant discretionary expenditure including travel, consultancy and conferencing and have achieved reductions in these areas. These actions are expected to deliver sustainable cost reductions in the 2010 financial year.

How BT Global Services is changing

The operational review was completed towards the end of 2009, resulting in a revised operating model and restructuring plan which will reshape and refocus the business, further enhancing BT Global Services’ ability to serve customers and establish a significantly lower cost base.

     Under the new operating model, BT Global Services will focus on three customer segments:

4		being the number one provider of networked IT services to corporate and public sector customers in the UK, building on BT Global Services’ strong market position and the group’s 21CN products and services
4		providing networked IT services to key multinational customers, differentiating BT Global Services through seamless global connectivity and delivery of BT’s core portfolio of products and services
4		creating a BT Global Services Enterprises unit consisting of a discrete portfolio of businesses addressing specific customer needs in key countries.

Significant structural changes are being implemented. The majority will be completed in 2010 in order to deliver the benefits of the new operating model which include:

4		integrated sales, marketing, professional services, account management and delivery capability, competing effectively in each target market
4		enhanced bid management and start-up processes to improve win rates on selected deals and ensure standardisation and quality of delivery
4		a single global service model, consolidating a large number of individual centres into a small number of larger operational hubs, which will provide a single point of customer contact and enable improved right first time customer service
4		continued rationalisation of systems and networks, reducing the number of systems by a third and halving the number of global networks, thereby removing duplication and enabling significant cost savings
4		restructuring corporate support functions to serve the three customer segments more efficiently and effectively
4		strategic partnering for sales, service and infrastructure.

As a result of this operational review, the group has recorded specific item restructuring charges of £280m in 2009, with further charges of approximately £420m in total expected to be recorded over the next two financial years, the majority in 2010. These charges predominantly arise from legacy networks and products rationalisation and restructuring costs associated with people and property. Further analysis of these charges, including their cashflow impact, is provided in the Specific items section of the Financial review on pages 36 to 37.

Market context

We believe that we have identified a clear path to a profitable and sustainable business, building on a strong market position.

     The global networked IT services market is valued at around £600bn. We remain well placed to help our global customers reduce costs and streamline their businesses in a challenging market environment. We are seeing continued interest in network operational efficiency, workforce management, security, unified communications (including Telepresence and conferencing) and global hosted contact centre solutions, as our customers respond to the current economic environment.

Operational performance

We serve businesses in virtually every sector of British industry, from banking and finance to transport, logistics and the public sector. We have around 1,800 multi-site customers in the UK.

     We continue to make progress on our N3, Spine and London Local Service Provider contracts with the National Health Service (NHS) National Programme for Information Technology (NPfIT), the largest non-military IT programme in the world.

     Building on our work as the local service provider responsible for upgrading NHS IT systems in London, we have taken on the running of IT systems at eight acute hospitals in the South of England. In addition, we are working with a further four acute trusts in the South of England which have yet to roll out systems as part of NPfIT, as well as implementing 25 new systems in community and mental health trusts in the region.

     We are deploying one of the world’s largest converged IP networks for the Department for Work and Pensions to be completed in 2010.

     Reinforcing our presence in the local government sector, we agreed a ten-year strategic partnership with South Tyneside Council, worth more than £180m for delivery of a number of key council services. We also won an extension to our existing arrangement with Liverpool City Council and a new contract with Sandwell Metropolitan Borough Council and two contracts with Norfolk County Council with a combined value of £40m to provide voice and data services and a schools internet service.

     We are the official communications services partner for the London 2012 Olympic Games and Paralympic Games. This involves the provision and management of voice and data networks, internet access and land lines required at each of the London 2012 Games venues.

     We signed a number of deals with major UK corporate sector customers including:

4

a seven-year, £160m outsourcing deal with Nationwide Building Society to manage its networked IT services

4		a three-year contract extension with Manpower to provide fully managed global wide area network (WAN) infrastructure and managed services
4		a five-year contract with Carillion worth £32m for voice/hosted voice, IP data, conferencing and private automated branch exchange (PABX) maintenance.

Outside the UK

BT Global Services signed orders with 529 new customers outside the UK in 2009 and we continued to strengthen our business with large multinational corporations.

     We signed a number of major deals in 2009, including:

4		a five-year, US$526m contract with Procter & Gamble to provide and manage local area network (LAN) and WAN infrastructure in more than 80 countries
4		a contract with BMW to manage a large part of its communications infrastructure, including voice over IP (VoIP), contact centres, email services and videoconferencing
4		a three-year managed services contract with SWIFT to connect strategic offices across Europe, the US and Asia with BT’s unified communications video solution
4		a three-year contract with Munich Re to provide security and network services in 33 countries
4		a contract with the Emirates airline to consolidate and manage its worldwide contact centres
4		a seven-year, €118m extension of current services provided to Syngenta for data and voice services plus deployment of IP telephony, managed LAN and BT OneVoice to 112 sites and the deployment of BT managed mobile services to 13 countries.

Successes in the public sector outside the UK included a contract with Barcelona City Council for 500 wireless broadband hot spots, providing free internet access across the city, and a contract with the Colombian government supporting digital inclusion – under which BT will convert 755 public schools into telecentres and provide additional bandwidth to a further 1,150 schools.

     We are also part of the Match consortium that won a €30m contract with the Dutch Ministry of Home Affairs for the housing and hosting of the national government’s IT infrastructure.

Financial performance

		2009				2008				2007
		£m				£m				£m
Revenue			8,828				7,889				7,312
Adjusted gross profita			2,576				2,839				2,759
Adjusted SG&A costsa			2,267				1,978				2,024
Adjusted EBITDAa			309				861				735
Contract and financial review charges			1,639				–				–
EBITDAb			(1,330	)			861				735
Operating (loss) profitb			(2,106	)			117				70

In 2009, BT Global Services revenue increased by 12% to £8,828m (2008: £7,889m, 2007: £7,312m), compared with growth of 8% in 2008. Revenue in 2009 includes the impact of foreign exchange rate movements of £588m and acquisitions of £368m. Excluding these, underlying revenue was £7,872m, compared with reported revenue of £7,889m in 2008. Revenue from outside the UK has increased to 47% of BT Global Services total revenue (2008: 40%, 2007: 36%), reflecting the impact of organic growth as well as the impact of foreign exchange rate movements and overseas acquisitions.

     Revenue from managed network solutions increased by 17% to £5,328m, compared with growth of 10% in 2008. The increase was driven by growth in revenue from both networked IT services and MPLS and reflects the impact of foreign exchange rate movements and acquisitions, together with substitution of UK calls and lines. Revenue from calls and lines decreased by 8% to £1,095m, compared with a decline of 6% in 2008. The decrease was due to the gradual decline in this revenue stream as customers switch to more email, IP network and conferencing products as shown by the growth in managed network solutions. Other revenue increased by 12% to £2,049m, compared with a growth of 11% in 2008. The increase was mainly driven by growth in revenue from the global carrier business and reflects the impact of foreign exchange rate movements and acquisitions. During the year, we won new networked IT services contracts worth £5.5bn (2008: £5.0bn, 2007: £5.2bn). Networked IT services contracts represent 68% of our total order value of £8.0bn (2008: £8.0bn, 2007: £9.3bn).

     Adjusted gross profit decreased by 9% to £2,576m in 2009 (2008: £2,839m, 2007: £2,759m), compared with an increase of 3% in 2008, primarily due to high costs and the continued decline in higher margin UK business. Including the impact of the contract and financial review charges of £1.6bn, gross profit in 2009 decreased by 66% to £965m.

     Gross profit is revenue less costs directly attributable to the provision of products and services reflected in revenue in the period. Selling, general and administrative (SG&A) costs are those costs that are ancilliary to the business processes of providing products and services and are the general business operating costs.

     Adjusted SG&A costs increased by 15% to £2,267m in 2009 (2008: £1,978m, 2007: £2,024m), compared with a decrease of 2% in 2008. SG&A costs include the impact of foreign exchange rate movements of £221m and acquisitions of £170m. Excluding these, underlying adjusted SG&A costs decreased by 5% to £1,876m, reflecting the renewed focus from the new management team on total labour resource, supplier negotiation and discretionary and general overhead expenditure in the second half of 2009. Including the impact of the contract and financial review charges of £28m included within SG&A costs, SG&A costs increased by 16% to £2,295m.

     The decrease in gross profit together with the impact of higher SG&A costs resulted in adjusted EBITDA of £309m, a reduction of £552m compared with 2008. In 2008, EBITDA increased by 17% to £861m. Depreciation and amortisation increased by 4% to £776m

12     BT GROUP PLC ANNUAL REPORT & FORM 20-F

(2008: £744m, 2007: £665m), compared with an increase of 12% in 2008. The increase reflects the increased investment in our global infrastructure, customer related capital expenditure and the impact of acquisitions, as well as the impact of foreign exchange movements.

     The above factors resulted in an operating loss of £2,106m, compared with an operating profit of £117m in 2008 (2007: £70m).

Business overview

BT Retail aims to help its customers enhance the way they live their lives and run their businesses. At home we enable our customers to keep in touch with friends and families and to enjoy fast, reliable, secure and safe connection to the internet. We are bringing broadband to the TV and TV to broadband so that people can watch what they want when they want. At work we serve small and medium-sized enterprises (SMEs) (typically with up to 1,000 employees, although some are significantly larger) and enable them to cut their costs and improve their service by using communications and IT services that were once available only to the largest businesses. We do this by taking the drudgery out of implementing new technologies so our customers can focus on doing what they do best.

     There are four divisions in BT Retail: BT Consumer, BT Business, BT Ireland and BT Enterprises.

     We are the UK’s largest communications provider, with 20.7m fixed lines and 4.8m broadband lines.

Market context

Market conditions have been challenging: the rate of growth in demand for broadband has been slowing as the market matures and competition intensifies, both from local loop unbundlers with large customer bases to whom they can sell broadband, and from the mobile operators who are now offering mobile broadband as well as mobile voice. At the same time the economic downturn is causing business and personal customers to shop around for the very best value.

     We have responded by offering customers complete packages that meet their needs and deliver great value for money.

Operational performance

BT Consumer
Voice

We offer value for money services with three main packages of calls and lines – Unlimited Weekend Calls, Unlimited Evening and Weekend Calls and Unlimited Anytime Calls. All offer competitive terms but customers who use us the most receive the best value.

     In 2009, we announced our new Friends & Family Mobile scheme which now offers discounts of up to 40% on calls to mobiles – making it cheaper to call a mobile from a BT landline than from prepay mobiles. We also announced that calls to 0845 and 0870 numbers would be included for free in our packages – a first for the UK market.

     Our new BT Basic tariff offers very low line rentals to vulnerable customers on low income benefits. We are the only communications provider in the UK to provide this service. In addition we design our handsets to be ‘inclusive’ and meet the needs of older and disabled customers.

     Our range of handsets won praise in 2009 for its contribution to reducing carbon emissions with new energy saving power supplies.

Broadband

BT Total Broadband is the UK’s most popular broadband service. We offer a more complete experience than our rivals by including in the price all the extras customers need to have a safe and enjoyable broadband experience. For example, we offer McAfee security on up to seven PCs in the house, and Digital Vault, which enables customers to back-up valuable digital material including music and pictures.

     The BT Home Hub is at the centre of BT Total Broadband. It has an iconic design and is the market-leading wireless router. Its latest release offers unbeatable wireless coverage and reduced energy consumption.

     Some customers want access to the internet on the move. We offer these customers 3G dongles as part of their Total Broadband package. Further, BT FON enables customers who agree to share a small, secure section of their home broadband connection access to broadband via other BT FON members’ locations and BT Openzone Wi-Fi hotspots. Between them, BT Openzone and BT FON offer BT customers the chance to get online at more than 150,000 locations in the UK and Ireland and another 50,000 locations worldwide through roaming partners.

     We also offer lower priced broadband and voice services under the award winning Plusnet brand. Acquired in 2007, Plusnet offers customers a leading online self-service experience.

     BT was named as the Reader’s Digest most trusted internet service provider (ISP) and voted joint top for broadband customer service in a poll conducted by the Broadband Genie comparison website.

BT Vision

Consumers increasingly want to buy telephony, broadband and TV from a single provider. BT Vision – our on-demand television service – enables us to meet these needs. It is available on subscription or pay-per-view terms.

     BT Vision gives customers access to more than 70 TV and radio channels and pay-per-view services from a wide range of content providers, including blockbuster movies and live Premiership football. At 31 March 2009, BT Vision was the UK’s largest on-demand service with more than 5,000 hours of programming available.

     The take-up of BT Vision accelerated during the financial year. By the end of March 2009, we had 423,000 customers, around double the number at the end of the previous year. More customers

 

We continued the rollout of our 21CN, which delivers carrier grade Ethernet services for both mobile operators and specifically to support the delivery of our new managed services contracts with 3 Ireland and O₂. Our investment in local loop unbundling (LLU) is bringing broadband with speeds of up to 24Mb to telephone exchanges serving over 330,000 homes and businesses in the Republic of Ireland, and in March 2009 we were delighted to announce that Belfast would be one of the first regions in the UK to benefit from BT’s investment in super-fast broadband.

BT Enterprises

Enterprises are a number of stand-alone businesses, including:

4		BT Conferencing – a leading global provider of audio, video and internet collaboration services
4		BT Directories – comprising Directory Enquiries (118 500), operator and emergency services, and The Phone Book. In July 2008 we acquired Ufindus, supporting the increasing demand for online directory enquiries
4		BT Payphones – providing street, managed, prison, card and private payphones
4		BT Redcare – providing alarm monitoring and tracking facilities
4		BT Expedite – offering integration solutions and services to retailers
4		BT Shop and dabs.com – a leading internet-based retailer of IT and technology products.

BT Conferencing was one of the main drivers of growth in Enterprises in 2009. Conferencing services are attractive to customers because they can help to save travel costs and reduce environmental impact. The acquisition of Wire One Holdings Inc (Wire One) – one of the leading providers of videoconferencing services in the US – enhanced BT Conferencing’s position as the leading videoconferencing operator in the world.

Efficiency

Although we continue to invest in new products and services, there is an intense focus on cost transformation activities in all parts of BT Retail. We have a range of programmes which aim to improve the customer experience and take the cost of failure out of the business. Customer service improvements included a 65% reduction in the time it takes consumer customers to get through to an adviser and a 20% improvement in the average time to clear network telephony faults experienced by business customers.

Financial performance

		2009				2008				2007
		£m				£m				£m
Revenue			8,471				8,477				8,346
Gross profit			3,186				3,114				2,938
SG&A costs			1,552				1,619				1,581
EBITDA			1,634				1,495				1,357
Operating profit			1,209				1,050				912

In 2009, BT Retail revenue was flat year on year at £8,471m (2008: £8,477m, 2007: £8,346m), reflecting growth in revenue from broadband and convergence, managed solutions and conferencing, offset by a decline in revenue from calls and lines. Revenue includes £65m in respect of foreign exchange rate movements and £146m in respect of acquisitions. Excluding these, underlying revenue of £8,260m declined by 3% compared with reported revenue in 2008. In 2008, revenue increased by 2%, driven by growth in broadband and managed solutions revenue, which was only partially offset by a decline in calls and lines revenue.

		2009				2008				2007
		£m				£m				£m
BT Retail external revenue
Managed solutions			519				456				361
Broadband and convergence			1,298				1,189				985
Calls and lines			4,825				5,167				5,409
Other			1,470				1,382				1,345
Total external revenue			8,112				8,194				8,100
Internal revenue			359				283				246
Total			8,471				8,477				8,346

Managed solutions revenue increased by 14% to £519m in 2009 (2008: £456m, 2007: £361m) due to growth in BT Business and reflecting the acquisitions of Basilica and Lynx in the second quarter of 2008. Towards the end of 2009 the group saw a slowdown in new contracts, reflecting the impact of the current economic environment on the SME sector.

     Broadband and convergence revenue increased by 9% to £1,298m in 2009 (2008: £1,189m, 2007: £985m), reflecting the successful retention of customers in the maturing broadband market, together with revenue from services such as BT Vision and mobility. The broadband installed base increased by 355,000, to 4.8m customers at 31 March 2009. These net additions represented a 31% share of the total broadband DSL and LLU net additions in 2009. At 31 March 2009, our share of the installed base was 34% (2008: 35%, 2007: 34%).

     Calls and lines revenue decreased by 7% in 2009 to £4,825m, compared with a decrease of 4% in 2008. The acceleration of the decline in 2009 reflects the increasingly competitive environment and further market declines.

and flexibility. At 31 March 2009, 21CN Ethernet was available from more than 600 nodes throughout the UK.

Wholesale broadband

We continued to develop a variety of tools and techniques to help our customers deliver an excellent broadband experience to end users and get more from their broadband connections. The I-Plate, for example, is a self-installable device that can be fitted to an end user’s master telephone socket to improve broadband speeds by eliminating electrical interference.

     Wholesale Broadband Connect, our next generation 21CN broadband service, offers customers average speeds of around 10Mb, guaranteed service level agreements, the ability to trade speed for stability, and enhanced line diagnostics. At 31 March 2009, less than a year after it was first introduced, this service was available from exchanges serving more than 10m homes and businesses, around 40% of the UK addressable market.

Capacity and call-based products

We continue to sell a wide range of capacity and call-based products and services, including regulated interconnect services and new, non-regulated products and services. As we refresh our core portfolio with next generation replacements, we will, over time, migrate these services to 21CN, enabling the decommissioning of certain parts of our legacy systems.

Efficiency

In 2009, we maintained our focus on the cost reduction opportunities that arise as our business changes. We reduced BT Wholesale’s cost base by 19% through headcount reduction (down 17% in the year on a like-for-like basis), eliminating duplication, achieving further operational efficiencies and aligning our resources more effectively with the evolving needs of our customers. By March 2009, 99% of broadband circuits were delivered to customers by the day promised, our best ever performance.

Financial performance

		2009				2008				2007
		£m				£m				£m
Revenue			4,658				4,959				5,386
Internal revenue			1,228				1,252				1,277
External revenue			3,430				3,707				4,109
Gross profit			1,427				1,593				1,796
SG&A costs			161				198				296
EBITDA			1,266				1,395				1,500
Operating profit			580				502				592

In 2009, BT Wholesale revenue declined by 6% to £4,658m (2008: £4,959m, 2007: £5,386m), an improvement in the rate of decline compared with the previous year (2008: 8%). Broadband revenue decreased by 23% to £482m (2008: £624m, 2007: £771m) primarily due to the continued trend of CPs switching to LLU provided by Openreach. Revenue from the transit business declined by 16% to £1,134m (2008: £1,349m, 2007: £1,485m), compared with a decline of 9% in 2008. The decline in the transit business has arisen as mobile operators build their own networks and are able to bypass BT. These declines, however, have been partially offset by growth in the managed network solutions business, where revenue increased by 76% to £518m (2008: £295m, 2007: £306m), principally due to new contracts signed in the year.

     Gross profit decreased by 10% to £1,427m in 2009 (2008: £1,593m, 2007: £1,796m), a marginal improvement in the rate of decline compared with the previous year (2008: 11%). BT Wholesale reduced the gross margin impact of the revenue declines through focused margin management initiatives. The impact of some of the downward trends on our revenue and gross margin has been offset by our continued focus on reducing costs. In 2009, SG&A costs decreased 19% to £161m (2008: £198m, 2007: £296m) compared with a reduction of 33% in 2008. BT Wholesale has benefited from continued cost efficiency programmes including the ‘right first time’ initiative, which aims to reduce or eliminate the cost of failure from existing processes.

     EBITDA decreased by 9% to £1,266m in 2009 (2008: £1,395m, 2007: £1,500m), compared with a decrease of 7% in 2008. EBITDA margin in 2009 was 27%, compared with 28% in 2008 and 2007. Depreciation and amortisation decreased by 23% to £686m as a result of lower depreciation on legacy assets (2008: £893m, 2007: £908m). Largely due to lower depreciation and amortisation, operating profit increased by 16% to £580m in 2009, compared with a decrease of 15% to £502m in 2008 (2007: £592m).

Openreach

Business overview

Openreach is responsible for the crucial ‘first mile’ of the telecommunications network in the UK. It offers all CPs (currently, more than 420) – including other BT lines of business – fair, equal and open access to our access and backhaul networks.

     One of the UK’s vital infrastructure assets, this first mile connects millions of homes and businesses to local telephone exchanges, via fixed-line local and backhaul connections.

     Openreach’s 21,000 field engineers work on behalf of all CPs, enabling them to provide their customers with a range of services from analogue telephone lines to complex networked IT services. It is committed to delivering a better network and an environment in which its customers can thrive.

     Our strategy in 2009 was to continue to deliver and comply with the Undertakings made to Ofcom, while driving efficiencies, providing the right levels of resourcing and enhancing service levels.

Efficiency

Openreach’s continued focus on service resulted in some significant cost savings in 2009. Investment in reducing the number of engineer visits, providing training to enhance good workmanship and the introduction of new technology to diagnose network faults before they occur have helped lower Openreach’s direct labour requirements. This, together with reduced demand resulting from the economic downturn, has enabled us to reduce the number of contractor and agency staff by 40% and the number of permanent employees by 4%.

     We also achieved efficiencies in our non-pay costs. Supplier contract renegotiations, engineering process improvement and reduced service level guarantee payments – as a result of improved network reliability and more orders delivered right first time – have all helped to reduce costs further.

Financial performance

		2009				2008				2007
		£m				£m				£m
Revenue			5,231				5,266				5,223
Internal revenue			4,253				4,380				4,538
External revenue			978				886				685
Operating costs			3,235				3,355				3,296
EBITDA			1,996				1,911				1,927
Operating profit			1,218				1,222				1,220

In 2009, Openreach revenue decreased by 1% to £5,231m (2008: £5,266m, 2007: £5,223m), compared with an increase of 1% in 2008. This decrease has been driven by reduced connections as the WLR and LLU markets react to the economic slowdown. Ethernet and LLU now forms just over 23% of our revenue, with WLR at 59%, reflecting the change in mix compared with 2007 when 18% of our revenue was from Ethernet and LLU and 64% was from WLR. This is the result of growth in the broadband market and unbundling activity taking place within the exchanges.

     External revenue was £978m in 2009, an increase of 10% (2008: 29% increase) and reflects the continued growth of the broadband and Ethernet markets and active competition among CPs. The significant growth in 2008 was largely the result of high LLU connection revenue as CPs invested in growing their infrastructure. In 2009, CPs have focused more on obtaining returns from this investment, partly as a response to the changing economic environment. External revenues now form 19% of our revenue compared with 17% in 2008 and 13% in 2007.

     Revenue from other BT lines of business decreased by 3% to £4,253m in 2009 (2008: £4,380m, 2007: £4,538m). These reductions reflect the shift of WLR and LLU volumes from other BT lines of business to external CPs. These reductions have been partially mitigated by the significant growth in the Ethernet portfolio, assisted by the launch of new products towards the end of 2009.

     Operating costs decreased by 4% in 2009, compared with an increase of 2% in 2008. The decrease in the year reflects the success in our cost saving initiatives primarily around improving our service and structuring our business so it is better equipped with a more flexible and agile workforce for the future.

     Over the past few years, we have made significant investments in improving our service. We have seen savings in our service level guarantee payments, which have reduced by 49% in 2009, despite starting to pay them out to external CPs proactively as opposed to on a claims basis.

     EBITDA was £1,996m in 2009, a 4% increase year on year. In 2008, EBITDA reduced by 1%. EBITDA margin was 38% in 2009, compared with 36% and 37% in 2008 and 2007, respectively.

     Depreciation and amortisation was £778m in 2009, 13% higher than 2008. In 2008, depreciation and amortisation decreased by 3%. The increase in 2009 is mainly driven by high value software being brought into use and the flow through of high capital investment in 2008. The reduction in the prior year was due to a number of the access network assets reaching the end of their useful economic lives.

     Operating profit was £1,218m in 2009, broadly flat when compared with 2008 and 2007.

BT Design

BT Design is responsible for designing and building the platforms, IT systems and processes that support the products and services we provide to our customers around the world. It is also responsible for network planning and the implementation of BT’s global 21CN platform.

     The development activities undertaken by BT Design are aligned with customer needs and the requirements of BT’s customer-facing businesses. BT Design has simplified and automated BT’s processes so that customers can choose to do it all themselves, ask for managed services or a combination of the two. New products and services are created using ‘agile’ development methods and resource management principles to increase the productivity of both in-house and third-party development resources. BT’s platforms have been built in an ‘open’ way to facilitate collaboration with third-party developers.

     In 2009, BT Design was able to deliver significant cost savings for the group, largely as a result of a reduction in its workforce, at the same time as increasing output.

 

We also participate in the Federated Apprentice Scheme, which offers young adults employed by SMEs in the South of England the opportunity to gain a qualification in ICT.

     We have recently introduced alternatives to voluntary redundancy and the emphasis has shifted to redeployment, retraining and skills management. We have, for example, developed an innovative scheme in which BT employees are placed with other organisations to work outside BT to help develop their skills. We are working with an external recruitment agency to use their network to maximise these opportunities. As our skills requirements change, so those people can be brought back in house.

Reward and recognition

We conduct a review of salaries every year. The 2009 review took into account the current difficult economic climate, market conditions and the need to maintain a sustainable and competitive cost base. Following discussions with our trades unions, BT has advised all employees – including senior executives – that there will be no increases to salary in the UK arising from the 2009 review. This principle will be followed as closely as possible in all other countries in which we operate.

     Around 40,000 managers are eligible for variable, performance-related bonuses. The long-term incentives for our most senior managers are linked to BT’s total shareholder return performance measured over a period of three years. For Openreach senior managers, the key measure is Openreach’s performance over a three-year period. For 2009, our bonus scheme was restructured to improve alignment to overall business results and affordability.

     Employees outside the UK receive an annual award of free BT shares or a cash equivalent depending on local legal and/or regulatory requirements. In the UK, employees receive free broadband. Employees in more than 25 countries also have the opportunity to save to buy BT shares at a discount to the price at the start of the savings period. Under the BT Employee Share Investment Plan, UK employees can buy BT shares from their pre-tax and pre-National Insurance salaries. More than 50% of eligible employees participate in one or more of these plans.

Pensions

Most of our UK employees are members of a pension scheme, either the BT Pension Scheme (BTPS), a defined benefit scheme, or until recently, the BT Retirement Plan (BTRP), a money purchase scheme. The BTPS was closed to new members on 31 March 2001 and the BTRP on 31 March 2009.

     During 2009 we conducted a review of our UK pension arrangements, including extensive consultation with the trade unions and employees. The aim was to ensure the schemes remain flexible, fair and sustainable for the long term.

     Changes to future benefit accruals under the BTPS were effective from 1 April 2009. Benefits built up before 1 April 2009 remain linked to final pensionable salary. The changes include increasing the normal retirement age to 65, moving to a career average revalued earnings basis, changes to member contributions and ceasing to contract out of the State Second Pension.

     The BTPS has around 64,000 active members, 181,000 pensioners and 96,000 deferred members.

     The BT Retirement Saving Scheme was set up on 1 April 2009 as a successor to the BTRP and the Syntegra Limited Flexible Pensions Plan (SLFPP). It is a contract-based, defined contribution arrangement, which means that what the pension members receive is linked to contributions paid, the performance of the fund and the annuity rates at retirement, rather than their final BT salary. Former BTRP and SLFPP members are being invited to transfer their accumulated assets to this scheme. All these pension schemes are controlled by independent trustees.

     We have reached agreement with the Trustee of the BTPS that deficit contributions of £525m per annum will be made in cash, or in specie, over the next three years. This agreement has been approved by the Pensions Regulator. See Pensions in the Financial review on page 42 for further details.

Flexibility and diversity

We continue to create an inclusive working environment in which employees can develop their careers regardless of their race, sex, religion/beliefs, disability, marital or civil partnership status, age, sexual orientation, gender identity, gender expression or caring responsibilities. This inclusiveness is supported by our flexible working arrangements.

     Examples of diversity include the fact that 22% of our workforce is female and women hold 21% of our top 400 leadership roles. In addition, more than 10% of our most highly rewarded people in the UK are from an ethnic minority background. Our policy is for people to be paid fairly regardless of gender, ethnic origin or disability.

     We work with specialist recruitment agencies to attract people with disabilities to work for BT, and in partnership with Remploy, we run a retention service to ensure that talented people can stay with us even if their capabilities change.

     Outside the UK, we are working to ensure that our policies and practices are tailored to address legislation country by country, as well as respecting cultural differences.

Health and safety

The health and safety of our people are of paramount importance and we continue to seek improvements by focusing on behavioural/lifestyle change.

     More detailed information on employee engagement, our health and safety performance and diversity in BT can be found in the chart on pages 24 and 25.

Employee communications

Employees are kept informed about our business through a wide range of communications channels, including our online news service, email bulletins, webchats and webcast briefings and a printed publication.

Corporate responsibility

We measure progress towards our corporate responsibility (CR) goals using our non-financial KPIs, which are shown in the chart on pages 24 and 25. We also report the direct costs to BT and the indirect impacts on society associated with the way we manage environmental and social issues. This is in accordance with the principles of the Connected Reporting Framework sponsored by HRH, the Prince of Wales. Our sustainability report (www.bt.com/betterworld) provides full details of our CR progress.

Supporting communities

All our lines of business support our community involvement activities.

UK

In 2009, we helped to launch Communicating for Success, a co-funded partnership between BT and the Football Foundation, to tackle digital exclusion and improve communications skills in the UK.

     We partner with a number of charities, including Childline, Children in Need and the Disasters Emergency Committee (DEC) in 2009, for which BT and BT employees raised over £4m. BT people volunteer to take donations in our call centres as part of major charity telephone and online appeals. We also manage the telephone networks and provide the online donation technology.

     For the past three years, Openreach has supported iCAN, a charity working for children with speech and language difficulties.

Rest of the world

The Inspiring Young Minds programme, our global development partnership with UNICEF, which brings IT skills to children, launches in China in 2010, following Brazil in 2008 and South Africa in 2007. In India, we support the work of the Katha IT and E-commerce school in one of Delhi’s poorest areas.

     We launched our first global disaster relief secondee programme with the Red Cross. BT volunteers with critical skills can be deployed into disaster zones alongside the aid charity’s own workers.

Protecting the environment

We aim to be a leader in the new low carbon economy. On the one hand, we recognise that the IT and communications industries constitute nearly 2% of global carbon emissions, and we are working hard to reduce these. On the other hand, communications technology reduces the need for people to travel and offers scope for improved logistics, energy distribution and energy management – which in turn reduces carbon emissions.

     We have been rated number one in the telecommunications sector in the Dow Jones Global Sustainability Index for the past eight years. We also hold the Queen’s Award for Enterprise for Sustainable Development and Business in the Community’s Community Mark.

     We meet the guidelines of the Association of British Insurers in reporting on social performance and have also applied the Prince of Wales’ Accounting for Sustainability reporting framework.

Corporate responsibility risks

During 2009, we continued to develop our knowledge and understanding of our corporate responsibility risks. Our most significant CR risks continue to be:

4		breach of our code of business ethics
4		climate change
4		diversity
4		health and safety
4		privacy
4		supply chain working conditions.

Each of these risks has an owner and a mitigation strategy in place. These risks are not regarded as material in relation to the group and consequently are not included in Principal risks and uncertainties.

		All targets have an end date of 31 March 2010 unless otherwise indicated.

Direct company impacts: Financial indicators		Indirect company impacts

2009

2008

2007

Total revenue

£21,390m

£20,704m

£20,223m

Average annual revenue per (UK) consumer household

£287

£274

£262

Employee costs

£5,506m

£5,358m

£5,223m

Employee engagement is a driver of customer satisfaction

Number of employees

107,021

111,858

106,200

BT will develop a relevant financial indicator for diversity next year

Establishing a diverse workforce promotes social cohesion

Cost to the business arising from injuries resulting in time off work

£7m

New measure in 2009

Lowering lost days from injuries and sickness reduces societal health care costs and improves productivity

BT sick pay costs

£85.2m

£89.8m

£84.7m

Total spend with suppliers

£8.9bn

£8.6bn

£6.8bn

Economic multiplier effect (e.g. employment) arising from BT’s supply chain procurement

Value of procurement contracts where our suppliers agree that we work with them to improve sustainability impacts (extrapolated from a representative supplier survey)

£7.4bn (83% of supplier spend)

£5.7bn (66% of supplier spend)

First measured in 2008

Quality of life — especially working conditions in emerging economies

Community investment (time, cash and in-kind support)

£25.0m

£22.3m

£21.8m

BT’s community programme focuses on improving communication and ICT skills. This helps improve people’s employment prospects and increase social inclusion

Total energy costs (fleet fuel + gas + oil + diesel for back up generators etc; UK and Ireland only)

£227m

£194m

£185m

Indirect negative impacts occur in the manufacture of equipment and through energy consumption in customer premises. Positive impacts arise from application of ICT to support low-carbon economy

Income from recycling

£7.42m

£6.70m

£4.48m

Dealing with end of life products sold into the market place. Acting to reduce obsolescence

Landfill tax savings

£1.15m

£0.89m

£0.84m

Waste costs

£(7.90)m

£(7.27)m

£(5.15)m

Net waste savings

£0.67m

£0.32m

£0.17m

Revenue Support (customer bids with a sustainability component)

£1.9bn

£2.2bn

£1.8bn

A responsible business culture, banning corrupt practices including facilitation payments, supports better international governance

 

Significant market power charge controls

As a result of SMP designations, the charges we can make for a number of wholesale services are subject to the following regulatory controls:

4		network charge controls (NCC) on wholesale interconnect services – we operate under interconnection agreements with most other CPs. Our charges for interconnect services are controlled by Ofcom, under the NCC regime. These controls are designed to ensure that our charges are reasonably derived from costs, plus an appropriate return on capital employed. Ofcom is currently reviewing the charge control to take effect for four years from 1 October 2009 and is consulting on a range of options where charges would be allowed to increase by more than inflation
4		partial private circuits (PPC) charge controls applying to certain wholesale leased lines that BT provides to other network operators. Ofcom has consulted on proposals for new controls to apply from 1 October 2009 and is expected to issue its final decision in the first quarter of the 2010 financial year
4		Ofcom is proposing to introduce charge controls on BT’s provision of wholesale Ethernet access and backhaul services at bandwidths of 1Gb or below from 1 October 2009. Again, Ofcom’s final decision on these controls is expected in the first quarter of the 2010 financial year
4		Ofcom has also been consulting on regulatory controls governing the charges Openreach applies to the provision of local loop unbundling (LLU) services and wholesale line rental (WLR). Ofcom is expected to publish a statement shortly setting out its conclusions on LLU charges and issue a further consultation on WLR charges.

BT’s Undertakings

In response to Ofcom’s 2005 strategic review of telecommunications, we proposed a number of legally binding Undertakings under the Enterprise Act 2002 (Enterprise Act). These Undertakings, which included the creation of Openreach, were accepted by Ofcom and came into force in September 2005. The Undertakings are intended to deliver clarity and certainty to the UK telecommunications industry about the way BT will provide ‘upstream’ regulated products to support effective and fair competition in related ‘downstream’ markets. This, in itself, should lead to a reduction in the need for regulation in those competitive downstream markets over time.

     BT is in discussion with Ofcom and the wider communications industry about the remaining Undertakings in the context of changing industry priorities and systems capacity. Any proposed changes will be subject to consultation during the 2009 calendar year.

Next generation access regulation

In March 2009, following consultation, Ofcom published a policy statement setting out a regulatory framework for next generation access (NGA). This gave sufficient regulatory certainty for BT to proceed with the initial phase of our super-fast broadband roll out and we will continue to work with Ofcom as our plans develop.

Regulation outside the UK

BT must comply with the regulatory regimes in the countries in which we operate and this can have a material impact on our business.

Communications regulation in each EU country is conducted within the regulatory framework determined by EU directives, regulations and recommendations. The manner and speed with which the existing directives have been implemented vary from country to country. National regulators are working together in the European Regulators Group to introduce greater harmonisation in their approach to the assessment of SMP and the imposition of appropriate remedies.

     BT does not have universal service obligations outside the UK, although in certain member states we may be required to contribute towards an industry fund to pay for the cost of meeting such obligations.

     The European Commission formally investigated the way the UK Government set BT’s property rates and those paid by Kingston Communications, and whether or not the UK Government complied with European Community Treaty rules on state aid. It concluded that no state aid had been granted. The Commission’s decision has now been appealed, but we continue to believe that any allegation of state aid is groundless, and that the appeal will not succeed.

The vast majority of the communications markets in which we operate around the world are subject to regulation, and in most of these we have to meet certain conditions and have had to obtain licences or other authorisations. The degree to which these markets are liberalised varies widely, which means that our ability to compete fully in some countries is constrained. We continue to press incumbent operators and their national regulatory authorities around the world (including in the EU) for cost-related wholesale access to their networks where appropriate and for advance notice of any changes to their network design or technology which would have an impact on our ability to serve our customers.

UK market trends

Broadband take up in the UK is slowing as the market matures and reaches high levels of penetration. However, usage is growing, driven for example by the increased popularity of peer-to-peer applications and of services such as the BBC iPlayer and BT Vision. Mobile broadband has also been a focus for many of the mobile operators as the voice and text markets approach saturation. Broadband providers are now expected to deliver an excellent level of service in addition to a range of applications and products tailored to the individual needs of customers.

 

 

The BT of today was largely created by a radical restructuring of the company in the 2002 financial year. This restructuring involved a rights issue (raising £5.9bn), the demerger of O₂ (comprising BT’s wholly owned mobile assets in Europe), the disposal of significant non-core businesses and assets, the unwinding of Concert (our joint venture with AT&T) and the creation of customer-focused lines of business.

     In 2007, we completed a number of acquisitions, including:

4		dabs.com (an online retailer of IT and technology products)
4		PlusNet (an internet service provider)
4		International Network Services (INS) (the California-based global provider of IT consulting and software solutions). In 2008, our acquisitions included:
4		i2i Enterprise Pvt Ltd (a Mumbai-based company which specialises in IP communications services for major Indian and global multinational companies)
4		Comsat International (a provider of data communications services for corporations and public sector organisations in Latin America)
4		the IT infrastructure division of CS Communication & Systèmes (the French IT systems and network services provider)
4		Frontline Technologies Corporation Ltd (one of the leading providers of end-to-end IT services in the Asia Pacific region).

We also completed the merger of I.NET SpA, an Italian data services provider with BT Italia SpA (formerly Albacom).

At 31 March 2009, we occupied approximately 7,000 properties in the UK and approximately 400 properties in the rest of the world. The majority of the UK properties are owned by – and leased from – the Telereal Group, which is part of the William Pears Group. Approximately 85% of the UK portfolio consists of operational telephone exchanges, which contain exchange equipment and are needed as part of our continuing activities. Other general purpose properties consist chiefly of offices, depots and computer centres.

     Our group property team manages waste and recycling on behalf of the rest of the business. More detailed information on waste management and recycling can be found in the chart on pages 24 to 25.

In common with all businesses, BT is affected by a number of risks and uncertainties, not all of which are wholly within our control. Although many of the risks and uncertainties influencing our performance are macroeconomic and likely to affect the performance of businesses generally, others are particular to our operations.

     This section highlights some of those particular risks and uncertainties affecting our business but it is not intended to be an extensive analysis of all risk and uncertainty affecting our business. Some may be unknown to us and others, currently regarded as immaterial, could turn out to be material. All of them have the potential to impact our business, revenue, profits, assets, liquidity and capital resources adversely.

     We have a defined enterprise wide risk management process for identifying, evaluating and managing the significant risks faced by the group. The key features of the risk management process are provided in the statement on Internal control and risk management on page 72 . The group risk register captures the most significant risks facing the business. Each risk is assigned a senior management owner responsible for monitoring and evaluating the risk and the mitigation strategies.

     In the 2008 Annual Report & Form 20-F, we highlighted ‘Transformation Strategy’ and ‘Technological Advances’ as principal risks. These are not included for 2009 because the group’s transformation programme was completed during the first half of the year. In addition, as the new 21CN core network has now been completed, any ongoing risks associated with general technological advances are managed as part of the group’s normal risk management process. Ongoing risks associated with the general competitive environment are set out below.

     The principal risks and uncertainties should be considered in conjunction with the risk management process, the forward looking statements in this document and the Cautionary statement regarding forward looking statements on page 148.

Competitive activity

We operate in highly competitive markets where customers can switch suppliers based on price and service levels as well as competitor activity. The profitability of these markets is declining as the competitive intensity and volatility of these markets increases.

     Factors contributing to levels of competitive activity include ‘resource rich’ competitors from adjacent markets entering our markets; competitors emerging with radically different costs bases, capabilities, propositions and/or business models; the emergence of new technologies and products offering increased performance at lower cost; decline in market growth rates and profitability due to the current economic environment; increased levels of customer churn and reduced levels of market differentiation.

Global economic and credit market conditions

A general reduction in business activity resulting from the current economic downturn in the global economy could lead to a loss of revenue and profits for us. Our business performance could also be adversely affected by increased exposure to the default of customers and suppliers as economic conditions worsen. In addition the impact of the current credit market conditions potentially impacts our ability to access liquidity in the capital markets and increases the risk of a counterparty exposure should any counterparty default on its contractual obligations. Volatility in the currency markets also affects our revenues and costs and while appropriate actions are taken to mitigate this risk there remains ongoing exposure to foreign exchange movements.

 

Security and resilience

We are critically dependant on the secure operation and resilience of our information systems, networks and data.

     Any significant failure or interruption of data transfer as a result of factors outside our control could have a material adverse effect on the business and our results from operations. We have a corporate resilience strategy and business continuity plans in place, designed to deal with such catastrophic events including, for example, major terrorist action, industrial action, extreme computer virus attack, hurricane or flooding. A failure to deliver that strategy may lead to a reduction in our profitability and there can be no assurance that material adverse events will not occur.

     The scale of our business and global nature of our operations means we are required to manage significant volumes of personal and sensitive information. We also store and transmit data for our customers all of which needs to be safeguarded from potential exposure and therefore requires a high level of management and security.

Pensions

We have a significant funding obligation to a defined benefit pension scheme.

     Declining investment returns, longer life expectancy and regulatory changes may result in the cost of funding BT’s defined benefit pension scheme (BTPS) becoming a significant burden on our financial resources. Whilst the triennial actuarial funding valuation as at 31 December 2008 has not yet been completed, as detailed on page 43, BT and the Trustee of the BTPS have agreed that deficit contributions of £525m per annum will be made over the next three years. This agreement has been approved by the Pensions Regulator.

     The results of future scheme valuations and associated funding requirements will be impacted by the future performance of investment markets, interest and inflation rates and the general trend towards longer life expectancy, as well as regulatory changes, all of which are outside our control.

 

In the Financial review we discuss the results of the group for 2009, 2008 and 2007. We explain the performance of the business using a variety of measures, some of which are not explicitly defined under IFRS, and are therefore termed ‘non-GAAP measures’. These measures are in addition to, and supplement, those prepared in accordance with IFRS. In particular, in this Financial review, we principally discuss the group’s results on an adjusted basis. Results on an adjusted basis are presented before the contract and financial review charges recorded within BT Global Services and specific items. Further discussion of the BT Global Services contract and financial review charges is given on page 10. In our income statement we separately identify specific items and present our results both before and after these items. This is consistent with the way that financial performance is measured by management and assists in providing a meaningful analysis of our results. The directors believe that presentation of the group’s trading results in this way is relevant to an understanding of the group’s performance as specific items are significant one-off or unusual in nature and have little predictive value. Specific items are therefore analysed and discussed separately in this Financial review. The other non-GAAP measures we use in this Financial review are underlying revenue, underlying operating costs, free cash flow and net debt.

     Each of these measures is discussed in more detail at the end of this section, on pages 47 and 48.

     In the Financial review, references we make to ‘2009’, ‘2008’, and ‘2007’ are to the financial years ended 31 March 2009, 2008 and 2007, respectively. References to ‘the year’ and ‘the current year’ are to the year ended 31 March 2009.

Line of business results

The financial performance of the lines of business for 2009, 2008 and 2007 are discussed in the Business review. We measure the financial performance of BT Retail, BT Wholesale and Openreach based on EBITDA and operating profit before specific items. For 2009 we measure the results of BT Global Services on an ‘adjusted’ basis, being before the impact of contract and financial review charges and specific items. For further discussion of these items, see pages 47 to 48. A reconciliation of adjusted EBITDA to group operating profit (loss) by line of business, and for the group, is provided in the table at the foot of pages 34 to 35.

Internal cost recorded by

BT Global

BT

BT

Services

Retail

Wholesale

Openreach

Other

Total

£m

£m

£m

£m

£m

£m

Internal revenue recorded by:

BT Global Services

–

–

–

–

–

–

BT Retail

219

–

51

4

85

359

BT Wholesale

–

–

–

1,228

–

1,228

Openreach

–

2,250

85

–

1,918

4,253

Total

219

2,250

136

1,232

2,003

5,840

The table above analyses the trading relationships between each of the lines of business for 2009. The majority of the internal trading relates to Openreach and arises on rentals, and any associated connection or migration charges, of the UK access lines and other network products to the customer-facing lines of business, both directly, and also indirectly through BT Operate which is included within Other in the table above. Internal revenue arising in BT Retail relates primarily to BT Ireland and Enterprises. Internal revenue arising in BT Wholesale relates to the sale of line cards and access electronic services to Openreach.

Group revenue

Revenue increased by 3% to £21,390m. This compares with growth of 2% in 2008 and 4% in 2007. Foreign exchange movements and the impact of acquisitions contributed £653m and £521m, respectively, to revenue growth in the year. Excluding these, underlying revenue decreased by 2% in 2009, compared with group revenue in 2008.

Underlying revenue

		2009
		£m
Group revenue			21,390
Foreign exchange movements			(653	)
Acquisitions			(521	)
Underlying revenuea			20,216

a		Underlying revenue is a new ‘non-GAAP measure’ used by the group for the first time in 2009. This measure is discussed in more detail at the end of this section on page 47.

Product revenue

		2009				2008				2007
		£m				£m				£m
Revenue by product
Managed solutions			6,365				5,320				4,825
Broadband and convergence			2,637				2,567				2,310
Calls and lines			6,305				6,818				7,098
Transit, conveyance, interconnect services, WLR, global carrier and other wholesale products			3,301				3,398				3,452
Other			2,782				2,601				2,538
Group total			21,390				20,704				20,223

Managed solutions revenue, including MPLS and networked IT services, increased by 20% to £6,365m, mainly due to the impact of foreign exchange movements on networked IT services revenue and an increase in BT Wholesale managed network solutions revenue arising from new contracts in 2009. In 2008, managed solutions revenue increased by 10%, driven by growth in revenue

 

 

Wholesale and carrier

Wholesale and carrier revenue decreased by 0.7% to £5,404m in 2009 (2008: £5,442m, 2007: £5,537m), compared with a decline of 2% in 2008, as a result of a decline in low margin transit revenue, conveyance volumes and revenue from DSL broadband. The declines were partially offset by higher revenue from LLU, managed network solutions and the global carrier business.

     In the UK, we had 13.8m wholesale broadband DSL and LLU connections, including 5.7m LLU lines, at 31 March 2009, an increase of 1.1m connections in the year.

Other operating income

Other operating income before specific items was £352m in 2009 (2008: £359m, 2007: £236m). The decrease in 2009 was largely due to lower income from the sale of intellectual property rights, licences, vehicles and other assets, partially offset by higher income from the sale of scrap and cable recovery. The increase in 2008 was largely due to growth in the third party business undertaken by our vehicle fleet operations, some upfront benefits from the transformation of our operational cost base through global sourcing and income from the exploitation of our intellectual property.

Operating costs

		2009				2008				2007
		£m				£m				£m
Staff costs before leaver costs			5,302				5,231				5,076
Leaver costs			204				127				147
Staff costs			5,506				5,358				5,223
Own work capitalised			(673	)			(724	)			(718	)
Net staff costs			4,833				4,634				4,505
Depreciation			2,249				2,410				2,536
Amortisation			641				479				384
Payments to telecommunications operators			4,266				4,237				4,162
Other operating costs			8,934				6,408				6,159
Operating costs before specific items			20,923				18,168				17,746
Specific items			395				529				169
Operating costs			21,318				18,697				17,915

Group operating costs before specific items increased by 15% to £20,923m. Group operating costs in 2009 include the impact of foreign exchange rate movements of £720m and the impact of acquisitions of £486m. Excluding these, the impact of the contract and financial review charges within BT Global Services of £1.6bn (see page 10) and specific items, underlying operating costs of £18,119m were broadly unchanged compared with the prior year. Outside of BT Global Services the rest of the group has reduced operating costs. Group operating costs before depreciation, amortisation and leaver costs, excluding BT Global Services costs of £8,562m, decreased by 6% to £7,669m, or 9% on an underlying basis excluding foreign exchange rate movements of £86m and acquisitions of £143m. The reduction reflects the success of the group’s cost savings initiatives. The group has reduced total labour resource by around 15,000 in 2009. Most of the reductions were in the area of indirect labour, including agency and contractors.

Adjusted												Depreciation
operating profit (loss)b												and amortisation												Adjusted EBITDAb
2009				2008				2007				2009				2008				2007				2009				2008				2007
£m				£m				£m				£m				£m				£m				£m				£m				£m
	(467	)			117				70				776				744				665				309				861				735			BT Global Services
	1,209				1,050				912				425				445				445				1,634				1,495				1,357			BT Retail
	580				502				592				686				893				908				1,266				1,395				1,500			BT Wholesale
	1,218				1,222				1,220				778				689				707				1,996				1,911				1,927			Openreach
	(82	)			4				(81	)			225				118				195				143				122				114			Other Intra-group
	2,458				2,895				2,713				2,890				2,889				2,920				5,348				5,784				5,633			Group totals