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Financial Review

Sales and operating profit

Pro forma sales for the Group grew 6% to £5,851m (2006: £5,510m) and pro forma benchmark operating profit grew 8% to £359.4m (2006: 331.8m). Group pro forma benchmark operating margin was 6.1% (2006: 6.0%). The drivers of this performance have been analysed as part of the preceding divisional reviews.

The definition of pro forma benchmark operating profit is operating profit before amortisation of acquisition intangibles, store impairment charges, exceptional items and costs related to demerger incentive schemes. As with pro forma sales, it is calculated on a 52-week basis. This represents the 52 weeks to 3 March 2007 and the comparable 52 weeks to 4 March 2006.

Net interest costs

Pro forma net interest income for the year was £16.6m. This reflects £1.2m of estimated net interest expense on Home Retail Group’s net debt/cash position during the course of the year on the basis of a pro forma allocation of £200m net debt as at 31 March 2006, improving to a net cash position of £60m as at 3 March 2007. Against this is the credit of £17.8m reflecting the financing costs charged within Financial Services’ benchmark operating profit.

Interest costs attributable to the GUS capital structure prior to the demerger were £46.1m (2006: £40.9m) and have been excluded from pro forma benchmark PBT.

Share of post-tax results of associates

These amounted to income of £0.7m (2006: loss of £4.2m). The improvement is principally due to the costs incurred in the previous year associated with the wind-down of AAGUS, a consumer finance company in The Netherlands in which Home Retail Group has a 33% holding.

Exceptional items

Demerger-related costs of £11.3m were incurred by Home Retail Group. As previously disclosed, these included costs in relation to early vesting of GUS plc share incentive schemes, banking set-up fees and other professional fees. An additional exceptional cost on demerger of £7.3m in relation to the waiver of a loan due from Experian was also taken in the first half of the financial year. Store impairment charges in respect of the Homebase store portfolio were £4.1m (2006: £12.8m).

Within net financing costs, exceptional finance income of £6.9m was recorded in the second half of the financial year. This relates to the gain made on the transfer of an interest rate swap associated with the £225m fixed rate financing facility novated from GUS plc on demerger.

Financing fair value remeasurements

Changes in the fair value of certain financial instruments are recognised in the income statement within net financing costs. These amounted to charges of £0.1m (2006: £2.4m).

Financing impact on retirement benefit balances

The credit through net financing costs in respect of the excess of expected return on retirement benefit assets over the interest expense on retirement benefit liabilities amounted to £12.3m (2006: £2.6m). The increase in the credit is principally as a result of the special contribution of £100m made in March 2006.

The ongoing accounting charge, which Home Retail Group believes to be a fairer reflection of the cost of providing retirement benefits, is already reflected in benchmark operating profit.

Profit before tax

Pro forma benchmark profit before tax for the year grew 12% to £376.7m (2006: £337.1m). Reported profit before tax was £296.9m (2006: £272.4m).

The definition of pro forma benchmark profit before tax is profit before amortisation of acquisition intangibles, store impairment charges, exceptional items, costs related to demerger incentive schemes, financing fair value remeasurements, financing impact on retirement benefit balances and taxation. Net interest income within pro forma benchmark PBT is calculated to illustrate the Group’s financial performance as if the demerger capital structure had existed at 31 March 2006 and had been achieved based on underlying cash flows prior to 31 March 2006. Benchmark PBT also includes Home Retail Group’s share of post-tax results of associates. It is calculated on a 52-week basis.

Taxation

Taxation attributable to pro forma benchmark PBT for the year was £122.1m (2006: £114.5m), representing an effective tax rate (excluding associates) of 32.5% (2006: 33.5%). The improvement in the effective rate largely reflects a lower level of disallowable expenditure for tax purposes.

The reported effective tax rate (excluding associates) is 37.0% (2006: 34.7%), representing a total tax expense for the period of £109.5m (2006: £96.0m).

Number of shares and earnings per share

On demerger, Home Retail Group was admitted to the Official List and to trading on the London Stock Exchange's market for listed securities with 877.4m issued ordinary shares.

The number of shares for the purpose of calculating earnings per share in the prior year has been taken as 869.0m, representing the number of shares in issue at the date of demerger, excluding 8.4m ordinary shares held in Home Retail Group’s Employee Share Ownership Trust (“ESOT”). For the financial period just ended, the weighted average number of shares since demerger has been used, which, excluding shares held in the ESOT, was 869.6m.

The calculation of diluted EPS reflects the potential dilutive effect of employee share incentive schemes in place post demerger. This increases the number of shares for diluted EPS purposes by 7.6m to 877.2m (2006: 876.6m).

Pro forma basic benchmark EPS is 29.3p (2006: 25.6p), with pro forma diluted benchmark EPS of 29.0p (2006: 25.4p). Reported basic EPS is 21.6p (2006: 20.3p), with reported diluted EPS of 21.4p (2006: 20.1p).

Balance sheet and return on capital

Reported net assets amounted to £3,078.7m, an increase of £128.8m on the previous balance sheet date. This is equivalent to 354p per share, excluding shares held in the ESOT (2006: 339p).

Benchmark pre-tax return on invested capital, based on benchmark operating profit plus share of post-tax results of associates of £360.1m and invested capital of £3,011.8m, was 12.0%, representing a 150 basis point improvement on the previous balance sheet date. The improvement represents the combination of the £32.5m improvement in profit, together with the £95.4m reduction in invested capital.

Balance sheet

Dividends

As indicated at the time of demerger, a policy whereby the full year dividend is ordinarily covered at least twice by basic benchmark EPS has been established by the Board. For the financial period to 3 March 2007, the Board are now proposing to pay the final dividend based on the higher figure of the 52-week pro forma basic benchmark EPS, rather than on a lower statutory reporting period basis as had previously been indicated.

A final dividend of 9.0p is therefore being recommended, making 13.0p for the year. Based on pro forma benchmark EPS of 29.3p, this represents cover of 2.25 times. Based on reported basic EPS of 21.6p, it represents cover of 1.66 times.

The final dividend, subject to approval by shareholders at the AGM, will be paid on 25 July 2007 to shareholders on the register at the close of business on 25 May 2007.

Cash flow and net debt

As part of the demerger, Home Retail Group was allocated pro forma net debt of £200m as at 31 March 2006.

Cash flows from operating activities (before incurring outflows related to interest, tax, investing and financing activities) were £604.5m in the period (2006: £367.4m). The principal drivers of the strong cash generation have been good management of working capital, together with the non-repeat of the prior year £100m special pension contribution to the Argos UK defined benefit pension scheme. As the cash generation is for a short period (i.e. circa 11 months) as a result of the change in year-end, there is also a benefit within it from the exclusion of March, historically a cash outflow month. It is estimated, based on previous cash flows for the month of March, that cash generation would therefore have been approximately £100m lower on a full year basis.

There has also been a lower level of capital expenditure at £162.4m in the period (2006: £254.9m). This is partly as a result of approximately £25m of capital expenditure that would ordinarily have occurred in the month of March, together with approximately £25m of capital expenditure delayed into the next financial year.

At 3 March 2007, the Group had a net cash position of £60.2m.

Disposals

The disposal of Whiteaway Laidlaw, a commercial bank which offers banking facilities to small businesses and personal customers, was completed in January 2007. Cash consideration was approximately £5m, resulting in a loss on disposal of £1m which was charged within Central Activities.

Retirement benefit assets

The Group provides a number of post-employment benefit arrangements covering both funded defined benefit and defined contribution schemes. Pension arrangements are operated principally through the Argos UK defined benefit scheme together with the GUS defined contribution scheme, which was replaced post year-end by the Home Retail Group defined contribution scheme.

The last actuarial valuation of the Argos UK defined benefit scheme was carried out as at 31 March 2006. The IAS 19 surplus as at 3 March 2007 for the UK defined benefit scheme was £9.3m (2006: £25.5m).

Capital structure

The Group finances its operations through a combination of retained profits, bank borrowings and property leases. The Group has significant liabilities through its obligations to pay rents under property leases.

The capitalised value of these liabilities is £2.6 billion based upon a simple eight-times multiple of the operating lease charge, or £2.9 billion based upon discounted cash flows of the expected future operating lease charges. The Group, in common with the credit rating agencies, treats its lease liabilities as debt when evaluating financial risk and investment returns.

The Group’s net debt varies significantly throughout the year due to trading seasonality.

Liquidity and funding

Liquidity is achieved through arranging funding ahead of requirements and maintaining sufficient un-drawn committed facilities to meet short term needs.

At 3 March 2007, the Group had un-drawn committed borrowing facilities available of £700m which expire in 2011. These facilities are in place to enable the Group to finance its working capital requirements and for general corporate purposes.

Treasury policy and risk management

The Group’s treasury function seeks to reduce exposures to foreign exchange, interest rate and other financial risks, and to ensure sufficient liquidity is available to meet foreseeable needs and to invest cash assets safely and profitably. Policies and procedures are subject to review and approval by the Board as well as subject to audit review.

Counterparty credit risk management

The Group’s exposure to credit risk is managed by dealing only with banks and financial institutions with strong credit ratings and within limits set for each organisation. Dealing activity is closely controlled and counterparty positions are monitored daily.

Interest rate risk management

The Group’s interest rate exposure is managed by the use of fixed and floating rate borrowings and by the use of interest rate swaps to adjust the balance of fixed and floating rate liabilities.

Currency risk management

The Group’s key objective is to reduce the effect of exchange rate volatility on profits. Transactional currency exposures that could significantly impact the Income Statement are hedged using forward purchases of foreign currencies.

Post balance sheet event

On 25 April 2007, Home Retail Group completed the acquisition of a 33% stake in ‘home store + more’, the Irish retailer, for a consideration of around £7m (€10m).

Share price and total shareholder return

The share price of Home Retail Group ranged from a low of 399.25p to a high of 444.5p during the financial year post demerger.

On 2 March 2007, the mid market price was 420.0p, giving a market capitalisation of £3.7bn at that date.

Total shareholder return (the increase in the value of a share including reinvested dividends) has been 3.4% in the approximate five-month period since demerger.This compares favourably with the total shareholder return for the FTSE 100, which was 1.5% over the same period.

Accounting standards and use of non-GAAP measures

The Group has prepared its consolidated financial statements under International Financial Reporting Standards for the period ended 3 March 2007. Accounting policies are outlined in Note 3 to the Financial Statements.

Home Retail Group has identified certain measures that it believes provide additional useful information on the underlying performance of the Group. These measures are applied consistently but as they are not defined under GAAP they may not be directly comparable with other companies’ adjusted measures. The non-GAAP measures are outlined in Note 3 to the Financial Statements.

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