Operating and financial review

These results deliver an attractive increase in adjusted Group profit before tax of 39% and adjusted earnings per share of 34%. The acquisition of Unigate's dairy and cheese business was completed with effect from July 2000 and therefore made only a partial contribution in the first half of last year. On a proforma basis, operating profit shows an increase over 10% against trading results of both businesses in the first half of last year. Reported operating profits show an increase of 43% for the six months to September 2001.

Dairy Crest's strategy to develop its brands and added value products continues to deliver an attractive performance. The Group's key brands demonstrated further strong progress, with Clover, Cathedral City and Frijj and the Yoplait brands showing impressive sales volume growth of between 10% and 25% for the six months to September 2001.

The investment programme to optimise the benefits of the acquisition is progressing smoothly. All the actions to restructure the combined business and deliver the synergy benefits outlined at the time of the acquisition have commenced. The planned synergies are being delivered in line with our expectations, which reinforces our confidence that the full acquisition benefits will be achieved as planned. We are directing our major investments to establish industry leading standards of operational cost efficiency across the Group and to continue the development of our brands and added value businesses.

Financial review

The Dairy Crest results in the comparative period for the six months to September 2000 included three months trading from the acquired dairy and cheese business and therefore a proportion of the enhanced performance relates to the inclusion of the acquisition for the full half year. The Group achieved half year turnover of £692 million compared with £559 million last year. On a proforma basis it declined by 6% reflecting lower ingredients and household sales volumes.

Adjusted operating profit (before operating exceptional items and goodwill amortisation), including the benefit of the acquisition for the full half year, was £43.5 million compared with £30.5 million previously. The planned restructuring of the Group has resulted in operating exceptional costs of £21.2 million charged against operating profits in the first half year. These costs mainly relate to the restructuring announced last year including the closure of the dairy at Westway, London and the cheese prepack plant at Carmarthen together with the elimination of duplicate central costs. In addition the Group has recognised non-operating income of £1.7 million representing its share of joint ventures' profit on the disposal of property. Goodwill amortisation amounted to £1.1 million.

The interest charge has increased from £6.1 million last year to £9.7 million in the half year to September. This increase largely reflects interest on borrowings taken out to finance the acquisition, cash flows associated with restructuring and capital investment, together with working capital expansion in the first half of the year.

Excluding the £20.6 million charge for operating exceptional items and goodwill amortisation net of the non-operating income, the adjusted Group profit before tax was £33.8 million, which represents an increase of 39% over the comparable £24.4 million reported in the first half of 2000/01. The tax charge of £3.6 million includes a tax credit on operating and non-operating exceptional items of £5.9 million, and it represents an effective tax rate of 28% on adjusted profits. Basic earnings per share, which is calculated after charging exceptional items and goodwill amortisation, was 8.0 pence compared with 11.7 pence in September 2000. Adjusted earnings per share has increased by 34% to 20.6 pence compared with the prior period. The directors have declared an interim dividend of 4.8 pence per share, which represents an increase of 7% over the 4.5 pence per share in the corresponding period last year. The dividend will be paid on 29 January 2002 to shareholders on the register at 23 November 2001.

Group net debt amounted to £296.1 million at September 2001 reflecting a net cash outflow of £49.8 million in the first half. Capital expenditure in the half amounted to £33.1 million and there was a net working capital outflow of £49.4 million, principally reflecting increased cheese and ingredients stocks with the normal seasonal stock build through the summer months amplified by the impact of around 20% increase in raw milk costs since October 2000.

Business operations

Dairy Crest's added value strategy continues to make encouraging progress and is a key driver of Group operating profit. Our ongoing investment in media and marketing to build branded growth has led to strong volume increases by our leading brands, Clover, Cathedral City and Frijj and the Yoplait brands.

Consumer Foods, which contains our added value businesses, achieved an operating profit of £29.0 million on turnover of £423 million producing an operating margin of 6.9%. This is a significant improvement on the results for the first half of last year where operating profit of £16.5 million was earned from turnover of £333 million at an operating margin of 5.0%. Food Services achieved an operating profit of £14.5 million on turnover of £269 million at an operating margin of 5.4% compared with last year's operating profit of £14.0 million on turnover of £226 million at an operating margin of 6.2%.

Our spreads business continued to benefit from Clover's excellent performance. Its sales volumes increased by 10% over the first half of last year compared with the dairy spreads market, which showed a small annual reduction of 1%. This growth, combined with Clover's premium position, helped maintain it as the clear market leading brand in the sector. The spreads business has benefited from the efficiencies achieved when we established Crudgington as the centre for the production of retail dairy spreads, packet and speciality butters helping the spreads business to provide a significant contribution to Dairy Crest's overall profit.

The cheese business reflected the financial and commercial benefits of several years of focus and investment. Our leading brand Cathedral City achieved outstanding progress with sales volumes ahead by over 20 % compared to the previous year. Consumers increasingly purchase Cathedral City in prepack form and sales in the half increased by 64%. Our cheese business continues to grow and prosper and this year we have also benefited from a tight market which has improved margins. This planned growth necessarily involves an increase in stocks of maturing cheese which is reflected in the working capital position. Dairy Crest is clearly positioned as the market leader whose focus and investment on building brands and adding value is proving attractive to both consumers and major retailers.

The branded Yoplait Dairy Crest fresh dairy products business continued to show strong growth with sales volumes ahead of the same period last year by over 20%. There were particularly encouraging performances by Petits Filous, including Frubes as well as the Weight Watchers from Heinz range.

These volume gains enhanced Yoplait Dairy Crest's position as the market leading supplier to the growing children's sector. However, market conditions in the retailer brand sector continue to be extremely demanding. In response to the pressures created by excess processing capacity in the UK and Europe, Yoplait Dairy Crest recently announced the closure of its Basildon facility with effect from Spring 2002. Yoplait Dairy Crest's financial results reflect the impact of the highly competitive retailer branded sector which more than offset the strong performance by the branded business, reducing Dairy Crest's share of joint ventures' operating profit by £0.6 million to £1.6 million. However, we remain confident that the fundamental attributes of an increasingly value added fresh dairy products sector will provide attractive longer term returns.

The retail liquid milk market remains highly competitive, but our market position has been completely transformed by the Unigate dairy acquisition. The £54 million investment programme to create the super dairies at Chadwell Heath, Essex and Severnside, Gloucestershire is proceeding well and in line with planned timescales. Chadwell Heath is now fully operational and Severnside will progressively accommodate volume being transferred from sites scheduled for closure during 2002. This major investment will achieve an operational capability to place the Company in the position as the UK's leading supplier of retail fresh milk. By Autumn 2002, Dairy Crest expects to have a least cost competitive advantage through the two largest and most efficient production plants in the country. The acquisition and subsequent investment are delivering enhanced business profitability, although competitive activity means that trading conditions remain challenging. However, we believe that Dairy Crest is now financially and strategically positioned to capitalise fully on any further industry consolidation. Frijj had another good half year with sales volumes increasing by over 20%.

The household business objective remains to drive the operation to deliver significant levels of profit and cash to invest in the further development of Dairy Crest's growth businesses. As anticipated the doorstep continued to experience a market decline of around 12% for the half year and we expect that rate to rise moderately in the second half year. The operation will continue to deliver further cost reduction, both throughout the depot structure and by eliminating central overheads, to counteract the impact of falling volumes. The household business continues to make a strong operating cash flow which helps finance Dairy Crest's growth aspirations.

Following the shortfall in milk production in the second half of 2000/01, Dairy Crest took the decision that it would only secure the milk necessary to serve its customers in its chosen market and to deliver the Company's financial objectives. We decided not to place additional pressure on the raw milk price in April 2001 as there were signs that ingredients realisations had peaked. Therefore we chose not to secure milk to service the full extent of our commodity ingredients business. These pricing pressures are expected to increase. However, the benefit of our milk buying strategy can be seen in the resilience of the Group's financial performance in the results to September 2001.

Board changes

After eleven years as Chief Executive, I reach my retirement date on 26 July 2002 at the age of 60. Accordingly, I will be retiring at the next Annual General Meeting scheduled for 18 July 2002, when I will be succeeded as Chief Executive by Drummond Hall.

Drummond, who joined the Company in September 1991, is currently an Executive Managing Director on the Dairy Crest Group plc Board, and has played a key role in the implementation of the Group's successful value added strategy. The Board is confident that the early announcement of this succession planning will ensure seamless change in the Group's strategic and operational performance.

Outlook

Our strategy to drive profitable growth through our value added and branded businesses continues to prove successful as demonstrated by the financial performance to September 2001. In these challenging times it is a source of great strength for the Company to have such valuable growing brands as Clover, Cathedral City and Frijj and the Yoplait brands in our portfolio. The benefits of our strategy to invest for material competitive advantage are clearly demonstrated by the progress being made in our retail liquid milk business, where competitive pressures will remain intense until further industry rationalisation is completed. We are pleased to report that the synergies arising from the Unigate acquisition are being delivered on time and in full.

We believe that the financial and commercial progress evidenced by these results gives confidence that Dairy Crest will continue to deliver the expected attractive financial performance necessary to continue to drive enhanced shareholder returns.