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Chairman's
Review

"We believe that our actions have drawn a line under a difficult year, establishing a platform to deliver long-term benefit to our shareholders by providing excellent customer service, cost effectively and efficiently."John Devaney

2009 in overview

2009 was a challenging year for National Express. The Group faced a succession of difficult issues - the global recession; the exit from the East Coast rail franchise; the departure of our Chief Executive; the protracted period during which we dealt with a series of potential bidders for the Group; and finally the demanding and complex refinancing we completed at the end of the year.

Against all this, we have delivered some positive results. We reduced costs by £50 million on an annualised basis, secured incremental cash generation of over £200 million to drive down debt, resolved the East Coast rail position, and capped the year with a strongly supported equity Rights Issue, overall delivering £520 million of debt reduction. This was followed by a successful bond issue. Together these have delivered an improved capital structure and, as a result, National Express ended 2009 in a far stronger position than it began the year.

Throughout all this, our businesses on the whole delivered a creditable performance. The UK Coach business improved profitability by over 25%, despite fewer passengers travelling. Spain’s performance was resilient, reducing costs and securing new and extended contracts, despite a tough domestic economy and high unemployment. Our retained UK Rail franchises improved profitability and established record operational performance levels.

Normalised continuing profit before tax this year, at £116.2 million, was £86.2 million lower than 2008. Whilst this is a substantial fall, the majority of this reduction was a result of the performance of the loss-making East Coast rail franchise. Adjusted to exclude just the East Coast normalised operating result from both years, this profit before tax measure would have been £142.5 million in 2009 compared to £172.4 million in 2008.

The East Coast issue has been resolved with a smooth handover of the franchise to government. We are now focused on driving forward the strong performance of Spain and UK Coach, whilst improving margins in North America school bus and UK Bus.

Our robust business model

National Express is essentially a road passenger transport business, while retaining a good capability in rail, operating in three main geographical markets: the UK, Spain and North America. Our competition is primarily modal, with our customers choosing between our bus and coach services, versus car, plane or train.

In both the UK and Spain, we are a market leader in long distance coach and commuter bus operations. In Spain, ALSA is the largest private operator. It manages 163 regional and long distance concessionary franchises, as well as urban bus services in 24 Spanish cities. These are regulated and supported by long - term concession agreements that provide exclusive rights to operate routes. ALSA has a diversified portfolio, an internationally recognised brand and a flexible operating structure that provides critical financial resilience.

This strength is mirrored in the UK Coach business, National Express. With 70% unprompted brand recognition, National Express is the only scheduled national coach operator in the country - and the largest in Europe. Operating in a highly deregulated market, the UK Coach business benefits from its sheer scale; from the breadth and interconnectivity of its national route network, serving over 1,000 domestic destinations, and from its flexible, outsourced operational model.

Our National Express West Midlands brand operates the largest single urban bus network in the UK outside of London. In a competitive, deregulated market, our UK Bus business enjoys considerable benefits of scale. For example, operating reliable bus services requires major infrastructure investment in depots and maintenance facilities. Our West Midlands network serves a target population where over 90% live within 250 metres of a bus stop.

In North America, National Express operates solely in the school bus market. One of only two operators with true continental geographic coverage, this is a market based on 3-5 year contracts, backed by local public school boards and, despite strong competition, once a contract has been won, the operator faces almost no revenue risk.

National Express has also built strong operational skills in UK Rail, the most deregulated railway system in Europe. However, 2009 demonstrated the volatile nature of the current franchising system, where the franchisee is required to guarantee an agreed level of service supply, irrespective of customer demand, with little ability to flex costs to respond to changes in customer travel patterns in the early years of the contract. With East Coast now handed back, National Express can focus on excellence in delivery of its two remaining rail franchises, East Anglia and c2c, until their expected contract termination in 2011.

Safety is our top priority. In 2009, both the UK and Spain reduced vehicle accident rates.

Our businesses give us a combination of core strengths on which to build - significant contracted revenues from public sector customers, long-term exclusive concessions and significant customer recognition. We deliver excellent customer service, cost effectively and efficiently. Our position relative to our peers, having less exposure to volatile rail markets, provides a platform to drive future shareholder value.

Our markets in 2009

Our performance in 2009 was against the backdrop of very difficult markets. The two main drivers of transport businesses are economic growth (GDP) and employment. The decline in GDP in 2009, 3.2% in the UK and 3.6% in Spain, led to a reduction in discretionary and business travel, impacting long distance coach and rail operations.

Employment-based travel to work is a major driver for our urban bus and commuter rail operations. Rising unemployment in the West Midlands impacted UK Bus, though commuter rail operations saw unemployment have less of an impact on performance than might have been predicted.

In Spain, several years of strong economic growth came to a halt late in 2008; by the end of 2009, official unemployment had risen to almost 20%. This has impacted the regional coach business, where migrant labour is a key passenger group, while urban operations were better protected by our concession agreements.

Forecasts of limited recovery of GDP in 2010 should progressively help passenger volumes in Coach operations. However, with unemployment a lagging indicator to economic recovery, all of our businesses have therefore responded to manage an environment where productivity growth, efficiency improvements and cost cutting are the norm. In 2009, cost reduction has been a major driver to limit the adverse impact of the recession on margins, with £50 million of annual savings delivered across the Group by the year-end. In both Spain and the UK, cost management has come to the fore, as we have sought to adapt services to meet the changing patterns of customer demand. Spain was particularly successful at reducing operating kilometres, by over 5% year-on-year. Compared to many sectors of both economies, however, the bus and coach sectors offer a relatively high level of revenue stability.

Delivering key milestones

Although the overall financial performance of the Group was disappointing after a record 2008, 2009 was a year when we made real progress in resolving many of the difficult challenges which emerged as the recession unfolded. These included the departure of our previous Chief Executive in June 2009 - successfully replaced by Dean Finch in February 2010 - and a series of takeover approaches for the Group.

However, the most significant of the issues to be resolved were the impact of the East Coast rail franchise and the Group’s highlevel of debt.

Limiting the impact of the East Coast rail franchise

When National Express won and began operating the East Coast main line rail franchise in 2007, it was expected that passenger revenue would increase by around 10% a year, based on increasing passenger numbers and fare yield. With the arrival of recession, this assumption proved unrealistic. Up to November 2009, annual passenger revenue on the franchise actually declined by 2%.

Therefore, despite significant improvements in service delivery and punctuality, our East Coast franchise rapidly moved into a significant loss as 2009 progressed, exacerbated by increasing premia payments to the UK government - and it became clear that the loss could extend for the life of the franchise. After extensive and difficult discussions with the UK government, we handed back the franchise, in an orderly manner, on 13 November 2009. The Group provided £40 million in cash support to cover operating losses on the franchise and paid £31.4 million in a performance bond to the government. We retained our two other profitable rail franchises. We also provided certainty to shareholders and funding partners.

£56.3 million of the year-on-year fall in the Group’s normalised continuing profit before taxation can be attributed to the East Coast franchise. Excluding East Coast, the remaining businesses achieved a more resilient outcome to 2009.

Reducing debt and improving the capital structure

Prior to 2008, National Express had increased its debt markedly to invest in developing the business through acquisitive growth.

The change in the global financial environment late in 2008 had a particularly detrimental effect on the Group. National Express suffered from restricted banking covenant headroom and limited funding maturity. Entering 2009 with nearly £1.2 billion of net bank debt required significant management attention to ensure the Group remained compliant with its debt covenants, whilst driving a programme of ‘self-help’ measures.

Much of this came from reducing investment and managing our working capital better. But savings also, necessarily, included the passing of the dividend. Such a decision was difficult for the Board, particularly in a year which saw our share price fall significantly. However, by year-end, we had delivered over £200 million of incremental cash generation from this self-help programme, more than double the target we had set 12 months earlier of £100 million. Given the longer term cash generative nature and earnings potential of the Group’s operations, the Board expects to resume a progressive dividend policy once the economic outlook is clearer and refinancing has been completed.

In November 2009, shareholders backed our successful Rights Issue. By the end of 2009, net debt had been reduced by £521.9 million to £657.9 million - with £357.9 million raised from shareholders and £164.0 million from organic cash generation and ‘self-help’ measures.

With our debt gearing ratio reduced to 2.5 times by the end of 2009 - from 3.5 times a year before – our capital structure is improved, our debt level reduced and our debt covenant headroom more flexible. This was reflected in a successful £350 million, seven year Sterling bond issue by the Group in January 2010, which was heavily oversubscribed. This bond issue has allowed us to pay down significant debt due in 2010 and 2011.

Focusing on business performance

We believe that our actions have drawn a line under a difficult year, establishing a platform to deliver long-term benefit to our shareholders. We believe we can demonstrate:

1. an ability to manage our ongoing operations effectively, despite challenging trading conditions, and to deliver resilient underlying performance;
2. a strong operational capability across the Group to deliver excellent customer service, minimise costs and take advantage of new business opportunities; and
3. a focus on driving the inherent cash generation qualities of each business to improve shareholder value.

In 2009, our ongoing businesses benefited from the leading market position we have in almost all of the markets in which we operate. Our UK Coach business, for example, carried over 18 million passengers in the year. However, it was the business operating model which helped us deliver so strongly, with a flexible cost structure that sees the majority of services outsourced to third-party operators. This has proved to be adaptable and resilient during the recession, with costs adjusted to meet changing customer demand. Normalised operating profit for the UK Coach business increased from £27.0 million in 2008 to £34.3 million in 2009.

In Spain, we benefited from scale and flexibility in our domestic bus and coach services, as well as from organic growth in North Africa. Effective cost management resulted in a limited profit decline in 2009. Despite the severity of the recession, our Spanish business still produced a normalised operating profit of £76.5 million, compared to £83.3 million in 2008.

Success in other parts of the Group was more limited. Normalised operating profits in the UK Bus business were down from £40.0 million in 2008 to £20.8 million. While predicted increases in fuel and pension costs, together with significant higher regional unemployment, have impacted the business - as well as the loss of profits from the sale of the Travel London operation - progress was made reducing overhead costs and operating mileage. Delivering improvements to UK Bus will be high on our list of priorities for 2010.

In North America, 2009 was a disappointing year, with normalised operating profit down to £25.3 million from £32.5 million in 2008, despite currency translation benefits. We remain confident that our investment programme will help us to reduce costs and improve revenue, but the benefits are coming through more slowly than we had hoped. Recent changes to the senior management team are aimed at steadily restoring profitability in the business from 2010 onwards, while refocusing our business recovery project on the areas of greatest benefit.

Delivering a simple, effective strategy

With the major issues impacting the Group’s structure and performance now resolved, we developed a strong interim strategy, ahead of the arrival of our new Chief Executive, Dean Finch, who joined the Company in February 2010. Building on the simple strengths of a public transport business, it is a ‘back-to-basics’ approach, designed to deliver greater shareholder value from increased focus on the Group’s core businesses. This strategy is focused on:

1. maximising cash generation;
2. delivering greater cost savings to drive margins; and
3. protecting and growing revenue selectively.

Maximising cash generation

Our business is naturally cash generative and, throughout 2009, we have sought to strengthen our balance sheet by focusing on cash generation to reduce debt – in 2009 we improved operating cash generation from £152.3 million in 2008 to £281.3 million. We continue to target deleveraging to further increase the Group’s financial flexibility by improving operating cash flow and disposing of non-core assets where values are appropriate.

Delivering cost savings

In 2009, our cost saving programmes delivered £50 million of annualised savings. We successfully reduced operating mileage by 3-5% in the UK and Spain, in response to lower passenger traffic. We made initial progress in reducing the proportion of revenue we spend on driver wages in North America, saving over US$7 million in 2009. Going forward, we want to achieve ‘best in class’ operating cost delivery in each business. This will particularly target margin improvement in UK Bus and North America.

Selective growth

We are focused on achieving organic growth in existing markets and on developing business in new markets where we can create value. In 2009, ALSA won a 15-year contract to operate urban bus services in the Moroccan city of Agadir. National Express coaches saw a 12% increase in passengers travelling to major events, despite the recession. Going forward, the Group’s core bus and coach operations are well placed, reputationally and financially, to access profitable growth as national economies recover from recession.

Delivering great customer service

National Express is a service business - and we will not prosper if we fail to deliver the service that our customers expect.

Despite the state of the economy, we have continued to deliver service improvements. The UK Coach business opened the Birmingham Coach Station on time and ready for Christmas travellers. This £15 million investment symbolises the style of modern coach travel that we now offer with its leather seats and onboard Wi-Fi. We have transformed a run-down bus terminus into a flagship that air travellers could envy. It will also become home to our new corporate head office during 2010, with associated cost savings from closing our current office in London.

Our new customer ticketing lounge at Stansted Airport has supported a return to year-on-year growth in airport coach routes and, in the UK Bus business, new partnerships are allowing the Group to develop tailored plans with local authorities to match changing customer demand. In UK Rail, both of our remaining franchises have delivered record service levels, including the best- ever punctuality performance by a UK train operating company.

In Spain, we continue to expand web ticketing as customer buying patterns change, and have introduced more premium coaches and Wi-Fi capability. In North America, we provided a school board customer in Illinois with a new bus routing solution which reduced buses by 33%, mileage by 29% and total route hours by 23%.

We will continue to offer outstanding and improved service to all our customers.

Looking ahead

We expect 2010 to be another challenging year. Low price inflation will leave limited scope to grow fare yields, and all our businesses will continue to focus on cost reduction to manage limited or zero passenger volume growth. This, together with lower fuel costs and selective revenue growth opportunities, is expected to improve overall margin and should enable us to drive shareholder value.

While 2009 was dominated by the need to resolve major issues in the Group’s capital structure and business portfolio, we believe that in 2010 we will be able to focus on operational improvement and building on the foundations that we have laid. National Express has many strengths and there is significant scope for improvement in some areas of our business, including UK Bus and our North American businesses.

Dean Finch inherits a senior management team that has worked exceptionally hard to put the Group on a sound footing, and a workforce of over 40,000 committed individuals, whose combined efforts will enable him – and the Group – to assess and drive forward opportunities.

John Devaney

Chairman
25 February 2010