Paddy Power suffered a 3% drop in operating profit to 30.1m and a 20% decline in its gross win, the amount of money lost by punters last year, despite seeing turnover race ahead by 18% to 1.4bn.

The somewhat mixed signals that those numbers send out were interpreted by the company well in advance of last week's results.

Paddy Power issued a trading statement last November warning of a fundamental shift in its Irish retail business. Its major rivals including William Hill and Boylesports have been aping Paddy Power's strategy of offering "punter-friendly" discounts, money-back specials and other incentives in an effort to win market share. Smaller operators, meanwhile, have increasingly been following suit simply to retain customers and survive. That pressure is made worse by competition from online-betting exchanges, which have lured some punters away from traditional bookmakers. It all adds up to margin erosion.

Paddy Power has warned that its long-term average gross winning margin will no longer lie within the 12% and 14% range that it historically maintained. For the foreseeable future it expects the retail margin to fall to between 11% and 13%. Competition has also hit the telephone and online divisions, though not to the same degree, leading to similar "reguidance" on expected future gross winning margins.

The 2005 numbers took a further hit from a run of good fortune for punters. The highlights included a run of nine Irish-trained winners at Cheltenham, an Irish Grand National winner and Liverpool's Champions League victory. All of those events attracted heavy betting from Irish punters and all resulted in big payouts from Paddy Power. Between margin erosion and lucky gamblers retail profit took a serious hit falling a full 47%, to 9.5m, in 2005.

Newly installed chief executive Patrick Kennedy said despite the altered guidance on the contribution from its betting shops and the poor run in 2005 the company remains confident that the business will continue to produce healthy year-on-year sales and profit growth. A strong economy, high disposable incomes and continuing population growth would all point to continued growth in retail, he said.

Kennedy, though, re-iterated company's November warning and emphasised that it was not being overly-conservative in its revised assumptions on future margins. "There's a bit of a sense that we might have sandbagged the numbers. I guarantee you, we wish that was the case, " he said.

The poor retail numbers, however, were offset by the massive growth Paddy Power experienced in its internet betting division. Online betting, casinos and poker are proving to be a strong additional revenue stream for the company. The 8.2m decline in operating profit from retail was compensated for by an equivalent rise in online profit. At 17m last year, internet revenue was up 93%.

Goodbody Stockbrokers analyst Neil Clifford said "2005 sort of marks a transition where the story has gone from one primarily about retail expansion to a twopronged story". Clifford also pointed out that the British retail estate, with 45 shops open at present, is still in the early stage of its development and has not yet made its presence felt on the bottom line.

Paddy Power expects each new shop to take about four years to build up a sufficient customer base to begin producing returns on the company's investment. Clifford said the first Paddy Power shops in Britain only opened in 2002 and the majority of the chain is even younger.

The online division, meanwhile, has plenty of untapped potential, according to Patrick Kennedy. In Ireland anticipated growth in internet usage and penetration of broadband from their current low bases should add to the potential market, he said.

The company hopes to have several new versions of Paddypower. com ready to roll in other European countries in time for the 2006 World Cup. "Ladbrokes has 13 language sites, William Hill have eight and we've got one.

That's our opportunity, " he said.

The company is also reviewing its strategy with regard to the US. Paddy Power not previously marketed its website in America, partly because of regulatory concerns over internet gambling in the states.

Merrion analyst Brid White said despite the company's optimism about the online division "the longer term growth picture is now looking more challenging".

She cited the better-thanexpected return from Power's foray into internet poker and online casinos as a positive.