British American Tobacco Regulatory News (BATS)

1 Mar 2007 07:06

British American Tobacco PLC01 March 2007 1 March 2007 PRELIMINARY ANNOUNCEMENT - YEAR ENDED 31 DECEMBER 2006 SUMMARY 2006 2005 Change Revenue - as reported £9,762m £9,325m +5%Profit from operations - as reported £2,622m £2,420m +8% - like-for-like £2,797m £2,607m +7%Adjusted diluted earnings per share 98.12p 89.34p +10%Dividends per share 55.90p 47.00p +19% • The reported Group profit from operations was 8 per cent higher at £2,622 million or 7 per cent higher on a like-for-like basis, with Asia-Pacific, Latin America and the Africa and Middle East regions particularly contributing to this good result. • Group volumes from subsidiaries increased by 2 per cent to 689 billion on both a reported and like-for-like basis. The reported Group revenue rose by 5 per cent to £9,762 million and also increased by 5per cent on a like-for-like basis. This excellent volume and revenue growth was achieved across a broad spread of markets. The four Global Drive Brands continued their impressive performance and achieved overall volume growth of 17 per cent. • Adjusted diluted earnings per share rose by 10 per cent to 98.12p, as the higher net finance costs and minority interests were more than offset by the improvement in profit from operations, the share of associates' post-tax results, a lower tax rate and the benefit from the share buy-back programme. The basic earnings per share was higher at 92.08p (2005: 84.34p). • Following a review of the Group's capital structure, the Board has decided that there is scope to increase significantly both the dividend payout ratio and the share buy-back programme. The Board is recommending a final dividend of 40.2p, which will be paid on 3 May 2007. This, together with the interim dividend, will take dividends declared in respect of 2006 as a whole to 55.9p, an increase of 19 per cent. In addition, the level of the share buy-back will rise from around £500 million to some £750 million per year, starting in 2007. • The Chairman, Jan du Plessis, commented "2006 has been a good year and I believe we can look ahead with confidence in our ability to achieve further growth and value for shareholders. Over the past five years, British American Tobacco has delivered an average annual total shareholder return of 26 per cent, compared to 7 per cent for the FTSE 100." ENQUIRIES:INVESTOR RELATIONS: PRESS OFFICE:RalphEdmondson/ 020 7845 1180 David Betteridge/Kate Matrunola 020 7845 2888Rachael Brierley 020 7845 1519 Catherine Armstrong BRITISH AMERICAN TOBACCO p.l.c.PRELIMINARY ANNOUNCEMENT - YEAR ENDED 31 DECEMBER 2006INDEX PAGE Chairman's statement 2 Business review 4 Continuation of share buy-back programme 8 Dividends 9 Group income statement 10 Group statement of changes in total equity 11 Group balance sheet 12 Group cash flow statement 14 Segmental analyses of volume, revenue and profit 15 Quarterly analyses of profit 17 Accounting policies and basis of preparation 19 Foreign currencies 20 Changes in the Group 20 Restructuring costs 21 Losses/gains on disposal of a business, brands and joint venture 21 Like-for-like information 22 Net finance costs 22 Associates 23 Taxation 24 Earnings per share 24 Cash flow 25 Total equity 28 Contingent liabilities 28 Share buy-back programme 36 Annual Report and Accounts 37 CHAIRMAN'S STATEMENT British American Tobacco has had another good year, with 7 per cent growth inour underlying profit from operations and a 10 per cent increase in adjusteddiluted earnings per share. The improvement in profit was driven by volumegrowth of 2 per cent and net revenue growth of 5 per cent. The impact ofexchange rates for the year as a whole was not material, although it wassignificantly negative in the last six months, especially in the last quarter,and has continued into the current year. These strong results, based on excellent organic growth, continue to provide asolid platform for a sustainable business. Our consistent and balanced approachto the four elements of our strategy for creating shareholder value (Growth,Productivity, Responsibility and Winning Organisation) is working well. Our Global Drive Brands were exceptionally successful, growing by 17 per cent.They now represent over 21 per cent of the Group's volume from subsidiaries,while international brands as a whole account for some 40 per cent of the total. Kent volume grew by 16 per cent to 45 billion, while Dunhill improved by 6 percent, with encouraging performances both in its new and its existing markets.Lucky Strike grew marginally and the star, once again, was Pall Mall, up 40 percent. There were net exceptional charges of £175 million, reflecting the restructuringcosts relating to the factory closure programme, partly offset by the gains on adisposal of brands. The annual savings from our supply chain programme in 2006amounted to £148 million, bringing the total to £374 million per year since westarted four years ago. We also saved a further £99 million from the overheads and indirects programme,bringing that total over the same four year period to £355 million on anannualised basis. The current overheads and indirects programme will becompleted in 2007. However, we intend to maintain our focus on costs and will beannouncing a further five year target, along with the final results from thefirst five years, in March 2008. We will also pursue additional supply chainsavings over the same five year period. Our associate companies, grew their volume by 4 per cent to 241 billion and ourshare of their post-tax results amounted to £431 million. This represents a 10per cent increase, if exceptional items are excluded, reflecting higher profitsfrom Reynolds American and ITC. The contribution from Reynolds American was £285million, with the early results from the acquisition of the Conwood smokelesstobacco business being distinctly encouraging. The improvement in profit from both subsidiaries and associates, together with alower effective tax rate and the benefit of the share buy-back programme, morethan offset the impact of higher net finance costs and minorities. As a result,adjusted diluted earnings per share rose by 10 per cent to 98.12p, just ahead ofour long term goal of achieving, on average, high single figure growth inearnings. By the close of business on 1 March, we expect that some 35 million shares willhave been bought back since 1 January 2006 at a cost of £500 million and at anaverage price of £14.19 per share. Since 2003, when the buy-back programmestarted, around 246 million shares have been repurchased at a cost of £2,191million, equivalent to an average price of £8.91 per share. We continue to viewthe purchase of our own shares as an excellent investment. Following a review of the Group's capital structure, the Board has decided thatthere is scope to increase significantly both the dividend payout ratio and theshare buy-back programme. Page 2 Chairman's statement cont... The previous policy was to pay out at least 50 per cent of long-term sustainableearnings in dividends, with the payout ratio in 2005 being 53 per cent. TheBoard has decided to raise the payout ratio to 65 per cent by 2008 inprogressive steps and is therefore proposing a final dividend for 2006 of 40.2p,an increase of 22 per cent. This takes the total for the year to 55.9p, anuplift of 19 per cent and raises the dividend payout ratio for 2006 to 57 percent. The dividend will be paid to shareholders on the Register at 9 March 2007.In line with our current practice, the interim dividend for 2007 will beapproximately one-third of the total for 2006. In addition, the level of the share buy-back will rise from around £500 millionto some £750 million per year, starting in 2007. The increase in the buy-backprogramme is likely to mean that, before the Annual General Meeting in 2008, thecombined interest of Richemont and Remgro (R&R) will rise above 30 per cent. Notonly is this the level at which, under normal circumstances, an offer would haveto be made by R&R for the remaining shares in British American Tobacco but suchan outcome is specifically prohibited by the existing agreement between R&R andthe Company. Following discussions with both the Takeover Panel and R&R, the Panel hasindicated, subject to final approval, that it is prepared to waive the 30 percent rule, if the independent shareholders approve such a waiver at the AGM.This will allow the Company to continue the share buy-back programme, despitethe fact that the R&R shareholding will increase above 30 per cent. The existingagreement restricting R&R's voting rights to 25 per cent will remain in place. R&R have given their consent to this proposal and in return have asked BritishAmerican Tobacco to obtain a secondary listing for its ordinary shares on theJohannesburg Stock Exchange, if and when requested by them. British AmericanTobacco has agreed to this. The proposal will be put to the Annual GeneralMeeting on 26 April for approval and the Board recommends the independentshareholders to vote in favour. The Board does not anticipate that it would continue the buy-back once R & R'sinterest had reached 35 per cent of the issued share capital of the Company. Atthe current share price, and at the proposed buy-back levels, this threshold isunlikely to be reached in the next seven years. While the increased level of the share buy-back programme will create value forshareholders, it continues to preserve financial flexibility because it can besuspended in the event of an opportunity to make a significant acquisition thatis both financially and strategically attractive in the longer term. Rupert Pennant-Rea will retire from the Board at the end of the Annual GeneralMeeting. I would like to thank him for the significant contribution he has madeover the last 11 years, not only as a Director but also as Chairman of the AuditCommittee. 2006 has been a good year and I believe we can look ahead with confidence in ourability to achieve further growth and value for shareholders. Over the past fiveyears, British American Tobacco has delivered an average annual totalshareholder return of 26 per cent, compared to 7 per cent for the FTSE 100. Jan du Plessis 1 March 2007 Page 3 BUSINESS REVIEW The reported Group profit from operations was 8 per cent higher at£2,622 million or, as explained on page 22, 7 per cent higher on a like-for-likebasis, with Asia-Pacific, Latin America and the Africa and Middle East regionscontributing to this good result. Group volumes from subsidiaries increased by 2 per cent to 689 billion on both areported and like-for-like basis. The reported Group revenue rose by 5 per centto £9,762 million and also increased by 5 per cent on a like-for-like basis.This excellent volume and revenue growth was achieved across a broad spread ofmarkets. The four Global Drive Brands continued their impressive performance and achievedoverall volume growth of 17 per cent. Kent volume grew by 16 per cent with significant increases in Russia, Romania,Ukraine and Chile, and share growth was also achieved in its major market,Japan. Dunhill rose by 6 per cent, driven by strong performances in South Korea,Taiwan, Australia, South Africa and the Middle East, although it was lower inMalaysia due to a reduced total market. Lucky Strike volumes rose marginally as the growth in Spain, France, Italy andIndonesia was largely offset by declines as a result of lower industry volumesin Germany and Japan. Pall Mall continued its exceptional growth and achieved anincrease of 40 per cent, driven by Spain, Greece, Poland, Russia and Bangladesh. In Europe, profit at £781 million was slightly lower mainly as a result of verycompetitive trading conditions in a number of markets and the inclusion in thecomparative period of a one-off benefit in Italy, resulting from the change interms of trade following the sale of Etinera. Excluding this benefit, profitincreased by £9 million, with strong growth from Russia, Hungary, Italy andFrance, largely offset by declines in Spain, Poland, Germany, Netherlands andUkraine. Regional volumes on a like-for-like basis were 2 per cent higher at 248billion, with growth in Russia, France, Spain and Hungary partly offset bydeclines in Ukraine, Italy and Germany. In Italy, profit grew strongly driven by improved margins after industry priceincreases and a successful productivity programme which has considerably reducedthe overall cost base. The growth in global drive brands was more than offset bythe decline in domestic brands. Profit in Germany was slightly down due to excise driven volume declines in theoverall market and down-trading to lower price and margin products after the endof Stix production. These factors were partly offset by cost reductions and thegood cigarette market share growth of Pall Mall and Lucky Strike, which led to ahigher overall cigarette market share. Profit in France grew strongly, benefiting from higher volumes, an improvedproduct mix and lower costs. In Switzerland, profit was higher due to theinclusion of the vending machine business acquired last year and despite pricecompetition. The continued growth of Parisienne volume and share was offset bythe decline in other brands, resulting in overall volumes the same as last yearand market share lower. In the Netherlands, profit was lower due to higher excise levels and an adverseproduct mix, partly offset by cost savings, while cigarette market shareincreased. Profit in Belgium was affected by intense price competition in theother tobacco segments, although overall cigarette market share increased asPall Mall and Winfield performed well. In Spain, despite strong growth involumes and a much higher share, the results were adversely affected by thesignificantly reduced market profitability resulting from intense pricecompetition. Page 4 Business review cont... The impressive performance in Russia continued through strong volume and profitincreases, with an improved product mix and lower production costs. A higheroverall market share resulted from significantly increased volumes of Kent andVogue, supported by good Pall Mall growth. In Romania, the Group continued togrow volumes and profit, consolidating its leadership position in a reducedmarket, affected by substantial excise increases. Volume performance was drivenby its premium brands, particularly Kent, which is now the largest sellingbrand, as well as Dunhill and Vogue. In Ukraine, profitability was adversely affected by the considerable decline involumes. However, Kent, Lucky Strike and Pall Mall grew market share. Profitgrew significantly in Hungary, benefiting from the recovery of the legal marketafter improved border controls, efficiency programmes and the strong volumegrowth from Viceroy and Pall Mall. In Poland, industry profitability wasseverely affected by increased excise rates and aggressive price competition.Volumes were down although Pall Mall and Vogue grew both share and volume. In Asia-Pacific, regional profit rose by £85 million to £616 million, mainlyattributable to good performances in Australasia, Malaysia, South Korea andPakistan. Volumes at 142 billion were 4 per cent higher as strong increases inPakistan, Bangladesh, South Korea and Vietnam were partially offset by declinesin Malaysia and Indonesia. Profit grew strongly in Australia, as a result of improved margins from acombination of product cost reductions, price increases and a substantialreduction in overheads. Good performances from Winfield and Dunhill, and thelaunch of Pall Mall, contributed to a higher overall market share in a reducedtotal market. New Zealand also showed strong profit growth in local currency asmargins increased but this was eroded by the weakening of the currency. Volumeswere in line with last year despite the growth of Dunhill and Pall Mall andmarket share was slightly down. In Malaysia, profit increased strongly due to productivity initiatives andhigher margins, as well as the absence of one-off costs which reduced profit in2005. Dunhill and Pall Mall grew market share but total volume declined due toreduced industry volumes as a result of the growth of illicit trade and theimpact of significant excise increases in the past two years. In Vietnam,volumes increased despite the higher prevalence of illicit brands. Pall Mallgrew strongly following its launch in the middle of the year and Craven 'A'continued its growth. However, profit was lower as a result of increasedmarketing investment. In South Korea, impressive profit growth was achieved from higher volumes andstrong market share gains by Dunhill and Vogue, helped by supply chain costreductions. Industry volumes increased, reflecting volume distortions last yearas a result of the excise increases at the end of 2004. Volumes and market sharegrew in Taiwan, but profit was adversely impacted by higher marketing investmentand down-trading after manufacturers' price increases. In Pakistan, market leadership was strengthened with excellent performances byGold Flake and Capstan, resulting in a strong market share increase. Profit wasup significantly with strong volume growth and higher margins. In Bangladesh,volumes and market share were higher while profit significantly increased, withimproved margins after industry wide price increases. In Sri Lanka, good profitgrowth was achieved with higher margins and an improved product mix. Profit in Latin America increased by £81 million to £611 million due to goodperformances across the region, coupled with a stronger average exchange rate inBrazil. Volumes grew in many of the markets which led to an overall increase of2 per cent to 153 billion. In Brazil, volume and market share increased, benefiting from marketinginitiatives and continuing anti-illicit trade operations by the government.Profit increased substantially as a result of higher volumes, improved marginsand the appreciation of the local currency. Page 5 Business review cont... The strong profit growth in Mexico was driven by higher margins, efficiencyprogrammes and synergy benefits from the contract manufacturing agreement withCanada. Volumes were slightly down as the growth in international brands,notably Pall Mall, was more than offset by the decline of local low-pricebrands. In Argentina, strong volume growth was achieved through an excellentperformance by Viceroy and a reduction in illicit competition. However, profitwas lower due to severe price competition. In Chile, profit grew strongly as volumes and prices increased, the product miximproved and the currency strengthened. The Global Drive Brands, Kent, LuckyStrike and Pall Mall, led the volume and share increases. In Venezuela, highermargins and increased volumes, led by Belmont and Consul, resulted in anexcellent increase in profit and market share. The Central America and Caribbeanarea showed a significant profit increase as a result of higher volumes andmargins, an improved product mix, supply chain savings and the benefits fromproductivity initiatives. Profit in the Africa and Middle East region grew by £34 million to £468 million,mainly driven by South Africa, Nigeria, the Middle East and Egypt. Volumes wereslightly higher at 103 billion, as a result of Nigeria, Egypt and the MiddleEast, partly offset by decreases in Turkey. In South Africa, despite the weaker average rand exchange rate, good profitgrowth was achieved as a result of an improved product mix and higher margins.Peter Stuyvesant's volumes were in line with last year while both Rothmans andDunhill continued their strong growth, with Dunhill recording its highest eversales. However, reduced volumes for other brands resulted in a lower marketshare. In Nigeria, volumes and market share grew with strong performances byBenson & Hedges and Pall Mall. Improved margins and volumes resulted in a higherprofit. In the Middle East, volume and profit continued to grow with good results fromIran, Iraq, and the Arabian Gulf, partly offset by the Levant. Dunhill was themain driver for the good performances in the Middle East. Profit in Egyptbenefited significantly from higher volumes and a reduction in costs. In Turkey, industry price increases led to higher margins, which, together withlower production costs, ensured a continued reduction in underlying operatinglosses. However, the move to direct distribution in this market resulted inone-off costs which, together with lower volumes, adversely impactedprofitability. The profit from the America-Pacific region decreased by £12 million to£424 million, while volumes were down 3 per cent to 44 billion. The increase inprofit and volumes from Japan were more than offset by lower contributions fromCanada. Profit in Canada was down £39 million to £280 million, largely due to lowervolumes following the growth of illicit product and a shift to low-pricedbrands, as well as the costs incurred in the move to direct distribution. Thiswas partially offset by the impact of efficiency savings, with the transfer ofproduction to Mexico, and the stronger Canadian dollar. The premium segment nowrepresents 53 per cent of the total market compared with 57 per cent last year.Imperial Tobacco Canada's total cigarette market share was down 1 share point to53 per cent. In Japan, volume, market share and profit grew strongly despite the decline inthe total market. Market share growth accelerated during the second half of theyear with strong performances from Kent and Kool. Profit rose significantly dueto the increased volumes, the benefit of the manufacturers' price increase andthe absence of one-off costs, which more than offset the impact of exchange. Page 6 Business review cont... Unallocated costs, which are net corporate costs not directly attributable toindividual regions, were £7 million higher at £103 million, mainly as a resultof increased pension costs. The above regional profits were achieved before accounting for restructuringcosts and losses/gains on disposal of a business, brands and joint venture, asexplained on page 21. Results of associates The Group's share of the post-tax results of associates increased by £39 millionto £431 million. Excluding the exceptional items explained on page 23, theGroup's share of the post-tax results of associates increased by £38 million to£427 million. The contribution from Reynolds American, excluding brand impairment charges andthe benefit from the favourable resolution of certain tax matters in both years,as well as other exceptional charges in 2005, was £18 million higher at £285million. This was mainly due to improved pricing and cost reductions, partiallyoffset by lower volumes. As explained on page 23, Reynolds American acquiredConwood on 31 May 2006. Reynolds American reported that on a US GAAP pro-formabasis, as if it had been owned since the beginning of 2005, Conwood increasedmargins and profits for the year to December 2006. The Group's associate in India, ITC, continued its strong growth, and, excludingthe one-off items in 2005, its contribution to Group profit rose by £11 millionto £91 million. Associates' volumes increased by 4 per cent to 241 billion, and with theinclusion of these, total Group volumes were 930 billion (2005: 910 billion). Page 7 CONTINUATION OF SHARE BUY-BACK PROGRAMME The Board believes that a share buy-back programme continues to be a highlyeffective way of maintaining an efficient capital structure and returningcapital to shareholders. For this reason, the Board is proposing to renew itsbuy-back authority for further purchases of up to 10 per cent of the Company'sordinary shares at the forthcoming Annual General Meeting (AGM). However, certain consequences will arise for the Company in the event that theshare buy-back programme continues as proposed. These are explained brieflybelow. Further information will be provided with the Notice of AGM, which willbe sent out later this month. Impact of Share Buy-Back on R & R Shareholding British American Tobacco's largest shareholder, R & R Holdings (which is theholding company for Richemont and Remgro's interests in the Company), holds 29.3per cent of the Company's issued share capital. Since the effect of continuingwith the share buy-back programme is to reduce the overall issued share capitalof the Company, R & R's interest in the Company will continue to grow, assumingit maintains its existing shareholding. As a result, if the Company continuesthe share buy-back programme at the enhanced level of £750 million per annum, itis possible that the interest of R & R will increase to over 30 per cent of theCompany before the 2008 AGM. Takeover Panel Waiver The Takeover Code normally requires any shareholder whose stake reaches orexceeds 30 per cent of a company's issued voting share capital to make a bid forthe remaining shares in the company. This requirement also applies toshareholders which have representatives on a company's board if their stakereaches such a level involuntarily as a result of a share buy-back programme.However, subject to final approval, the Takeover Panel has indicated that it isprepared to waive this requirement, if the independent shareholders approve sucha waiver at the AGM. R & R will not vote on this resolution. R & R Consent The Company has also discussed this matter with R & R, Richemont and Remgro. Inparticular, the Board has considered the terms of the Standstill Agreement whichwas entered into at the time of the merger with Rothmans International in 1999.This agreement expressly prohibits the Company from continuing its sharebuy-back programme, if it would increase R & R's shareholding to 30 per cent ormore without the consent of R & R and its shareholders. They have given theirconsent subject to the Takeover Panel waiver and in return have asked BritishAmerican Tobacco to obtain a secondary listing for its ordinary shares on theJohannesburg Stock Exchange if and when requested by them. British AmericanTobacco has agreed to this. R & R Voting The Standstill Agreement limits R & R's voting rights to 25 per cent,irrespective of their actual shareholding. No amendments are proposed to thisagreement and so this restriction would continue to apply even if R & R'sshareholding were to reach or exceed 30 per cent due to the Company'sbuy-back programme. Annual Shareholder and Panel Approval The Board currently envisages that it would seek further buy-back authorities atfuture AGMs, in order to allow a continuation of the programme. However, theBoard does not anticipate that it would continue the buy-back once R & R'sinterest had reached 35 per cent of the issued share capital of the Company. Atthe current share price, and at the currently proposed buy-back levels, thisthreshold is unlikely to be reached in the next seven years. Conclusion The Directors (other than R & R's two representatives, who have not participatedin the discussions) believe that continuing with the share buy-back programme,and therefore seeking the consent of R & R and its shareholders and the TakeoverPanel's waiver, is in the best interests of shareholders as a whole. Page 8 DIVIDENDS The Directors will be recommending to the shareholders at the Annual GeneralMeeting to be held on 26 April 2007, the payment on 3 May 2007 of a finaldividend for the year of 40.2p per ordinary share of 25p. Valid transfers received by the Registrar of the Company up to 9 March 2007 willbe in time to rank for payment of this dividend. Ordinary shares go ex-dividendon 7 March 2007. The following is a summary of the dividends declared for the years ended 31December 2006 and 2005. 2006 2005 pence per pence per share £m share £mOn ordinary shares:Interim 2006 paid 13 September 2006 15.7 323(see page 28) 2005 paid 14 September 2005 14.0 293Final 2006 payable 3 May 2007 40.2 821 2005 paid 4 May 2006 33.0 685 ------- ------- ------ ------- 55.9 1,144 47.0 978 ====== ======= ====== ======= In accordance with IFRS, the proposed final dividend amounting to £821 million(2005: £685 million), payable on 3 May 2007, will be recognised in the Groupaccounts for the year ending 31 December 2007. For the year ended 31 December2006, the accounts include the final dividend paid in respect of the year ended31 December 2005, amounting to £685 million and the interim dividend amountingto £323 million, paid on 13 September 2006. For the year ended 31 December 2005,the accounts include the final dividend paid in respect of the year ended 31December 2004, amounting to £617 million and the 2005 interim dividends,amounting to £293 million. Page 9 GROUP INCOME STATEMENT For the year ended 31 December 2006 2005 restated £m £m Gross turnover (including duty, excise and other taxes of £15,427 million(2005: £14,659 million)) 25,189 23,984 ======== ======== Revenue 9,762 9,325 Raw materials and consumables used (2,861) (2,760)Changes in inventories of finished goods and work in progress (11) (2)Employee benefit costs (1,554) (1,557)Depreciation and amortisation costs (401) (383)Other operating income 181 179Other operating expenses (2,494) (2,382) -------- --------Profit from operations 2,622 2,420after (charging)/crediting: ------------------------- restructuring costs (216) (271)-(losses)/gains on disposal of a business, brands and joint venture 41 72 ------------------------ ------------------------Finance income 110 118Finance costs (399) (346) ------------------------Net finance costs (289) (228)Share of post-tax results of associates and joint venture 431 392after (charging)/crediting: ------------------------ restructuring costs (13)- US Federal tobacco buy-out (12)- brand impairments (13) (29)- exceptional tax credits and other impairments 17 57 ------------------------ -------- --------Profit before taxation 2,764 2,584Taxation on ordinary activities (716) (690) -------- --------Profit for the year 2,048 1,894 ======== ======== Attributable to:Shareholders' equity 1,896 1,767 ======== ======== Minority interests 152 127 ======== ======== Earnings per shareBasic 92.08p 84.34p ======== ======== Diluted 91.33p 83.66p ======== ======== See notes on pages 19 to 37. Page 10 GROUP STATEMENT OF CHANGES IN TOTAL EQUITY For the year ended 31 December 2006 2005 restated £m £m Differences on exchange (685) 425Cash flow hedges- net fair value gains 13 17- reclassified and reported in net profit (15) 38- reclassified as basis adjustments 3Available-for-sale investments- net fair value losses (2) (1)- reclassified and reported in net profit 1Net investment hedges- net fair value gains/(losses) 117 (52)Tax on items recognised directly in equity (12) (41) ------- -------Net (losses)/gains recognised directly in equity (584) 390Profit for the period page 10 2,048 1,894 ------ --------Total recognised income for the year 1,464 2,284 ------------------------ shareholders' equity 1,334 2,128- minority interests 130 156 -----------------------Employee share options- value of employee services 41 42- proceeds from shares issued 28 30Dividends - ordinary shares (1,008) (910) - to minority interests (137) (112)Purchase of own shares- held in Employee Share Ownership Trusts (77) (48)- share buy-back programme (500) (501)Acquisition of minority interests (13)Other movements 13 17 ------- ------- (189) 802Balance 1 January 6,877 6,117Change in accounting policy page 19 (42) ------- -------Balance 31 December 6,688 6,877 ======= ======= See notes on pages 19 to 37. Page 11 GROUP BALANCE SHEET At 31 December 2006 2005 restated £m £m AssetsNon-current assetsIntangible assets 7,476 7,987Property, plant and equipment 2,207 2,331Investments in associates and joint ventures 2,108 2,193Retirement benefit assets 29 35Deferred tax assets 273 290Trade and other receivables 192 197Available-for-sale investments 24 27Derivative financial instruments 76 87 -------- --------Total non-current assets 12,385 13,147 ======== ======== Current assetsInventories 2,056 2,274Income tax receivable 59 81Trade and other receivables 1,568 1,577Available-for-sale investments 128 96Derivative financial instruments 124 86Cash and cash equivalents 1,456 1,790 -------- --------Total current assets 5,391 5,904 ======== ======== -------- --------Total assets 17,776 19,051 ======== ======== See notes on pages 19 to 37. Page 12 GROUP BALANCE SHEET At 31 December 2006 2005 restatedEquity £m £m Capital and reservesShareholders' funds 6,461 6,630 --------------------------after deducting cost of own shares held in Employee Share Ownership Trusts (197) (182) --------------------------Minority interests 227 247 -------- --------Total equity 6,688 6,877 ======== ======== Liabilities Non-current liabilitiesBorrowings 5,568 5,058Retirement benefit liabilities 435 543Deferred tax liabilities 296 277Other provisions for liabilities and charges 161 261Trade and other payables 146 180Derivative financial instruments 29 19 -------- --------Total non-current liabilities 6,635 6,338 ======== ======== Current liabilitiesBorrowings 1,058 2,202Income tax payable 292 374Other provisions for liabilities and charges 253 234Trade and other payables 2,766 2,883Derivative financial instruments 84 143 -------- --------Total current liabilities 4,453 5,836 ======== ======== Total equity and liabilities 17,776 19,051 ======== ======== See notes on pages 19 to 37. Page 13 GROUP CASH FLOW STATEMENT For the year ended 31 December 2006 2005 £m £m Cash generated from operations 2,816 2,893Dividends received from associates 259 193Tax paid (713) (762) -------- --------Net cash from operating activities 2,362 2,324 ======== ======== Interest and dividends received 121 110Purchases of property, plant and equipment (425) (381)Proceeds on disposal of property, plant and equipment 64 41Purchases and disposals of intangible assets 2 36Purchases and disposals of investments (37) 22Purchases and disposals of minorities and subsidiaries (39) (25)Purchases of associates (1) (95) -------- --------Net cash from investing activities (315) (292) ======== ======== Interest paid (389) (371)Finance lease rental payments (22) (45)Proceeds from issue of shares and exercise of options 28 30Proceeds from increases in and new borrowings 1,365 742Movements relating to derivative financial instruments 142 (33)Purchases of own shares (577) (549)Reductions in and repayments of borrowings (1,739) (878)Dividends paid (1,147) (1,043) -------- --------Net cash from financing activities (2,339) (2,147)Net cash flows from operating, investing and financing activities (292) (115)Differences on exchange (96) 49 -------- --------Decrease in net cash and cash equivalents in the year (388) (66)Net cash and cash equivalents at 1 January 1,664 1,730 -------- --------Net cash and cash equivalents at 31 December 1,276 1,664 ======== ======== See notes on pages 19 to 37. Page 14 SEGMENTAL ANALYSES OF VOLUME, REVENUE AND PROFIT For the year ended 31 December Volume 31.12.06 31.12.05 bns bns Europe 247.7 244.0Asia-Pacific 141.9 137.1Latin America 152.6 149.3Africa and Middle East 103.3 102.6America-Pacific 43.8 45.0 ---------- ----------- 689.3 678.0 =========== ========== Revenue 31.12.06 31.12.05 Inter Inter External segment Revenue External segment Revenue £m £m £m £m £m £m Europe 3,495 526 4,021 3,456 569 4,025Asia-Pacific 1,755 27 1,782 1,646 3 1,649Latin America 1,780 2 1,782 1,541 4 1,545Africa and Middle East 1,063 24 1,087 964 34 998America-Pacific 1,090 1,090 1,108 1,108 -------- -------- -------- ------- ------- --------Revenue 9,183 579 9,762 8,715 610 9,325 ======== ======== ======== ======= ======= ======== The segmental analysis of revenue is based on location of manufacture andfigures based on location of sales would be as follows: 31.12.06 31.12.05 £m £m Europe 3,545 3,497Asia-Pacific 1,839 1,758Latin America 1,791 1,555Africa and Middle East 1,489 1,405America-Pacific 1,098 1,110 ---------- ----------- 9,762 9,325 =========== ========== Page 15 Segmental analyses of volume, revenue and profit cont... Profit from operations 31.12.06 31.12.05 Adjusted Adjusted Segment segment Segment segment result result* result result* £m £m £m £m Europe 676 781 696 784Asia-Pacific 609 616 517 531Latin America 611 611 524 530Africa and Middle East 444 468 425 434America-Pacific 385 424 354 436 -------- -------- -------- ------- 2,725 2,900 2,516 2,715Unallocated costs (103) (103) (96) (96) -------- -------- -------- ------- 2,622 2,797 2,420 2,619 ======== ======== ======== ======= *Excluding restructuring costs, as well as losses/gains on disposal of a business, brands and joint venture as explained on page 21. The segmental analysis of the Group's share of the post-tax results ofassociates and joint ventures is as follows: 31.12.06 31.12.05 Adjusted Adjusted Segment segment Segment segment result result* result result* £m £m £m £m Europe 46 46 39 39Asia-Pacific 92 92 107 81Africa and Middle East 4 4 2 2America-Pacific 289 285 244 267 -------- -------- -------- ------- 431 427 392 389 ======== ======== ======== ======= *Excluding restructuring costs, US Federal tobacco buy-out, brand impairmentsand exceptional tax credits and other impairments as explained on page 23. Page 16 QUARTERLY ANALYSES OF PROFIT As explained on page 19, certain exchange differences are now required to bereflected in equity movements. The quarterly analyses for 2005 on page 18 havebeen restated to reflect these changes. As the adjusted diluted earnings pershare calculations already reflected these adjustments, no restatement of theseamounts was required. 3 months to Year to 31.3.06 30.6.06 30.9.06 31.12.06 31.12.06 £m £m £m £m £m Europe 168 212 214 187 781 Asia-Pacific 155 150 161 150 616 Latin America 155 148 144 164 611 Africa and Middle East 114 122 126 106 468 America-Pacific 93 132 107 92 424 -------- ------- ------- ------- ------- 685 764 752 699 2,900 Unallocated costs (33) (27) (17) (26) (103) -------- ------- ------- ------- ------- 652 737 735 673 2,797 Restructuring costs (21) (27) (116) (52) (216) -------- ------- ------- ------- -------(Losses)/gainson impairment of a business and disposalof brands (15) (1) 57 41 -------- ------- ------- ------- ------- Profit from operations 616 709 619 678 2,622 Net finance costs (68) (56) (85) (80) (289) -------- ------- -------- ------- -------Share of post-tax results of associates and joint ventures 120 123 105 83 431 -------- ------- -------- ------- ------- Profit before taxation 668 776 639 681 2,764 Taxation (178) (188) (152) (198) (716) -------- ------- -------- ------- -------Profit for the period 490 588 487 483 2,048 ======== ======= ======== ======= ======= Earnings per share - basic 21.81p 26.57p 21.73p 21.97p 92.08p ======== ======= ======== ======= ======= - adjusted diluted 22.05p 27.06p 25.89p 23.12p 98.12p ======== ======= ======== ======= ======= Page 17 Quarterly analyses of profit cont... 3 months to Year to -------------------------------------------------- ---------- 31.3.05 30.6.05 30.9.05 31.12.05 31.12.05 restated restated restated restated restated £m £m £m £m £m Europe 181 198 237 168 784 Asia-Pacific 126 133 159 113 531 Latin America 115 124 139 152 530 Africa and Middle East 97 103 108 126 434 America-Pacific 88 118 121 109 436 -------- ------- -------- -------- -------- 607 676 764 668 2,715 Unallocated costs (25) (31) (16) (24) (96) -------- ------- -------- -------- -------- 582 645 748 644 2,619 Restructuring costs (42) (100) (129) (271) Gains on disposal of brands and joint venture 68 4 72 -------- ------- -------- -------- -------- Profit from operations 582 671 648 519 2,420 Net finance costs (46) (57) (59) (66) (228) -------- ------- -------- -------- --------Share of post-tax results of associates and joint ventures 88 108 81 115 392 ------- ------- -------- -------- ------- Profit before taxation 624 722 670 568 2,584 Taxation (166) (187) (194) (143) (690) -------- ------- -------- -------- --------Profit for the period 458 535 476 425 1,894 ======== ======= ======== ======== ======== ======== ======= ======== ======== ========Earnings per share - basic 20.26p 23.88p 21.21p 18.99p 84.34p ======== ======= ======== ======== ========-adjusted diluted 19.26p 21.59p 25.79p 22.70p 89.34p ======== ======= ======== ======== ======== Page 18 ACCOUNTING POLICIES AND BASIS OF PREPARATION The financial information has been extracted from the audited financialstatements for the year ended 31 December 2006. From 1 January 2005, the Group has prepared its annual consolidated financialstatements in accordance with International Financial Reporting Standards (IFRS)as adopted by the European Union and implemented in the UK. The Group's financial statements for the year ended 31 December 2006 have beenprepared under the historical cost convention, except in respect of certainfinancial instruments. IAS32 and IAS39 on financial instruments were applied from 1 January 2005 andthe changes as at 1 January 2005 principally reflect: (a) The measurement of available-for-sale investments at fair value. (b) The reclassification of interest accruals to form part of the carrying valueof the related asset or liability. (c) The measurement of all derivative financial instruments at fair value. (d) Derecognition of deferred losses on derivatives. This resulted in a reduction in total equity of £42 million as at 1 January 2005,which is shown as the impact of the change in accounting policy on page 11. In December 2005, the International Accounting Standards Board issued anamendment to IAS21 on foreign exchange rates. The amendment to IAS21 allowedinter company balances that form part of a reporting entity's net investment ina foreign operation to be denominated in a currency other than the functionalcurrency of either the ultimate parent or the foreign operation itself. Thismeans that certain exchange differences previously taken to the income statementare instead reflected directly in changes in total equity. However, as thisamendment was only adopted by the EU in 2006, the interim report to 30 June 2006contained the first published results to reflect this change. The previouslypublished results have been restated accordingly, which has resulted in anincrease in net finance costs of £4 million for the year ended 31 December 2005.The quarterly results on page 18 have also been restated as follows: 3 months to 31.3.05 30.6.05 30.9.05 31.12.05 £m £m £m £mIncrease/(decrease) innet finance costs 2 2 1 (1) While this amendment was not applicable for Group reporting until it wasendorsed by the European Union, as this was expected in 2006, it was allowed forin the adjusted earnings per share calculations in the published results for theyear ended 31 December 2005. The International Accounting Standards Board has issued IFRIC Interpretation 4,which is applicable for annual reporting periods beginning on or after 1 January2006. This interpretation is to determine whether an arrangement, which is notin the legal form of a lease, is in substance a lease and should be accountedfor in accordance with IAS17 (Leases). This has resulted in the recognition ofcertain arrangements as leases. The previously published balance sheet for 2005has been restated in respect of finance leases to increase property, plant andequipment by £4 million and borrowings by a similar amount. Page 19 FOREIGN CURRENCIES The results of overseas subsidiaries and associates have been translated tosterling as follows: The income and cash flow statements have been translated at the average ratesfor the respective periods. Assets and liabilities have been translated at therelevant period end rates. For high inflation countries, the local currencyresults are adjusted for the impact of inflation prior to translation tosterling at closing exchange rates. The principal exchange rates used were as follows: Average Closing ------------------- ------------------ 2006 2005 2006 2005 US dollar 1.844 1.819 1.957 1.717Canadian dollar 2.091 2.206 2.278 2.005Euro 1.467 1.463 1.484 1.455South African rand 12.520 11.574 13.799 10.889Brazilian real 4.009 4.421 4.179 4.019 The growth in reported revenue and profit from operations of 5 per cent and 8per cent respectively, was the same at both current and comparable rates ofexchange. CHANGES IN THE GROUP On 29 December 2004, the Group sold Etinera S.p.A., the distribution business ofthe Italian subsidiary. In 2005, following the sale of Etinera, volumes andprofits in Italy benefited by 2 billion and £12 million respectively from achange in the terms of trade with Etinera. On 4 October 2005, the Group announced that it had agreed the sale of its 55 percent stake in BAR Honda, held through BARH Ltd. (BARH), to Honda and the salewas completed on 20 December 2005. For the period 7 January 2005 to 20 December2005, BARH was equity accounted, reflecting shared control with Honda. On 21 October 2005, the Group announced the exercise of its pre-emption rightsover shares in Skandinavisk Tobakskompagni AS, its Danish associate, and thetransaction was completed on 12 December 2005. This increased the Group'sholding from 26.6 per cent to 32.3 per cent at a cost of £95 million, resultingin goodwill of £69 million. On 25 November 2005, the Group acquired Restomat AG, the largest operator ofcigarette vending machines in Switzerland, at a cost of £25 million, resultingin goodwill of £7 million. On 10 March 2006, the Group's Italian subsidiary signed an agreement to sell itscigar business, Toscano, to Maccaferri for euro 95 million. The sale was subjectto regulatory and governmental approval and was completed on 19 July 2006. From August 2006, the Group purchased minority interests in its subsidiary inChile for a cost of £91 million, raising the Group shareholding from 70.4 percent to 96.5 per cent. The goodwill arising on these transactions was £80million and the minority interests in Group equity were reduced by £11 million. Page 20 RESTRUCTURING COSTS In 2003, the Group commenced a detailed review of its manufacturing operationsand organisational structure, including the initiative to reduce overheads andindirect costs. The restructuring continued, with major announcements during2005 which covered the cessation of production in the UK, Ireland and Canada,with production to be transferred elsewhere. The profit from operations for theyear ended 31 December 2005 included a charge for restructurings of£271 million. Further restructurings continued in 2006 and on 22 September agreement wasreached on the closure of the plant at Zevenaar in the Netherlands. The plantwill close by the end of 2008, with the production being transferred to Bayreuthin Germany and Augustow in Poland. The total restructuring costs of £216 million for the year ended 31 December2006 principally comprise fixed asset impairment charges and staff costs, andare mainly in respect of costs for Zevenaar and further costs for the UK andCanadian restructurings. LOSSES/GAINS ON DISPOSAL OF A BUSINESS, BRANDS AND JOINT VENTURE In April 2005, the Group sold to Gallaher Group plc its Benson & Hedges and SilkCut trademarks in Malta and Cyprus, together with the Silk Cut trademark inLithuania, resulting in a gain on disposal of £68 million included in otheroperating income in the profit from operations. The transactions are inaccordance with contracts of 1993 and 1994 in which Gallaher agreed to acquirethese trademarks in European Union states and the accession of Malta, Cyprus andLithuania, necessitated the sale. The transactions in respect of BARH described on page 20, resulted in a gain of£5 million which was included in other operating income in the profit fromoperations in 2005. The sale of the Italian cigar business in 2006 described on page 20, resulted ina loss of £19 million, reflecting a £15 million impairment charge included indepreciation and amortisation costs in the profit from operations and £4 millionof other costs included in other operating expenses in the profit fromoperations. On 29 November 2006, the Group completed a trademark transfer agreement withPhilip Morris International. Under this arrangement the Group sold its MurattiAmbassador brand in certain markets, as well as the L&M and Chesterfieldtrademarks in Hong Kong and Macao, while acquiring the Benson & Hedges trademarkin certain African countries. These transactions resulted in a gain of £60million included in other operating income in the profit from operations. Page 21 LIKE-FOR-LIKE INFORMATION The table below shows like-for-like revenue and profit from operations afterexcluding restructuring costs, loss on impairment of a business and gains ondisposal of brands and a joint venture, as well as the change in terms of tradein Italy. On this basis, the revenue for the year to 31 December 2006 of£9,762 million would represent growth of 5 per cent and the profit fromoperations of £2,797 million would represent growth of 7 per cent. Revenue Profit from operations 2006 2005 2006 2005 £m £m £m £m As reported (page 10) 9,762 9,325 2,622 2,420Etinera - change in terms of trade (24) (12)Restructuring costs (page 10) 216 271Losses/(gains) on disposal of a business,brands and joint venture (page 10) (41) (72) ----- ----- ----- -----Like-for-like 9,762 9,301 2,797 2,607 ===== ===== ===== ===== NET FINANCE COSTS Net finance costs comprise: Year to 31.12.06 31.12.05 £m £m Finance costs (399) (346)Finance income 110 118 ------- -------- (289) (228) ======= ========Comprising:Interest payable (410) (373)Interest and dividend income 122 106Fair value changes - derivatives 212 (218)Exchange differences (213) 257 ------- ------- (1) 39 ------- -------- (289) (228) ======= ======== Net finance costs at £289 million were £61 million higher than last year,principally reflecting the impact of higher interest rates as well asderivatives. The £1 million loss (2005: £39 million gain) of fair value changes and exchangedifferences reflects a loss of £7 million (2005: £3 million gain) from the netimpact of exchange rate movements and a gain of £6 million (2005: £36 million)principally due to interest related changes in the fair value of derivatives. Page 22 Net finance costs cont... IFRS requires fair value changes for derivatives, which do not meet the testsfor hedge accounting under IAS39, to be included in the income statement. Inaddition, certain exchange differences are required to be included in the incomestatement under IFRS and, as they are subject to exchange rate movements in aperiod, they can be a volatile element of net finance costs. These amounts donot always reflect an economic gain or loss for the Group and, at the 2005 yearend the Group decided that, in calculating the adjusted earnings per share, itis appropriate to exclude certain amounts. The adjustments for the year to 31December 2006 are as follows: (a) £nil million (2005: £8 million gain) relating to derivatives for which hedgeaccounting was obtained during 2005. (b) £nil million (2005: £11 million gain) relating to exchange in net financecosts where there is a compensating exchange amount reflected in differences inexchange taken directly to changes in total equity. Excluding the above items, fair value changes and exchange differences are a netloss of £1 million compared to a net gain of £20 million in 2005. The Group's interest cover was distorted by the impact of the exceptional items,shown in the adjusted earnings per share calculations (page 25), on the profitbefore taxation. On an adjusted basis, interest cover based on profit beforeinterest payable over interest payable was 8.1x (2005: 8.8x) reflecting higherinterest costs. ASSOCIATES The share of post-tax results of associates and joint ventures was £431 million(2005: £392 million) after tax of £216 million (2005: £163 million). The shareof associates is after exceptional charges and credits: - In the year ended 31 December 2006, Reynolds American benefited from thefavourable resolution of tax matters of which the Group's share was £17 million(2005: £31 million). Reynolds American also modified the previously anticipatedlevel of support between certain brands and the projected net sales of certainbrands, resulting in a brand impairment charge of which the Group's shareamounted to £13 million (net of tax) (2005: £29 million). - In the year ended 31 December 2005, Reynolds American also incurredrestructuring costs and a one-off charge related to the stabilisation inventorypool losses associated with the US tobacco quota buy-out programme. The Group'sshare (net of tax) of these amounted to £13 million and £12 millionrespectively. - In the year to 31 December 2005, the contribution from ITC in India included abenefit of £26 million (net of tax), principally related to the write-back ofprovisions for taxes partly offset by the impairment of a non-currentinvestment. On 25 April 2006, Reynolds American announced an agreement to acquire Conwood,the second largest manufacturer of smokeless tobacco products in the US, forUS$3.5 billion, and the acquisition was completed on 31 May 2006. Theacquisition was funded principally with debt and the fair value of assetsacquired and liabilities assumed was US$4.1 billion and US$0.6 billionrespectively. Included in the assets were US$2.5 billion in respect of goodwilland US$1.4 billion in respect of brands. Page 23 TAXATION Year to 31.12.06 31.12.05 £m £m UK corporation tax 14 42Overseas tax 743 705Adjustment in respect of prior periods (62) (12) ---------- -----------Current tax 695 735Deferred tax 21 (45) ---------- ----------- 716 690 ========== ========== The tax rates in the income statement of 25.9 per cent in 2006 and 26.7 per centin 2005 are affected by the inclusion of the share of associates' post-taxprofit in the Group's pre-tax results. The underlying tax rate for subsidiariesreflected in the adjusted earnings per share below was 29.6 per cent in 2006 and31.4 per cent in 2005, and the decrease reflects the inclusion of a tax creditin Canada in respect of prior years and changes in the mix of profits. The UKcorporation tax charge of £14 million in 2006 is reduced to £nil million by anequal and opposite deferred tax credit of £14 million and will not result in thepayment of any UK tax. EARNINGS PER SHARE Basic earnings per share are based on the profit for the year attributable toordinary shareholders and the average number of ordinary shares in issue duringthe year (excluding shares held by the Group's Employee Share Ownership Trusts). For the calculation of the diluted earnings per share, the average number ofshares reflects the potential dilutive effect of employee share schemes. The earnings per share are based on: 31.12.06 31.12.05 Earnings Shares Earnings Shares £m m £m mBasic 1,896 2,059 1,767 2,095Diluted 1,896 2,076 1,767 2,112 Page 24 Earnings per share cont... The earnings have been distorted by exceptional items, together with certaindistortions to net finance costs under IFRS (see page 23), and to illustrate theimpact of these distortions, the adjusted diluted earnings per share are shownbelow: Diluted earnings per share Year to 31.12.06 31.12.05 restated pence pence Unadjusted earnings per share 91.33 83.66Effect of restructuring costs 8.09 10.13Effect of disposal of a business, brands and jointventure (1.11) (3.41)Effect of associates' restructuring costs, US Federaltobacco buy-out, brand impairments and exceptionaltax credits and other impairments (0.19) (0.14)Net finance costs adjustments (0.90) ------- --------Adjusted diluted earnings per share 98.12 89.34 ======= ======== Adjusted earnings per share are based on:- adjusted earnings (£m) 2,037 1,887- shares (m) 2,076 2,112 Similar types of adjustments would apply to basic earnings per share. For theyear to 31 December 2006, basic earnings per share on an adjusted basis would be98.93p (2005: 90.06p) compared to unadjusted amounts of 92.08p (2005: 84.34p). CASH FLOW a) The IFRS cash flow includes all transactions affecting cash and cashequivalents, including financing. The alternative cash flow below is presentedto illustrate the cash flows before transactions relating to borrowings. 2006 2005 £m £m Net cash from operating activities before restructuringcosts and taxation 3,295 3,229Restructuring costs (220) (143)Taxation (713) (762) ------- -------Net cash from operating activities (page 14) 2,362 2,324Net interest (263) (231)Net capital expenditure (419) (378)Dividends to minority interests (139) (133) ------- -------Free cash flow 1,541 1,582Dividends paid to shareholders (1,008) (910)Share buy-back (500) (501)Other net flows (5) (49) ------- -------Net cash flows 28 122 ======= ======= The Group's net cash flow from operating activities at £2,362 million was £38million higher. The growth in underlying operating performance was offset by thetiming of working capital movements. However, a £49 million fall in taxoutflows, reflecting the timing of payments, as well as £66 million higherdividends from associates, more than offset the higher restructuring flows. Page 25 Cash flow cont... After higher net interest flows and net capital expenditure, with similar levelsof dividends to minority interests, the free cash flow is £41 million lower thanin 2005 at £1,541 million. This inflow exceeds the total cash outlay ondividends to shareholders and share buy-back by £33 million. The other net flows in 2006 principally reflect the purchase of minorityinterests in Chile and shares for the Group's share based compensation plans,largely offset by the sale of Toscana in Italy and the disposal of brands. Theother net flows in 2005 mainly arise from the acquisition of further shares inthe Group's Danish associate and the acquisition of Restomat AG in Switzerland,partly offset by the proceeds of the brand sale to Gallaher. The above flows resulted in net cash inflows of £28 million compared to £122million in 2005. After taking account of transactions related to borrowings,especially the net repayment of borrowings, the above flows resulted in a netdecrease of cash and cash equivalents of £292 million compared to a net decreaseof £115 million in 2005, as shown in the IFRS cash flow on page 14. These cash flows, after an adverse exchange impact of £96 million, resulted incash and cash equivalents, net of overdrafts, decreasing by £388 million in 2006(2005: £66 million). Borrowings, excluding overdrafts but taking into account derivatives relating toborrowings, were £6,401 million compared to £7,117 million as at 31 December2005. The decrease in this figure principally reflected the net repayment ofborrowings and the impact of exchange movements. Current available-for-sale investments at 31 December 2006 were £128 million (31December 2005: £96 million). As a result of the above borrowings, net of cash, cash equivalents and currentavailable for sale investments, were £4,996 million (31 December 2005: £5,357million). b) Cash generated from operations (page 14) Year to Year to 31.12.06 31.12.05 restated £m £m Profit before taxation 2,764 2,584Share of post-tax results of associates and joint venture (431) (392)Net finance costs 289 228Gains on disposal of brands and joint venture (60) (72)Depreciation and impairment of property, plant and equipment 367 348Amortisation and impairment of intangible assets 34 35Decrease/(increase) in inventories 21 (28)(Increase) in trade and other receivables (105) (178)Increase in trade and other payables 57 326(Decrease) in net retirement benefit liabilities (69) (52)(Decrease)/increase in other provisions for liabilities and charges (68) 61Other 17 33 ------- ------- 2,816 2,893 ======= ======= Page 26 Cash flow cont... c) IFRS Investing and financing activities The investing and financing activities in the IFRS cash flows on page 14 includethe following items: Interest and dividends received include dividends received of £2 million (2005:£1 million). Purchases and disposals of intangible assets include £60 million and £74 millionof sales proceeds for the year to 31 December 2006 and 2005 respectively, mainlyfrom the brands sale explained on page 21. Purchases and disposals of investments (which comprise available-for-saleinvestments and loans and receivables) include an outflow in respect of currentinvestments of £41 million for the year to 31 December 2006 (31 December 2005:£7 million decrease) and £4 million sales proceeds from non-current investmentsfor the year to 31 December 2006 (31 December 2005: £15 million). Purchases and disposals of subsidiaries for the year ended 31 December 2006,principally reflect the cost of acquiring minority interests in the Group'sChilean subsidiary less the proceeds from the sale of Toscano in Italy.Purchases and disposals of subsidiaries for the year to 31 December 2005principally reflect the acquisition of Restomat. These transactions aredescribed on page 20. During the year to 31 December 2006, Euro 600 million Eurobonds with a maturityof 2014, £325 million Eurobonds with a maturity of 2016 and Euro 525 millionfloating rate notes with a maturity of 2010 were issued. The proceeds, togetherwith cash resources, were used to repay bonds including Euro 1 billion floatingrate notes, a DM1 billion Eurobond and a Euro 500 million Eurobond. During theyear to 31 December 2005, a US$400 million Eurobond, Euro 300 million floatingrate notes and a Deutschmark 500 million Eurobond were repaid and a Euro 750million Eurobond with a 2012 maturity was issued. The movement relating to derivative financial instruments is in respect ofderivatives taken out to hedge cash and cash equivalents and externalborrowings, derivatives taken out to hedge inter company loans and derivativestreated as net investment hedges. Derivatives taken out as cash flow hedges inrespect of financing activities are also included in the movement relating toderivative financial instruments, while other such derivatives in respect ofoperating and investing activities are reflected along with the underlyingtransactions. Purchases of own shares include the buy-back programme as described on page 36,together with purchases of shares held in employee share schemes of £77 millionin 2006 (2005: £48 million). Dividends paid for the year to 31 December 2006 include £1,008 million ofdividends to Group shareholders and £139 million to minority shareholders (2005:£910 million and £133 million respectively). d) Net cash and cash equivalents in the cash flow statement comprise: 31.12.06 31.12.05 £m £m Cash and cash equivalents per balance sheet 1,456 1,790Accrued interest (1)Overdrafts (179) (126) ------ ----- 1,276 1,664 ====== ===== Page 27 TOTAL EQUITY 31.12.06 31.12.05 restated £m £m Share capital 517 524Share premium account 48 43Capital redemption reserves 90 83Merger reserves 3,748 3,748Translation reserve (177) 383Hedging reserve 10 10Available-for-sale reserve 13 15Other reserves 573 573Retained earnings 1,639 1,251-----------------------------------------------------------------------------------------after deducting: cost of own shares held in Employee Share Ownership Trusts (197) (182)----------------------------------------------------------------------------------------- --------- -------- Total shareholders' funds 6,461 6,630Minority interests 227 247 --------- --------- 6,688 6,877 ======== ======= Total equity was £189 million lower at £6,688 million. The profit retained afterpayment of dividends exceeded the impact of the share buy-back by £388 million.However, this was more than offset by a £580 million adverse impact fromexchange movements reflecting the general strength of sterling. For the first time, the Company needed to file interim accounts which wereprepared to recognise additional dividend income during 2006. As a result of theCompany not doing so, the interim dividend of £323 million paid on 13 September2006 did not comply with the technical requirements of the Companies Act 1985.It is proposed that the appropriation of distributable profits to the payment ofthe interim dividend will be ratified by shareholders by way of a specialresolution at the Annual General Meeting. Accordingly the payment has been shownas a dividend payment on pages 9 and 11. Between 22 September 2006 and 4 December 2006, the Company sought to repurchase6,927,790 shares for an aggregate consideration of £100 million, which areincluded in the purchase of own shares on page 11. However, as a result of thetechnical infringement of the Companies Act 1985, the repurchase andcancellation of these shares was invalid and accordingly their nominal value isincluded within the Company's share capital as at 31 December 2006 shown above.These shares will be repurchased on 1 March 2007 from their present holders, theCompany's brokers, at the same prices agreed between 22 September 2006 and 4December 2006. CONTINGENT LIABILITIES There are contingent liabilities in respect of litigation, overseas taxes andguarantees in various countries. Product liability litigation Group companies, notably Brown & Williamson Holdings, Inc. (formerly Brown &Williamson Tobacco Corporation) (B&W), as well as other leading cigarettemanufacturers, are defendants, principally in the US, in a number of productliability cases. In a number of these cases, the amounts of compensatory andpunitive damages sought are significant. Page 28 Contingent liabilities cont... Indemnity On 30 July 2004, B&W completed transactions combining its US tobacco businessassets, liabilities and operations with R.J. Reynolds Tobacco Company. A newcompany called R.J. Reynolds Tobacco Company (RJRT) was created as a result ofthe combination transactions. These transactions (the Business Combination) wereaccomplished through a publicly traded holding company Reynolds American Inc.(RAI), which is the indirect parent corporation of RJRT. As a result of theBusiness Combination: (a) B&W discontinued the active conduct of any tobaccobusiness in the US; (b) B&W contributed to RJRT all of its assets other than thecapital stock of certain subsidiaries engaged in non-US businesses and otherlimited categories of assets; (c) RJRT assumed all liabilities of B&W (exceptliabilities to the extent relating to businesses and assets not contributed by B&W to RJRT and other limited categories of liabilities) and contributedsubsidiaries or otherwise to the extent related to B&W's tobacco business asconducted in the US on or prior to 30 July 2004; and, (d) RJRT agreed toindemnify B&W and each of its affiliates (other than RAI and its subsidiaries)against, among other matters, all losses, liabilities, damages, expenses,judgments, attorneys' fees, etc, to the extent relating to or arising from suchassumed liabilities or the assets contributed by B&W to RJRT (the RJRTIndemnification). The scope of the RJRT Indemnification includes all expensesand contingent liabilities in connection with litigation to the extent relatingto or arising from B&W's US tobacco business as conducted on or prior to 30 July2004, including smoking and health tobacco litigation, whether the litigation iscommenced before or after 30 July 2004 (the tobacco litigation). Pursuant to the terms of the RJRT Indemnification, RJRT is liable for anypossible judgments, the posting of appeal bonds or security, and all otherexpenses of and responsibility for managing the defence of the tobaccolitigation. RJRT has assumed control of the defence of the tobacco litigationinvolving B&W and RJRT is also a party in most (but not all) of the same cases.Accordingly, RJRT uses or plans to use the same law firm or firms to representboth B&W and RJRT in any single or similar case (except in certain limitedcircumstances) as RJRT's interests are typically aligned with B&W's interests,and RJRT has substantial experience in managing recognised external legalcounsel in defending tobacco litigation, and external counsel have independentprofessional responsibilities to represent the interests of B&W. In addition, inaccordance with the terms of the RJRT Indemnification, affiliates of B&W haveretained control of the defence in certain tobacco litigation cases with respectto which such affiliates are entitled to indemnification. In addition to US litigation involving Group companies which is covered by theRJRT Indemnification, RAI group companies are named in litigation which does notinvolve Group companies. While it is impossible to be certain of the outcome ofany particular case or of the amount of any possible adverse verdict, it is notimpossible that the results of operations or cash flows of RAI in particularquarterly or annual periods could be materially affected by this and by thefinal outcome of any particular litigation. However, having regard to thecontingent liability disclosures on litigation made by RAI in its publicfinancial reports, the Directors are satisfied with the carrying value for RAIas stated in the consolidated audited annual accounts of the Group for thefinancial year ended 31 December 2006. US litigation The total number of US product liability cases pending at 31 December 2006involving B&W and other Group companies was approximately 3,492 (2005: 3,810).At 31 December 2006 UK-based Group companies have been named as co-defendants insome seven of those cases (2005: 965). The reduction in this figure is primarilyin consequence of the dismissal of B.A.T Industries p.l.c. as defendant in theWest Virginia consolidated smoking and health cases (see below under "UK-based Page 29 Contingent liabilities cont... Group companies"). Only one case against B&W was tried in 2006 (VanDenBurg),which resulted in a defence verdict. No US cases involving the UK-based Groupcompanies were tried in 2006. Only perhaps five cases are likely to come totrial in 2007, some involving amounts ranging possibly into the hundreds ofmillions and even billions of dollars. Since many of these pending cases seekunspecified damages, it is not possible to quantify the total amounts beingclaimed, but the aggregate amounts involved in such litigation are significant.The cases fall into four broad categories: (a) Medical reimbursement cases These civil actions seek to recover amounts spent by government entities andother third party providers on healthcare and welfare costs claimed to resultfrom illnesses associated with smoking. Although B&W continues to be a defendantin healthcare cost recovery cases involving plaintiffs such as hospitals, NativeAmerican tribes, and foreign governments, the vast majority of such cases havebeen dismissed on legal grounds. At 31 December 2006, one reimbursement suit was pending against B&W by an Indiantribe, and no suits were pending against B&W by county or other politicalsubdivisions of the states. The Master Settlement Agreement (MSA) with the 46states includes a credit for any amounts paid in suits brought by the states'political subdivisions; nevertheless, RJRT intends to defend and is defendingthese cases vigorously. Based on somewhat different theories of claim are twonon-governmental medical reimbursement cases and health insurers' claims. Onethird party reimbursement case (City of St. Louis), consists of more than 60public and non-profit hospitals in Missouri seeking reimbursement of past andfuture alleged smoking related healthcare costs. No trial date is currently setfor this case. At 31 December 2006, B&W was named as a defendant in two (2005: two) casesbrought by foreign government entities in a single US court (Republic of Panamaand State of Sao Paolo) seeking reimbursement of medical costs which theyincurred for treatment for persons in their own countries who are alleged tohave smoked imported cigarettes, including those manufactured by B&W. These twocases, originally filed in state court in Louisiana, were consolidated and thendismissed by the trial court on the basis that Louisiana was the inappropriateforum. These plaintiffs filed new cases in the Superior Court for the State ofDelaware on 19 July 2005. On 13 July 2006, the Delaware Superior Court granteddefendants' motion to dismiss. Plaintiffs filed notices of appeal to the SupremeCourt of Delaware on 19 July 2006. Oral argument on plaintiffs' appeal was heardon 6 December 2006 by the Supreme Court of Delaware, which reserved decision. (b) Class actions At 31 December 2006, B&W was named as a defendant in some 15 (2005: 15) separateactions attempting to assert claims on behalf of classes of persons allegedlyinjured or financially impacted through smoking or where classes of tobaccoclaimants have been certified. Even if the classes remain certified and thepossibility of class-based liability is eventually established, it is likelythat individual trials will still be necessary to resolve any actual claims.Class-action suits have been filed in a number of states against individualcigarette manufacturers and their parent corporations, alleging that the use ofthe terms 'lights' and 'ultralights' constitutes unfair and deceptive tradepractices. A class action complaint (Schwab) was filed in the US District Courtfor the Eastern District of New York on 11 May 2004 against B&W and certainUK-based Group companies. The complaint challenges the practices of defendantswith respect to the marketing, advertising, promotion and sale of 'light'cigarettes. The court granted plaintiffs' motion for class certification on 25September 2006. By order dated 17 November 2006, the Second Circuit Court ofAppeals granted defendants' motion to stay the district court proceedings inthis case, and further granted defendants' petition for leave to appeal thedistrict court's class certification order. Other types of class-action suitsassert claims on behalf of classes of individuals who claim to be addicted,injured, or at greater risk of injury by the use of tobacco or exposure toenvironmental tobacco smoke, or the legal survivors of such persons. Page 30 Contingent liabilities cont... In Engle (Florida), one jury awarded a total of US$12.7 million to three classrepresentatives, and in a later stage of this three phase trial process, a juryassessed US$17.6 billion in punitive damages against B&W. In November 2000, B&Wposted a surety bond in the amount of US$100 million (the amount required byFlorida law) to stay execution of this punitive damages award. On 21 May 2003,the intermediate appellate court reversed the trial court's judgment andremanded the case to the trial court with instructions to decertify the class.On 16 July 2003, plaintiffs filed a motion for rehearing which was denied on 22September 2003. On 12 May 2004, the Florida Supreme Court agreed to review thiscase and, on 6 July 2006, it upheld the intermediate appellate court's decisionto decertify the class, and vacated the jury's punitive damages award. Further,the Florida Supreme Court permitted the judgments entered for two of the threeEngle class representatives to stand, but dismissed the judgment entered infavour of the third Engle class representative. Finally, the Court has permittedputative Engle class members to file individual lawsuits against the Engledefendants within one year of the Court's decision. The Court's order precludesdefendants from litigating certain issues of liability against the putativeEngle class members in these individual actions. On 7 August 2006, defendantsfiled a motion for rehearing before the Florida Supreme Court, which was grantedin part, and denied in part, on 21 December 2006. The Florida Supreme Court's 21December 2006 ruling did not amend any of the earlier decision's major holdings,which included decertifying the class, vacating the punitive damages judgment,and permitting individual members of the former class to file separate suits.Instead, the ruling addressed the claims on which the Engle jury's phase oneverdict will be applicable to the individual lawsuits that were permitted tostand. In the first 'phase three' trial of an individual Engle class member (Lukacs),the jury awarded the plaintiff US$37.5 million in compensatory damages (B&W'sshare: US$8.4 million). On 1 April 2003, the jury award was reduced to US$25.125million (B&W's share: US$5.65 million) but no final judgment will be entereduntil the Engle appeal is fully resolved. Therefore the time to appeal this casehas not yet begun to run. In a Louisiana medical monitoring case brought on behalf of Louisiana smokers(Scott), on 28 July 2003, the jury returned a verdict in favour of defendants onthe medical monitoring claim but made findings against defendants with respectto claims relating to fraud, conspiracy, marketing to minors and smokingcessation. On 21 May 2004, the jury returned a verdict in the amount of US$591million on the class's claim for a smoking cessation program. On 1 July 2004,the court upheld the jury's verdict and entered final judgment. On 29 September2004, defendants posted a US$50 million bond (legislation in Louisiana limitsthe amount of a bond to prevent execution upon such a judgment to US$50 millioncollectively for signatories to the MSA). RJRT posted US$25 million (i.e. theportions for RJRT and B&W) towards the bond. On 12 April 2006, the LouisianaFourth Circuit Court of Appeal heard argument on defendants' appeal. Theappellate court issued a decision on 7 February 2007 that affirmed classcertification and upheld the smoking cessation program for certain smokers whobegan smoking before 1988, but reduced the US$591 million jury award by US$312million and rejected any award of prejudgement interest. Defendants are in theprocess of seeking further review of this decision. A federal judge in New York certified a nation-wide punitive-damages-only class(Simon II) in September 2002. Defendants sought reconsideration of thecertification ruling, which was denied on 25 October 2002. On 14 February 2003,the US Court of Appeals for the Second Circuit granted defendants' petition toreview the class certification decision. Oral argument was heard on 20 November2003. On 6 May 2005, the Second Circuit Court of Appeals vacated the districtcourt's class certification order. The district court permitted plaintiffs tovoluntarily dismiss this action on 8 December 2005. The district court enteredits final judgment dismissing this case on 20 March 2006. Page 31 Contingent liabilities cont... (c) Individual cases Approximately 3,471 cases were pending against B&W at 31 December 2006 (2005:3,767) filed by or on behalf of individuals in which it is contended thatdiseases or deaths have been caused by cigarette smoking or by exposure toenvironmental tobacco smoke (ETS). Of these cases: (a) approximately 75% are ETScases brought by flight attendants who were members of a class action (Broin)that was settled on terms that allow compensatory but not punitive damagesclaims by class members; (b) approximately 20% of the individual cases against B&W are cases brought in consolidated proceedings in West Virginia; and (c) onlyabout 5% are cases filed by other individuals. Of the individual cases that went to trial or were decided or remained on appealduring 2006, several resulted in verdicts against B&W: In November 2003, a Missouri jury (Thompson) awarded US$210,000 damages againstB&W. A notice of appeal was filed on 8 March 2004. Oral argument before theMissouri Court of Appeals was heard on 3 November 2005. The Missouri Court ofAppeals affirmed the judgment on all points on 22 August 2006. B&W moved beforethe Missouri Court of Appeals to transfer this appeal to the Missouri SupremeCourt on 6 September 2006. B&W's motion was denied by the Missouri Court ofAppeals on 26 September 2006. On 10 October 2006, B&W filed an application withthe Missouri Supreme Court for transfer of this action to the Missouri SupremeCourt. The Missouri Supreme Court denied B&W's application on 19 December 2006. In December 2003, a New York jury (Frankson) awarded US$350,000 compensatorydamages against B&W and two industry organisations. In January 2004, the samejury awarded US$20 million punitive damages. On 22 June 2004, the trial judgegranted a new trial unless the parties agreed to an increase in compensatorydamages to US$500,000 and a decrease in punitive damages to US$5 million, ofwhich US$4 million would be assigned to B&W. Plaintiffs agreed to a decrease inpunitive damages, but B&W has not agreed to an increase in compensatory damages.On 25 January 2005, B&W appealed to an intermediate New York State appellatecourt. Oral argument was heard on 8 May 2006. The appellate court affirmed thejudgment on 5 July 2006. B&W filed a motion for leave to reargue, or in thealternative, for leave to appeal to the New York Court of Appeals, on 3 August2006. The intermediate appellate court denied this motion on 5 October 2006. On8 December 2006, the trial judge granted plaintiff's application for entry ofjudgment, and granted plaintiff's motion to vacate that part of the 2004 ordergranting a new trial unless the parties agreed to an increase in compensatorydamages to US$500,000. B&W intends to seek further appellate review of the trialcourt's judgment. On 1 February 2005, a Missouri jury (Smith) awarded US$500,000 in compensatorydamages against B&W and then, on 2 February 2005, awarded US$20 million inpunitive damages, also against B&W. On 1 June 2005, B&W filed its notice ofappeal. B&W filed its opening appellate brief on 28 April 2006. Oral argumentwas heard on 31 August 2006 and a decision is awaited. On 18 March 2005, a New York jury (Rose) awarded US$1.7 million in compensatorydamages against B&W. On 18 August 2005, B&W filed its notice of appeal. RJRTposted a bond in the approximate amount of US$2.058 million on 7 February 2006.Oral argument on this appeal was heard on 12 December 2006 by an intermediateNew York appellate court, which reserved decision. Page 32 Contingent liabilities cont... (d) Other claims The Flintkote Company (Flintkote), a US asbestos production and sales company,was included in the acquisition of Genstar Corporation by Imasco in 1986 andbecame a group subsidiary following the restructuring of Imasco Limited (nowImperial Tobacco Canada Limited (Imperial)) in 2000. Soon after thisacquisition, and as part of the acquisition plan, Genstar began to sell most ofits assets, including the non-asbestos related operations and subsidiaries ofFlintkote. The liquidation of Flintkote assets produced cash proceeds and,having obtained legal and financial advice that sufficient assets would remainto satisfy liabilities, Flintkote and Imasco authorized the payment of twodividends. In 2003, Imperial divested Flintkote and then, in 2004, Flintkotefiled for bankruptcy in the United States Bankruptcy Court for the District ofDelaware. In 2006, Flintkote, certain representatives of both the present andfuture asbestos claimants as well as certain individual asbestos claimants werepermitted by the bankruptcy court to file a complaint against Imperial andnumerous other defendants for the recovery of the dividends and othercompensation under various legal theories. The parties are presently engaged incase management discussions to establish the scope and manner of discovery inthis case. This litigation is expected to take several years to proceed totrial. At 31 December 2006, no cases (2005: 1) were pending against B&W on behalf ofasbestos companies. In these cases, certain asbestos companies soughtreimbursement for costs and judgments paid in litigation brought by thirdparties against them. These companies claimed that, but for the smoking of theclaimants, their damages would have been less. The final asbestos contributionclaim (Fibreboard) was voluntarily dismissed by plaintiffs on 28 July 2006. In Wisconsin, the authorities have identified potentially responsible parties tofund the clean up of the Fox River, Wisconsin. The pollution was caused bydischarges of toxic material from paper mills operating close to the river. Thecost of the clean up work is currently estimated to be in the order of US$600million. Among the potentially responsible parties are NCR Corporation andAppleton Papers Inc. who may be liable for a proportion of the clean up costs.B.A.T Industries p.l.c. purchased what was then NCR's Appleton Papers Divisionfrom NCR Corporation and spun off this business in 1990, obtaining fullindemnities from Appleton Papers Inc. for past and future environmental claims.Disputes between NCR Corporation and B.A.T Industries p.l.c. as to theindemnities given and received under the purchase agreement in 1978 have beenthe subject of arbitration in 1998 and 2006. Under the terms of the arbitrationawards, B.A.T Industries p.l.c. has an obligation to share the costs ofenvironmental claims with NCR Corporation, but has never been required to payany sums in this regard because Appleton Papers Inc. has paid any sums demanded.It is believed that all future environmental liabilities will continue to be metdirectly by Appleton Papers Inc. by self-funding or insurance cover and nodemand will be made upon B.A.T Industries p.l.c. by NCR Corporation. Settlement of state healthcare reimbursement cases During 2003, agreement was reached on certain disputed MSA payments relating toMSA calculations based on 1999 and 2000 sales. This agreement resulted in abenefit of £27 million which is excluded from the 2003 costs shown in theconsolidated audited annual accounts of the Company for the financial year ended31 December 2004. In other developments, after an Independent Auditor found thatthe terms of the MSA were a "significant factor" in market share lossesexperienced by signatories to the MSA in 2003, several US tobacco companies,including B&W, asserted their rights under the NPM (or Non-ParticipatingManufacturer) Adjustment provision of the MSA to recover a payment credit oroffset - against their April 2006 payment obligations - for MSA payments made inApril 2004 in respect of cigarettes shipped or sold in the US in 2003. Theamount at stake exceeds US$1 billion. The settling states oppose these MSApayment reduction claims and, in late April 2006, began filing motions in MSAcourts across the country seeking enforcement of certain MSA provisions and adeclaration of the parties' rights under the NPM Adjustment provision of theMSA. Defendants have opposed these motions, arguing that their NPM Adjustmentclaims must go instead to arbitration. To date, the overwhelming majority of MSAcourts to decide these motions have ruled in defendants' favour. Page 33 Contingent liabilities cont... UK-based Group companies At 31 December 2006, B.A.T Industries p.l.c. was a defendant in the US in oneclass action, the Schwab case mentioned previously. In that case, B.A.TIndustries p.l.c. was substituted for British American Tobacco p.l.c. as adefendant. In the West Virginia consolidated smoking and health cases, the courtso-ordered the parties' stipulation and order dismissing B.A.T Industries p.l.c.from the action, with prejudice, on 12 December 2006. This is a significantdecision as B.A.T Industries p.l.c. was previously a defendant in around 1,000consolidated individual cases in West Virginia. British American Tobacco(Investments) Limited has been dismissed from those West Virginia consolidatedsmoking and health cases in which it was a defendant. British American Tobacco(Investments) Limited had been served in one reimbursement case (City of St.Louis), the Department of Justice case (see below), two class actions (Clearyand Schwab), and three individual actions. Conduct based claims On 22 September 1999, the US Department of Justice brought an action in the USDistrict Court for the District of Columbia against various industry members,including RJRT, B&W, B.A.T Industries p.l.c., and British American Tobacco(Investments) Limited. B.A.T Industries p.l.c. was dismissed for lack ofpersonal jurisdiction on 28 September 2000. The Government sought to recoverfederal funds expended in providing healthcare to smokers who have developeddiseases and injuries alleged to be smoking-related, and, in addition, sought,pursuant to the federal Racketeer Influenced and Corrupt Organizations Act(RICO), disgorgement of profits the Government contends were earned as aconsequence of a RICO 'enterprise.' On 28 September 2000, the portion of theclaim which sought recovery of federal funds expended in providing healthcare tosmokers who have developed diseases and injuries alleged to be smoking-relatedwas dismissed. The bench (non-jury) trial of the RICO portion of the claim beganon 21 September 2004, and ended on 9 June 2005. On 17 November 2004, theWashington DC Circuit Court of Appeals heard an appeal by defendants against anearlier District Court decision that disgorgement of profits is an appropriateremedy to the RICO violations alleged by the Government. On 4 February 2005, theCourt of Appeals allowed the appeal, ruling that the Government could not claimdisgorgement of profits. On 17 October 2005, the US Supreme Court declined tohear the appeal by the US Government in respect of the claim for disgorgement ofU.S.$280 billion of past profits from the US tobacco industry. The disgorgementclaim was a centrepiece of the Government's claim. On 17 August 2006, the district court issued its final judgment, consisting ofsome 1600 pages of factual findings and legal conclusions. The court found infavour of the Government, and against certain defendants, including B&W andBritish American Tobacco (Investments) Limited. The court also ordered a widearray of injunctive relief, including a ban on the use of "lights" and othersimilar descriptors with effect from 1 January 2007. Compliance with thecourt-ordered remedies may cost RJRT and British American Tobacco (Investments)Limited millions of dollars. In addition, the Government is seeking the recoveryof roughly US$1.9 million in litigation costs. Defendants filed a motion to stayenforcement of the judgment shortly after the judgment was issued. The courtdenied defendants' stay motion on 28 September 2006. Defendants, including B&Wand British American Tobacco (Investments) Limited, filed their notices ofappeal to the Washington DC Circuit Court of Appeals on 11 September 2006, andfiled an emergency motion to stay the judgment before the same court on 29September 2006. On 31 October 2006, the Court of Appeals granted defendants'motion to stay enforcement of the judgment pending the outcome of the appeal. Various departments of the Republic of Colombia brought actions against varioustobacco companies including B&W and other UK-based group companies alleging thatdefendants engaged in cigarette smuggling and money laundering in theirterritories. Each of these actions sought compensatory, punitive and trebledamages. Defendants' motion to dismiss the complaint was granted in 2002 andplaintiffs appealed. The US Court of Appeals for the Second Circuit affirmed thedismissals, and on 9 January 2006, the US Supreme Court denied plaintiffs'petition for a writ of certiorari. Page 34 Contingent liabilities cont... In the Daric Smith case, purchasers of cigarettes in the state of Kansas broughta class action in the Kansas state court against B&W, British American Tobacco(Investments) Limited and certain other tobacco companies seeking injunctiverelief, treble damages, interest and costs. The allegations are that thedefendants participated in a conspiracy to fix or maintain the price ofcigarettes sold in the US, including the state of Kansas, in violation of theKansas Restraint of Trade Act. The matter will be defended vigorously. Product liability outside the US At 31 December 2006, active claims against Group companies existed in 18 (2005:19) countries outside the US but the only countries with more than five activeclaims were Argentina, Brazil, Canada, Chile, Italy, and the Republic ofIreland. At 31 December 2006, there were some 1,142 (2005: 1,097) pending individualcases in Italy. Some 1,113 (2005: 1,077) of these cases are pending beforeJustice of the Peace courts, the majority of which relate to claims of allegedfraud in connection with 'light' cigarettes. Because of the type of courtinvolved, the most that any individual plaintiff can recover is 1,033 Euros. 678of these cases have been suspended or decisions given in favour of BritishAmerican Tobacco Italia S.p.A. There are around 27 smoking and health casespending before Italian Civil Courts filed by or on behalf of individuals inwhich it is contended that diseases or deaths have been caused by cigarettesmoking. There are also two labour cases for alleged occupational exposurepending in Italy. In Canada, the government of the Province of British Columbia brought a claimpursuant to the provisions of the Tobacco Damages and Health Care Costs RecoveryAct 2000 against domestic and foreign 'manufacturers' seeking to recover theplaintiff's costs of health care benefits. The constitutionality of the 2000 Actwas challenged by certain defendants and, on 5 June 2003, the British ColumbiaSupreme Court found the Act to be beyond the competence of the British Columbialegislature and, accordingly, dismissed the government's claim. The governmentappealed that decision to the British Columbia Court of Appeal which, on 20 May2004, overturned the lower court's decision and declared the Act to beconstitutionally valid. Defendants appealed to the Supreme Court of Canada inJune and that court gave its judgment in September 2005 dismissing the appealsand declaring the Act to be constitutionally valid. Non-Canadian defendants challenged the personal jurisdiction of the BritishColumbia Court and those motions were heard in the Supreme Court of BritishColumbia. On 23 June 2006, the court dismissed all defendants' motions, findingthat there is a "real and substantial connection" between British Columbia andthe foreign defendants. Subsequently, defendants were granted leave to appeal.The appeal was dismissed on 15 September 2006. Defendants filed leave to appealto the Supreme Court on 10 November 2006. Similar legislation has been enacted,but not yet brought into force, in some other Canadian provinces, and is alsobeing considered by other Canadian provinces. In addition, there are five class actions and four individual cases in Canada.In the Knight class action, the Supreme Court of British Columbia certified aclass of all consumers of cigarettes bearing "light" or "mild" descriptors since1974 manufactured in British Columbia by Imperial, the Group's operating companyin Canada. Imperial filed an appeal against the certification which was heard inFebruary 2006. The Appeal Court confirmed the certification of the class but haslimited any financial liability, if proved, to the period from 1997. This is a'lights' class action in which the plaintiff alleges that the marketing of lightand mild cigarettes is deceptive because it conveys a false and misleadingmessage that those cigarettes are less harmful than regular cigarettes. Althoughthe claim arises from health concerns, it does not seek compensation forpersonal injury. Instead it seeks compensation for amounts spent on "light andmild" products and a disgorgement of profits from Imperial. The motion of theFederal Government to strike out the third party notice issued against them byImperial was heard in February 2006 and a decision is awaited. A similar"lights" and "mild" class action claim has been filed in Newfoundland. Imperialhas filed a third party notice against the Federal Government. No hearing datehas been set. Page 35 Contingent liabilities cont... There are currently two class actions in Quebec. On 21 February 2005, the QuebecSuperior Court granted certification. The court certified two classes, whichinclude residents of Quebec who suffered from lung, throat and laryngeal canceror emphysema, and residents who were addicted to nicotine at the time theproceedings were filed and who have since remained addicted. There is no rightof appeal. Plaintiffs have served a Statement of Claim. This litigation isexpected to take several years to proceed to trial. The other class action is anattempt to establish a class claiming for personal injury or damage to propertyfrom fires caused by cigarettes that did not automatically extinguish on beingdropped or left unattended. Certification of such a class was denied in October2005. Plaintiffs have appealed. No hearing date has been set for the appeal. Other litigation outside the US In November 2004 the Royal Canadian Mounted Police (RCMP) obtained a warrant tosearch and seize business records and documents at the head office of Imperialin Montreal. The affidavit filed by the RCMP to obtain the search warrant madeallegations in relation to the smuggling of cigarettes in Canada between 1989and 1994, naming Imperial, British American Tobacco p.l.c., B.A.T. Industriesp.l.c., and certain former directors and employees. No charges have yet beenlaid. Imperial believes that it has conducted itself appropriately at all times,but cannot predict the outcome of any such investigation, or whether additionalinvestigations will occur. Two actions have been started in Russia by a minority shareholder in OJSCCompany British American Tobacco-Yava (BAT-Yava), a Russian incorporatedsubsidiary of British American Tobacco Holdings (Russia) B.V. The minorityshareholder, Branston Holdings, issued a claim in Moscow seeking to have acontract between BAT-Yava and its sister company invalidated, and issued anotherclaim in the Stavropol region alleging that certain of the directors ofBAT-Yava, and other parties, took various unlawful steps. The Moscow Court hasdismissed the claim and the Stavropol Court has ordered the transfer of the casefiled there to Moscow. An appeal of the dismissed Moscow case has been sent tothe Moscow Appellate Court. Branston has also threatened actions in theNetherlands and England but has not yet commenced these. The Company considersthese actions to be without merit and will defend the claims strenuously. Conclusion While it is impossible to be certain of the outcome of any particular case or ofthe amount of any possible adverse verdict, the Company believes that thedefences of the Group companies to all these various claims are meritorious bothon the law and the facts, and a vigorous defence is being made everywhere. If anadverse judgment is entered against any of the Group companies in any case, anappeal will be made. Such appeals could require the appellants to post appealbonds or substitute security in amounts which could in some cases equal orexceed the amount of the judgement. In any event, with regard to US litigation,the Group has the benefit of the RJRT Indemnification. At least in the aggregateand despite the quality of defences available to the Group, it is not impossiblethat the results of operations or cash flows of the Group in particularquarterly or annual periods could be materially affected by this and by thefinal outcome of any particular litigation. Having regard to all these matters, the Directors (i) do not consider itappropriate to make any provision in respect of any pending litigation and (ii)do not believe that the ultimate outcome of this litigation will significantlyimpair the financial condition of the Group. SHARE BUY-BACK PROGRAMME The Group initiated an on-market share buy-back programme at the end of February2003. By the close of business on 1 March, we expect that some 35 million shareswill have been bought back since 1 January 2006 at a cost of £500 million (seepage 28). During the year to 31 December 2005, 45 million shares were bought at a cost of£501 million. Page 36 ANNUAL REPORT AND ACCOUNTS The financial information in this preliminary announcement does not constitutestatutory accounts within the meaning of section 240 of the Companies Act (asamended). The figures contained herein have been extracted from the Group's full IFRSfinancial statements for the year ended 31 December 2006, which will bedelivered to the Registrar of Companies. The Group's full IFRS financialstatements for the year ended 31 December 2005 have been delivered to theRegistrar of Companies. The auditors' report on both these sets of financialstatements were unqualified and did not contain a statement under section 237(2)or section 237(3) of the Companies Act. The Annual General Meeting will be held on 26 April 2007, at the MermaidConference & Events Centre, Puddle Dock, Blackfriars, London EC4V 3DB. The Report and Accounts will be posted to shareholders in March 2007. ------------------------------------------------ Copies of this Report will be posted to shareholders and may also be obtainedduring normal business hours from the Company's Registered Office at GlobeHouse, 4 Temple Place, London WC2R 2PG. Nicola Snook Secretary 1 March 2007 Page 37 This information is provided by RNS The company news service from the London Stock Exchange