Preliminary Results

British American Tobacco PLC 01 March 2007 1 March 2007 PRELIMINARY ANNOUNCEMENT - YEAR ENDED 31 DECEMBER 2006 SUMMARY 2006 2005 Change Revenue - as reported Â£9,762m Â£9,325m +5% Profit from operations - as reported Â£2,622m Â£2,420m +8% - like-for-like Â£2,797m Â£2,607m +7% Adjusted diluted earnings per share 98.12p 89.34p +10% Dividends per share 55.90p 47.00p +19% â€¢ The reported Group profit from operations was 8 per cent higher at Â£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. â€¢ 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 Â£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. â€¢ 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). â€¢ 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 Â£500 million to some Â£750 million per year, starting in 2007. â€¢ 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: Ralph Edmondson/ 020 7845 1180 David Betteridge/Kate Matrunola 020 7845 2888 Rachael Brierley 020 7845 1519 Catherine Armstrong BRITISH AMERICAN TOBACCO p.l.c. PRELIMINARY ANNOUNCEMENT - YEAR ENDED 31 DECEMBER 2006 INDEX 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 in our underlying profit from operations and a 10 per cent increase in adjusted diluted earnings per share. The improvement in profit was driven by volume growth of 2 per cent and net revenue growth of 5 per cent. The impact of exchange rates for the year as a whole was not material, although it was significantly 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 a solid platform for a sustainable business. Our consistent and balanced approach to 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 per cent, 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 per cent. There were net exceptional charges of Â£175 million, reflecting the restructuring costs relating to the factory closure programme, partly offset by the gains on a disposal of brands. The annual savings from our supply chain programme in 2006 amounted to Â£148 million, bringing the total to Â£374 million per year since we started four years ago. We also saved a further Â£99 million from the overheads and indirects programme, bringing that total over the same four year period to Â£355 million on an annualised basis. The current overheads and indirects programme will be completed in 2007. However, we intend to maintain our focus on costs and will be announcing a further five year target, along with the final results from the first five years, in March 2008. We will also pursue additional supply chain savings over the same five year period. Our associate companies, grew their volume by 4 per cent to 241 billion and our share of their post-tax results amounted to Â£431 million. This represents a 10 per cent increase, if exceptional items are excluded, reflecting higher profits from Reynolds American and ITC. The contribution from Reynolds American was Â£285 million, with the early results from the acquisition of the Conwood smokeless tobacco business being distinctly encouraging. The improvement in profit from both subsidiaries and associates, together with a lower effective tax rate and the benefit of the share buy-back programme, more than 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 of our long term goal of achieving, on average, high single figure growth in earnings. By the close of business on 1 March, we expect that some 35 million shares will have been bought back since 1 January 2006 at a cost of Â£500 million and at an average price of Â£14.19 per share. Since 2003, when the buy-back programme started, around 246 million shares have been repurchased at a cost of Â£2,191 million, equivalent to an average price of Â£8.91 per share. We continue to view the purchase of our own shares as an excellent investment. 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. Page 2 Chairman's statement cont... The previous policy was to pay out at least 50 per cent of long-term sustainable earnings in dividends, with the payout ratio in 2005 being 53 per cent. The Board has decided to raise the payout ratio to 65 per cent by 2008 in progressive 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, an uplift of 19 per cent and raises the dividend payout ratio for 2006 to 57 per cent. 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 be approximately one-third of the total for 2006. In addition, the level of the share buy-back will rise from around Â£500 million to some Â£750 million per year, starting in 2007. The increase in the buy-back programme is likely to mean that, before the Annual General Meeting in 2008, the combined interest of Richemont and Remgro (R&R) will rise above 30 per cent. Not only is this the level at which, under normal circumstances, an offer would have to be made by R&R for the remaining shares in British American Tobacco but such an outcome is specifically prohibited by the existing agreement between R&R and the Company. Following discussions with both the Takeover Panel and R&R, the Panel has indicated, subject to final approval, that it is prepared to waive the 30 per cent rule, if the independent shareholders approve such a waiver at the AGM. This will allow the Company to continue the share buy-back programme, despite the fact that the R&R shareholding will increase above 30 per cent. The existing agreement 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 British American Tobacco to obtain a secondary listing for its ordinary shares on the Johannesburg Stock Exchange, if and when requested by them. British American Tobacco has agreed to this. The proposal will be put to the Annual General Meeting on 26 April for approval and the Board recommends the independent shareholders to vote in favour. The Board does not anticipate that it would continue the buy-back once R & R's interest had reached 35 per cent of the issued share capital of the Company. At the current share price, and at the proposed buy-back levels, this threshold is unlikely to be reached in the next seven years. While the increased level of the share buy-back programme will create value for shareholders, it continues to preserve financial flexibility because it can be suspended in the event of an opportunity to make a significant acquisition that is both financially and strategically attractive in the longer term. Rupert Pennant-Rea will retire from the Board at the end of the Annual General Meeting. I would like to thank him for the significant contribution he has made over the last 11 years, not only as a Director but also as Chairman of the Audit Committee. 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. Jan du Plessis 1 March 2007 Page 3 BUSINESS REVIEW The reported Group profit from operations was 8 per cent higher at Â£2,622 million or, as explained on page 22, 7 per cent higher on a like-for-like basis, with Asia-Pacific, Latin America and the Africa and Middle East regions 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 Â£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 of markets. The four Global Drive Brands continued their impressive performance and achieved overall 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 in Malaysia due to a reduced total market. Lucky Strike volumes rose marginally as the growth in Spain, France, Italy and Indonesia was largely offset by declines as a result of lower industry volumes in Germany and Japan. Pall Mall continued its exceptional growth and achieved an increase of 40 per cent, driven by Spain, Greece, Poland, Russia and Bangladesh. In Europe, profit at Â£781 million was slightly lower mainly as a result of very competitive trading conditions in a number of markets and the inclusion in the comparative period of a one-off benefit in Italy, resulting from the change in terms of trade following the sale of Etinera. Excluding this benefit, profit increased by Â£9 million, with strong growth from Russia, Hungary, Italy and France, largely offset by declines in Spain, Poland, Germany, Netherlands and Ukraine. Regional volumes on a like-for-like basis were 2 per cent higher at 248 billion, with growth in Russia, France, Spain and Hungary partly offset by declines in Ukraine, Italy and Germany. In Italy, profit grew strongly driven by improved margins after industry price increases and a successful productivity programme which has considerably reduced the overall cost base. The growth in global drive brands was more than offset by the decline in domestic brands. Profit in Germany was slightly down due to excise driven volume declines in the overall market and down-trading to lower price and margin products after the end of Stix production. These factors were partly offset by cost reductions and the good cigarette market share growth of Pall Mall and Lucky Strike, which led to a higher overall cigarette market share. Profit in France grew strongly, benefiting from higher volumes, an improved product mix and lower costs. In Switzerland, profit was higher due to the inclusion of the vending machine business acquired last year and despite price competition. The continued growth of Parisienne volume and share was offset by the decline in other brands, resulting in overall volumes the same as last year and market share lower. In the Netherlands, profit was lower due to higher excise levels and an adverse product mix, partly offset by cost savings, while cigarette market share increased. Profit in Belgium was affected by intense price competition in the other tobacco segments, although overall cigarette market share increased as Pall Mall and Winfield performed well. In Spain, despite strong growth in volumes and a much higher share, the results were adversely affected by the significantly reduced market profitability resulting from intense price competition. Page 4 Business review cont... The impressive performance in Russia continued through strong volume and profit increases, with an improved product mix and lower production costs. A higher overall market share resulted from significantly increased volumes of Kent and Vogue, supported by good Pall Mall growth. In Romania, the Group continued to grow volumes and profit, consolidating its leadership position in a reduced market, affected by substantial excise increases. Volume performance was driven by its premium brands, particularly Kent, which is now the largest selling brand, as well as Dunhill and Vogue. In Ukraine, profitability was adversely affected by the considerable decline in volumes. However, Kent, Lucky Strike and Pall Mall grew market share. Profit grew significantly in Hungary, benefiting from the recovery of the legal market after improved border controls, efficiency programmes and the strong volume growth from Viceroy and Pall Mall. In Poland, industry profitability was severely 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 Â£85 million to Â£616 million, mainly attributable to good performances in Australasia, Malaysia, South Korea and Pakistan. Volumes at 142 billion were 4 per cent higher as strong increases in Pakistan, Bangladesh, South Korea and Vietnam were partially offset by declines in Malaysia and Indonesia. Profit grew strongly in Australia, as a result of improved margins from a combination of product cost reductions, price increases and a substantial reduction in overheads. Good performances from Winfield and Dunhill, and the launch of Pall Mall, contributed to a higher overall market share in a reduced total market. New Zealand also showed strong profit growth in local currency as margins increased but this was eroded by the weakening of the currency. Volumes were in line with last year despite the growth of Dunhill and Pall Mall and market share was slightly down. In Malaysia, profit increased strongly due to productivity initiatives and higher margins, as well as the absence of one-off costs which reduced profit in 2005. Dunhill and Pall Mall grew market share but total volume declined due to reduced industry volumes as a result of the growth of illicit trade and the impact of significant excise increases in the past two years. In Vietnam, volumes increased despite the higher prevalence of illicit brands. Pall Mall grew strongly following its launch in the middle of the year and Craven 'A' continued its growth. However, profit was lower as a result of increased marketing investment. In South Korea, impressive profit growth was achieved from higher volumes and strong market share gains by Dunhill and Vogue, helped by supply chain cost reductions. Industry volumes increased, reflecting volume distortions last year as a result of the excise increases at the end of 2004. Volumes and market share grew in Taiwan, but profit was adversely impacted by higher marketing investment and down-trading after manufacturers' price increases. In Pakistan, market leadership was strengthened with excellent performances by Gold Flake and Capstan, resulting in a strong market share increase. Profit was up significantly with strong volume growth and higher margins. In Bangladesh, volumes and market share were higher while profit significantly increased, with improved margins after industry wide price increases. In Sri Lanka, good profit growth was achieved with higher margins and an improved product mix. Profit in Latin America increased by Â£81 million to Â£611 million due to good performances across the region, coupled with a stronger average exchange rate in Brazil. Volumes grew in many of the markets which led to an overall increase of 2 per cent to 153 billion. In Brazil, volume and market share increased, benefiting from marketing initiatives and continuing anti-illicit trade operations by the government. Profit increased substantially as a result of higher volumes, improved margins and the appreciation of the local currency. Page 5 Business review cont... The strong profit growth in Mexico was driven by higher margins, efficiency programmes and synergy benefits from the contract manufacturing agreement with Canada. Volumes were slightly down as the growth in international brands, notably Pall Mall, was more than offset by the decline of local low-price brands. In Argentina, strong volume growth was achieved through an excellent performance by Viceroy and a reduction in illicit competition. However, profit was lower due to severe price competition. In Chile, profit grew strongly as volumes and prices increased, the product mix improved and the currency strengthened. The Global Drive Brands, Kent, Lucky Strike and Pall Mall, led the volume and share increases. In Venezuela, higher margins and increased volumes, led by Belmont and Consul, resulted in an excellent increase in profit and market share. The Central America and Caribbean area showed a significant profit increase as a result of higher volumes and margins, an improved product mix, supply chain savings and the benefits from productivity initiatives. Profit in the Africa and Middle East region grew by Â£34 million to Â£468 million, mainly driven by South Africa, Nigeria, the Middle East and Egypt. Volumes were slightly higher at 103 billion, as a result of Nigeria, Egypt and the Middle East, partly offset by decreases in Turkey. In South Africa, despite the weaker average rand exchange rate, good profit growth 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 and Dunhill continued their strong growth, with Dunhill recording its highest ever sales. However, reduced volumes for other brands resulted in a lower market share. In Nigeria, volumes and market share grew with strong performances by Benson & Hedges and Pall Mall. Improved margins and volumes resulted in a higher profit. In the Middle East, volume and profit continued to grow with good results from Iran, Iraq, and the Arabian Gulf, partly offset by the Levant. Dunhill was the main driver for the good performances in the Middle East. Profit in Egypt benefited significantly from higher volumes and a reduction in costs. In Turkey, industry price increases led to higher margins, which, together with lower production costs, ensured a continued reduction in underlying operating losses. However, the move to direct distribution in this market resulted in one-off costs which, together with lower volumes, adversely impacted profitability. The profit from the America-Pacific region decreased by Â£12 million to Â£424 million, while volumes were down 3 per cent to 44 billion. The increase in profit and volumes from Japan were more than offset by lower contributions from Canada. Profit in Canada was down Â£39 million to Â£280 million, largely due to lower volumes following the growth of illicit product and a shift to low-priced brands, as well as the costs incurred in the move to direct distribution. This was partially offset by the impact of efficiency savings, with the transfer of production to Mexico, and the stronger Canadian dollar. The premium segment now represents 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 to 53 per cent. In Japan, volume, market share and profit grew strongly despite the decline in the total market. Market share growth accelerated during the second half of the year with strong performances from Kent and Kool. Profit rose significantly due to the increased volumes, the benefit of the manufacturers' price increase and the 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 to individual regions, were Â£7 million higher at Â£103 million, mainly as a result of increased pension costs. The above regional profits were achieved before accounting for restructuring costs and losses/gains on disposal of a business, brands and joint venture, as explained on page 21. Results of associates The Group's share of the post-tax results of associates increased by Â£39 million to Â£431 million. Excluding the exceptional items explained on page 23, the Group's share of the post-tax results of associates increased by Â£38 million to Â£427 million. The contribution from Reynolds American, excluding brand impairment charges and the benefit from the favourable resolution of certain tax matters in both years, as well as other exceptional charges in 2005, was Â£18 million higher at Â£285 million. This was mainly due to improved pricing and cost reductions, partially offset by lower volumes. As explained on page 23, Reynolds American acquired Conwood on 31 May 2006. Reynolds American reported that on a US GAAP pro-forma basis, as if it had been owned since the beginning of 2005, Conwood increased margins and profits for the year to December 2006. The Group's associate in India, ITC, continued its strong growth, and, excluding the one-off items in 2005, its contribution to Group profit rose by Â£11 million to Â£91 million. Associates' volumes increased by 4 per cent to 241 billion, and with the inclusion 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 highly effective way of maintaining an efficient capital structure and returning capital to shareholders. For this reason, the Board is proposing to renew its buy-back authority for further purchases of up to 10 per cent of the Company's ordinary shares at the forthcoming Annual General Meeting (AGM). However, certain consequences will arise for the Company in the event that the share buy-back programme continues as proposed. These are explained briefly below. Further information will be provided with the Notice of AGM, which will be 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 the holding company for Richemont and Remgro's interests in the Company), holds 29.3 per cent of the Company's issued share capital. Since the effect of continuing with the share buy-back programme is to reduce the overall issued share capital of the Company, R & R's interest in the Company will continue to grow, assuming it maintains its existing shareholding. As a result, if the Company continues the share buy-back programme at the enhanced level of Â£750 million per annum, it is possible that the interest of R & R will increase to over 30 per cent of the Company before the 2008 AGM. Takeover Panel Waiver The Takeover Code normally requires any shareholder whose stake reaches or exceeds 30 per cent of a company's issued voting share capital to make a bid for the remaining shares in the company. This requirement also applies to shareholders which have representatives on a company's board if their stake reaches 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 is prepared to waive this requirement, if the independent shareholders approve such a 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. In particular, the Board has considered the terms of the Standstill Agreement which was entered into at the time of the merger with Rothmans International in 1999. This agreement expressly prohibits the Company from continuing its share buy-back programme, if it would increase R & R's shareholding to 30 per cent or more without the consent of R & R and its shareholders. They have given their consent subject to the Takeover Panel waiver and in return have asked British American Tobacco to obtain a secondary listing for its ordinary shares on the Johannesburg Stock Exchange if and when requested by them. British American Tobacco 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 this agreement and so this restriction would continue to apply even if R & R's shareholding were to reach or exceed 30 per cent due to the Company's buy-back programme. Annual Shareholder and Panel Approval The Board currently envisages that it would seek further buy-back authorities at future AGMs, in order to allow a continuation of the programme. However, the Board does not anticipate that it would continue the buy-back once R & R's interest had reached 35 per cent of the issued share capital of the Company. At the current share price, and at the currently proposed buy-back levels, this threshold is unlikely to be reached in the next seven years. Conclusion The Directors (other than R & R's two representatives, who have not participated in the discussions) believe that continuing with the share buy-back programme, and therefore seeking the consent of R & R and its shareholders and the Takeover Panel'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 General Meeting to be held on 26 April 2007, the payment on 3 May 2007 of a final dividend 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 will be in time to rank for payment of this dividend. Ordinary shares go ex-dividend on 7 March 2007. The following is a summary of the dividends declared for the years ended 31 December 2006 and 2005. 2006 2005 pence per pence per share Â£m share Â£m On ordinary shares: Interim 2006 paid 13 September 2006 15.7 323 (see page 28) 2005 paid 14 September 2005 14.0 293 Final 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 Â£821 million (2005: Â£685 million), payable on 3 May 2007, will be recognised in the Group accounts for the year ending 31 December 2007. For the year ended 31 December 2006, the accounts include the final dividend paid in respect of the year ended 31 December 2005, amounting to Â£685 million and the interim dividend amounting to Â£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 31 December 2004, amounting to Â£617 million and the 2005 interim dividends, amounting to Â£293 million. Page 9 GROUP INCOME STATEMENT For the year ended 31 December 2006 2005 restated Â£m Â£m Gross turnover (including duty, excise and other taxes of Â£15,427 million(2005: Â£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 181 179 Other operating expenses (2,494) (2,382) -------- -------- Profit from operations 2,622 2,420 after (charging)/crediting: ------------------------ - restructuring costs (216) (271) -(losses)/gains on disposal of a business, brands and joint venture 41 72 ------------------------ ------------------------ Finance income 110 118 Finance costs (399) (346) ------------------------ Net finance costs (289) (228) Share of post-tax results of associates and joint venture 431 392 after (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 2,584 Taxation 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 share Basic 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 Â£m Â£m Differences on exchange (685) 425 Cash flow hedges - net fair value gains 13 17 - reclassified and reported in net profit (15) 38 - reclassified as basis adjustments 3 Available-for-sale investments - net fair value losses (2) (1) - reclassified and reported in net profit 1 Net 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) 390 Profit 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 30 Dividends - 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) 802 Balance 1 January 6,877 6,117 Change 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 Â£m Â£m Assets Non-current assets Intangible assets 7,476 7,987 Property, plant and equipment 2,207 2,331 Investments in associates and joint ventures 2,108 2,193 Retirement benefit assets 29 35 Deferred tax assets 273 290 Trade and other receivables 192 197 Available-for-sale investments 24 27 Derivative financial instruments 76 87 -------- -------- Total non-current assets 12,385 13,147 ======== ======== Current assets Inventories 2,056 2,274 Income tax receivable 59 81 Trade and other receivables 1,568 1,577 Available-for-sale investments 128 96 Derivative financial instruments 124 86 Cash 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 restated Equity Â£m Â£m Capital and reserves Shareholders' 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 liabilities Borrowings 5,568 5,058 Retirement benefit liabilities 435 543 Deferred tax liabilities 296 277 Other provisions for liabilities and charges 161 261 Trade and other payables 146 180 Derivative financial instruments 29 19 -------- -------- Total non-current liabilities 6,635 6,338 ======== ======== Current liabilities Borrowings 1,058 2,202 Income tax payable 292 374 Other provisions for liabilities and charges 253 234 Trade and other payables 2,766 2,883 Derivative 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 Â£m Â£m Cash generated from operations 2,816 2,893 Dividends received from associates 259 193 Tax paid (713) (762) -------- -------- Net cash from operating activities 2,362 2,324 ======== ======== Interest and dividends received 121 110 Purchases of property, plant and equipment (425) (381) Proceeds on disposal of property, plant and equipment 64 41 Purchases and disposals of intangible assets 2 36 Purchases and disposals of investments (37) 22 Purchases 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 30 Proceeds from increases in and new borrowings 1,365 742 Movements 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 247.7 244.0 Asia-Pacific 141.9 137.1 Latin America 152.6 149.3 Africa and Middle East 103.3 102.6 America-Pacific 43.8 45.0 ---------- ----------- 689.3 678.0 =========== ========== Revenue 31.12.06 31.12.05 Inter Inter External segment Revenue External segment Revenue Â£m Â£m Â£m Â£m Â£m Â£m Europe 3,495 526 4,021 3,456 569 4,025 Asia-Pacific 1,755 27 1,782 1,646 3 1,649 Latin America 1,780 2 1,782 1,541 4 1,545 Africa and Middle East 1,063 24 1,087 964 34 998 America-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 and figures based on location of sales would be as follows: 31.12.06 31.12.05 Â£m Â£m Europe 3,545 3,497 Asia-Pacific 1,839 1,758 Latin America 1,791 1,555 Africa and Middle East 1,489 1,405 America-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* Â£m Â£m Â£m Â£m Europe 676 781 696 784 Asia-Pacific 609 616 517 531 Latin America 611 611 524 530 Africa and Middle East 444 468 425 434 America-Pacific 385 424 354 436 -------- -------- -------- ------- 2,725 2,900 2,516 2,715 Unallocated 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 of associates and joint ventures is as follows: 31.12.06 31.12.05 Adjusted Adjusted Segment segment Segment segment result result* result result* Â£m Â£m Â£m Â£m Europe 46 46 39 39 Asia-Pacific 92 92 107 81 Africa and Middle East 4 4 2 2 America-Pacific 289 285 244 267 -------- -------- -------- ------- 431 427 392 389 ======== ======== ======== ======= *Excluding restructuring costs, US Federal tobacco buy-out, brand impairments and 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 be reflected in equity movements. The quarterly analyses for 2005 on page 18 have been restated to reflect these changes. As the adjusted diluted earnings per share calculations already reflected these adjustments, no restatement of these amounts was required. 3 months to Year to 31.3.06 30.6.06 30.9.06 31.12.06 31.12.06 Â£m Â£m Â£m Â£m Â£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)/gains on impairment of a business and disposal of 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 Â£m Â£m Â£m Â£m Â£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 financial statements for the year ended 31 December 2006. From 1 January 2005, the Group has prepared its annual consolidated financial statements 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 been prepared under the historical cost convention, except in respect of certain financial instruments. IAS32 and IAS39 on financial instruments were applied from 1 January 2005 and the 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 value of 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 Â£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 an amendment to IAS21 on foreign exchange rates. The amendment to IAS21 allowed inter company balances that form part of a reporting entity's net investment in a foreign operation to be denominated in a currency other than the functional currency of either the ultimate parent or the foreign operation itself. This means that certain exchange differences previously taken to the income statement are instead reflected directly in changes in total equity. However, as this amendment was only adopted by the EU in 2006, the interim report to 30 June 2006 contained the first published results to reflect this change. The previously published results have been restated accordingly, which has resulted in an increase in net finance costs of Â£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 Â£m Â£m Â£m Â£m Increase/(decrease) in net finance costs 2 2 1 (1) While this amendment was not applicable for Group reporting until it was endorsed by the European Union, as this was expected in 2006, it was allowed for in the adjusted earnings per share calculations in the published results for the year 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 January 2006. This interpretation is to determine whether an arrangement, which is not in the legal form of a lease, is in substance a lease and should be accounted for in accordance with IAS17 (Leases). This has resulted in the recognition of certain arrangements as leases. The previously published balance sheet for 2005 has been restated in respect of finance leases to increase property, plant and equipment by Â£4 million and borrowings by a similar amount. Page 19 FOREIGN CURRENCIES The results of overseas subsidiaries and associates have been translated to sterling as follows: The income and cash flow statements have been translated at the average rates for the respective periods. Assets and liabilities have been translated at the relevant period end rates. For high inflation countries, the local currency results are adjusted for the impact of inflation prior to translation to sterling 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 1.717 Canadian dollar 2.091 2.206 2.278 2.005 Euro 1.467 1.463 1.484 1.455 South African rand 12.520 11.574 13.799 10.889 Brazilian real 4.009 4.421 4.179 4.019 The growth in reported revenue and profit from operations of 5 per cent and 8 per cent respectively, was the same at both current and comparable rates of exchange. CHANGES IN THE GROUP On 29 December 2004, the Group sold Etinera S.p.A., the distribution business of the Italian subsidiary. In 2005, following the sale of Etinera, volumes and profits in Italy benefited by 2 billion and Â£12 million respectively from a change in the terms of trade with Etinera. On 4 October 2005, the Group announced that it had agreed the sale of its 55 per cent stake in BAR Honda, held through BARH Ltd. (BARH), to Honda and the sale was completed on 20 December 2005. For the period 7 January 2005 to 20 December 2005, BARH was equity accounted, reflecting shared control with Honda. On 21 October 2005, the Group announced the exercise of its pre-emption rights over shares in Skandinavisk Tobakskompagni AS, its Danish associate, and the transaction was completed on 12 December 2005. This increased the Group's holding from 26.6 per cent to 32.3 per cent at a cost of Â£95 million, resulting in goodwill of Â£69 million. On 25 November 2005, the Group acquired Restomat AG, the largest operator of cigarette vending machines in Switzerland, at a cost of Â£25 million, resulting in goodwill of Â£7 million. On 10 March 2006, the Group's Italian subsidiary signed an agreement to sell its cigar business, Toscano, to Maccaferri for euro 95 million. The sale was subject to regulatory and governmental approval and was completed on 19 July 2006. From August 2006, the Group purchased minority interests in its subsidiary in Chile for a cost of Â£91 million, raising the Group shareholding from 70.4 per cent to 96.5 per cent. The goodwill arising on these transactions was Â£80 million and the minority interests in Group equity were reduced by Â£11 million. Page 20 RESTRUCTURING COSTS In 2003, the Group commenced a detailed review of its manufacturing operations and organisational structure, including the initiative to reduce overheads and indirect costs. The restructuring continued, with major announcements during 2005 which covered the cessation of production in the UK, Ireland and Canada, with production to be transferred elsewhere. The profit from operations for the year ended 31 December 2005 included a charge for restructurings of Â£271 million. Further restructurings continued in 2006 and on 22 September agreement was reached on the closure of the plant at Zevenaar in the Netherlands. The plant will close by the end of 2008, with the production being transferred to Bayreuth in Germany and Augustow in Poland. The total restructuring costs of Â£216 million for the year ended 31 December 2006 principally comprise fixed asset impairment charges and staff costs, and are mainly in respect of costs for Zevenaar and further costs for the UK and Canadian 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 Silk Cut trademarks in Malta and Cyprus, together with the Silk Cut trademark in Lithuania, resulting in a gain on disposal of Â£68 million included in other operating income in the profit from operations. The transactions are in accordance with contracts of 1993 and 1994 in which Gallaher agreed to acquire these trademarks in European Union states and the accession of Malta, Cyprus and Lithuania, necessitated the sale. The transactions in respect of BARH described on page 20, resulted in a gain of Â£5 million which was included in other operating income in the profit from operations in 2005. The sale of the Italian cigar business in 2006 described on page 20, resulted in a loss of Â£19 million, reflecting a Â£15 million impairment charge included in depreciation and amortisation costs in the profit from operations and Â£4 million of other costs included in other operating expenses in the profit from operations. On 29 November 2006, the Group completed a trademark transfer agreement with Philip Morris International. Under this arrangement the Group sold its Muratti Ambassador brand in certain markets, as well as the L&M and Chesterfield trademarks in Hong Kong and Macao, while acquiring the Benson & Hedges trademark in certain African countries. These transactions resulted in a gain of Â£60 million 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 after excluding restructuring costs, loss on impairment of a business and gains on disposal of brands and a joint venture, as well as the change in terms of trade in Italy. On this basis, the revenue for the year to 31 December 2006 of Â£9,762 million would represent growth of 5 per cent and the profit from operations of Â£2,797 million would represent growth of 7 per cent. Revenue Profit from operations 2006 2005 2006 2005 Â£m Â£m Â£m Â£m As reported (page 10) 9,762 9,325 2,622 2,420 Etinera - change in terms of trade (24) (12) Restructuring costs (page 10) 216 271 Losses/(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 Â£m Â£m Finance costs (399) (346) Finance income 110 118 ------- -------- (289) (228) ======= ======== Comprising: Interest payable (410) (373) Interest and dividend income 122 106 Fair value changes - derivatives 212 (218) Exchange differences (213) 257 ------- ------- (1) 39 ------- -------- (289) (228) ======= ======== Net finance costs at Â£289 million were Â£61 million higher than last year, principally reflecting the impact of higher interest rates as well as derivatives. The Â£1 million loss (2005: Â£39 million gain) of fair value changes and exchange differences reflects a loss of Â£7 million (2005: Â£3 million gain) from the net impact of exchange rate movements and a gain of Â£6 million (2005: Â£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 tests for hedge accounting under IAS39, to be included in the income statement. In addition, certain exchange differences are required to be included in the income statement under IFRS and, as they are subject to exchange rate movements in a period, they can be a volatile element of net finance costs. These amounts do not always reflect an economic gain or loss for the Group and, at the 2005 year end the Group decided that, in calculating the adjusted earnings per share, it is appropriate to exclude certain amounts. The adjustments for the year to 31 December 2006 are as follows: (a) Â£nil million (2005: Â£8 million gain) relating to derivatives for which hedge accounting was obtained during 2005. (b) Â£nil million (2005: Â£11 million gain) relating to exchange in net finance costs where there is a compensating exchange amount reflected in differences in exchange taken directly to changes in total equity. Excluding the above items, fair value changes and exchange differences are a net loss of Â£1 million compared to a net gain of Â£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 profit before taxation. On an adjusted basis, interest cover based on profit before interest payable over interest payable was 8.1x (2005: 8.8x) reflecting higher interest costs. ASSOCIATES The share of post-tax results of associates and joint ventures was Â£431 million (2005: Â£392 million) after tax of Â£216 million (2005: Â£163 million). The share of associates is after exceptional charges and credits: - In the year ended 31 December 2006, Reynolds American benefited from the favourable resolution of tax matters of which the Group's share was Â£17 million (2005: Â£31 million). Reynolds American also modified the previously anticipated level of support between certain brands and the projected net sales of certain brands, resulting in a brand impairment charge of which the Group's share amounted to Â£13 million (net of tax) (2005: Â£29 million). - In the year ended 31 December 2005, Reynolds American also incurred restructuring costs and a one-off charge related to the stabilisation inventory pool losses associated with the US tobacco quota buy-out programme. The Group's share (net of tax) of these amounted to Â£13 million and Â£12 million respectively. - In the year to 31 December 2005, the contribution from ITC in India included a benefit of Â£26 million (net of tax), principally related to the write-back of provisions for taxes partly offset by the impairment of a non-current investment. On 25 April 2006, Reynolds American announced an agreement to acquire Conwood, the second largest manufacturer of smokeless tobacco products in the US, for US$3.5 billion, and the acquisition was completed on 31 May 2006. The acquisition was funded principally with debt and the fair value of assets acquired and liabilities assumed was US$4.1 billion and US$0.6 billion respectively. Included in the assets were US$2.5 billion in respect of goodwill and US$1.4 billion in respect of brands. Page 23 TAXATION Year to 31.12.06 31.12.05 Â£m Â£m UK corporation tax 14 42 Overseas tax 743 705 Adjustment in respect of prior periods (62) (12) ---------- ----------- Current tax 695 735 Deferred tax 21 (45) ---------- ----------- 716 690 ========== ========== The tax rates in the income statement of 25.9 per cent in 2006 and 26.7 per cent in 2005 are affected by the inclusion of the share of associates' post-tax profit in the Group's pre-tax results. The underlying tax rate for subsidiaries reflected in the adjusted earnings per share below was 29.6 per cent in 2006 and 31.4 per cent in 2005, and the decrease reflects the inclusion of a tax credit in Canada in respect of prior years and changes in the mix of profits. The UK corporation tax charge of Â£14 million in 2006 is reduced to Â£nil million by an equal and opposite deferred tax credit of Â£14 million and will not result in the payment of any UK tax. EARNINGS PER SHARE Basic earnings per share are based on the profit for the year attributable to ordinary shareholders and the average number of ordinary shares in issue during the year (excluding shares held by the Group's Employee Share Ownership Trusts). For the calculation of the diluted earnings per share, the average number of shares 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 Â£m m Â£m m Basic 1,896 2,059 1,767 2,095 Diluted 1,896 2,076 1,767 2,112 Page 24 Earnings per share cont... The earnings have been distorted by exceptional items, together with certain distortions to net finance costs under IFRS (see page 23), and to illustrate the impact of these distortions, the adjusted diluted earnings per share are shown below: Diluted earnings per share Year to 31.12.06 31.12.05 restated pence pence Unadjusted earnings per share 91.33 83.66 Effect of restructuring costs 8.09 10.13 Effect of disposal of a business, brands and joint venture (1.11) (3.41) Effect of associates' restructuring costs, US Federal tobacco buy-out, brand impairments and exceptional tax 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 (Â£m) 2,037 1,887 - shares (m) 2,076 2,112 Similar types of adjustments would apply to basic earnings per share. For the year to 31 December 2006, basic earnings per share on an adjusted basis would be 98.93p (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 cash equivalents, including financing. The alternative cash flow below is presented to illustrate the cash flows before transactions relating to borrowings. 2006 2005 Â£m Â£m Net cash from operating activities before restructuring costs and taxation 3,295 3,229 Restructuring costs (220) (143) Taxation (713) (762) ------- ------- Net cash from operating activities (page 14) 2,362 2,324 Net interest (263) (231) Net capital expenditure (419) (378) Dividends to minority interests (139) (133) ------- ------- Free cash flow 1,541 1,582 Dividends 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 Â£2,362 million was Â£38 million higher. The growth in underlying operating performance was offset by the timing of working capital movements. However, a Â£49 million fall in tax outflows, reflecting the timing of payments, as well as Â£66 million higher dividends 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 levels of dividends to minority interests, the free cash flow is Â£41 million lower than in 2005 at Â£1,541 million. This inflow exceeds the total cash outlay on dividends to shareholders and share buy-back by Â£33 million. The other net flows in 2006 principally reflect the purchase of minority interests 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. The other net flows in 2005 mainly arise from the acquisition of further shares in the 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 Â£28 million compared to Â£122 million in 2005. After taking account of transactions related to borrowings, especially the net repayment of borrowings, the above flows resulted in a net decrease of cash and cash equivalents of Â£292 million compared to a net decrease of Â£115 million in 2005, as shown in the IFRS cash flow on page 14. These cash flows, after an adverse exchange impact of Â£96 million, resulted in cash and cash equivalents, net of overdrafts, decreasing by Â£388 million in 2006 (2005: Â£66 million). Borrowings, excluding overdrafts but taking into account derivatives relating to borrowings, were Â£6,401 million compared to Â£7,117 million as at 31 December 2005. The decrease in this figure principally reflected the net repayment of borrowings and the impact of exchange movements. Current available-for-sale investments at 31 December 2006 were Â£128 million (31 December 2005: Â£96 million). As a result of the above borrowings, net of cash, cash equivalents and current available for sale investments, were Â£4,996 million (31 December 2005: Â£5,357 million). b) Cash generated from operations (page 14) Year to Year to 31.12.06 31.12.05 restated Â£m Â£m Profit before taxation 2,764 2,584 Share of post-tax results of associates and joint venture (431) (392) Net finance costs 289 228 Gains on disposal of brands and joint venture (60) (72) Depreciation and impairment of property, plant and equipment 367 348 Amortisation and impairment of intangible assets 34 35 Decrease/(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) 61 Other 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 include the following items: Interest and dividends received include dividends received of Â£2 million (2005: Â£1 million). Purchases and disposals of intangible assets include Â£60 million and Â£74 million of sales proceeds for the year to 31 December 2006 and 2005 respectively, mainly from the brands sale explained on page 21. Purchases and disposals of investments (which comprise available-for-sale investments and loans and receivables) include an outflow in respect of current investments of Â£41 million for the year to 31 December 2006 (31 December 2005: Â£7 million decrease) and Â£4 million sales proceeds from non-current investments for the year to 31 December 2006 (31 December 2005: Â£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's Chilean subsidiary less the proceeds from the sale of Toscano in Italy. Purchases and disposals of subsidiaries for the year to 31 December 2005 principally reflect the acquisition of Restomat. These transactions are described on page 20. During the year to 31 December 2006, Euro 600 million Eurobonds with a maturity of 2014, Â£325 million Eurobonds with a maturity of 2016 and Euro 525 million floating rate notes with a maturity of 2010 were issued. The proceeds, together with cash resources, were used to repay bonds including Euro 1 billion floating rate notes, a DM1 billion Eurobond and a Euro 500 million Eurobond. During the year to 31 December 2005, a US$400 million Eurobond, Euro 300 million floating rate notes and a Deutschmark 500 million Eurobond were repaid and a Euro 750 million Eurobond with a 2012 maturity was issued. The movement relating to derivative financial instruments is in respect of derivatives taken out to hedge cash and cash equivalents and external borrowings, derivatives taken out to hedge inter company loans and derivatives treated as net investment hedges. Derivatives taken out as cash flow hedges in respect of financing activities are also included in the movement relating to derivative financial instruments, while other such derivatives in respect of operating and investing activities are reflected along with the underlying transactions. 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 Â£77 million in 2006 (2005: Â£48 million). Dividends paid for the year to 31 December 2006 include Â£1,008 million of dividends to Group shareholders and Â£139 million to minority shareholders (2005: Â£910 million and Â£133 million respectively). d) Net cash and cash equivalents in the cash flow statement comprise: 31.12.06 31.12.05 Â£m Â£m Cash and cash equivalents per balance sheet 1,456 1,790 Accrued interest (1) Overdrafts (179) (126) ------ ----- 1,276 1,664 ====== ===== Page 27 TOTAL EQUITY 31.12.06 31.12.05 restated Â£m Â£m Share capital 517 524 Share premium account 48 43 Capital redemption reserves 90 83 Merger reserves 3,748 3,748 Translation reserve (177) 383 Hedging reserve 10 10 Available-for-sale reserve 13 15 Other reserves 573 573 Retained earnings 1,639 1,251 ----------------------------------------------------------------------------------------- after deducting: cost of own shares held in Employee Share Ownership Trusts (197) (182) ----------------------------------------------------------------------------------------- --------- -------- Total shareholders' funds 6,461 6,630 Minority interests 227 247 --------- --------- 6,688 6,877 ======== ======= Total equity was Â£189 million lower at Â£6,688 million. The profit retained after payment of dividends exceeded the impact of the share buy-back by Â£388 million. However, this was more than offset by a Â£580 million adverse impact from exchange movements reflecting the general strength of sterling. For the first time, the Company needed to file interim accounts which were prepared to recognise additional dividend income during 2006. As a result of the Company not doing so, the interim dividend of Â£323 million paid on 13 September 2006 did not comply with the technical requirements of the Companies Act 1985. It is proposed that the appropriation of distributable profits to the payment of the interim dividend will be ratified by shareholders by way of a special resolution at the Annual General Meeting. Accordingly the payment has been shown as a dividend payment on pages 9 and 11. Between 22 September 2006 and 4 December 2006, the Company sought to repurchase 6,927,790 shares for an aggregate consideration of Â£100 million, which are included in the purchase of own shares on page 11. However, as a result of the technical infringement of the Companies Act 1985, the repurchase and cancellation of these shares was invalid and accordingly their nominal value is included 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, the Company's brokers, at the same prices agreed between 22 September 2006 and 4 December 2006. CONTINGENT LIABILITIES There are contingent liabilities in respect of litigation, overseas taxes and guarantees 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 cigarette manufacturers, are defendants, principally in the US, in a number of product liability cases. In a number of these cases, the amounts of compensatory and punitive damages sought are significant. Page 28 Contingent liabilities cont... Indemnity On 30 July 2004, B&W completed transactions combining its US tobacco business assets, liabilities and operations with R.J. Reynolds Tobacco Company. A new company called R.J. Reynolds Tobacco Company (RJRT) was created as a result of the combination transactions. These transactions (the Business Combination) were accomplished through a publicly traded holding company Reynolds American Inc. (RAI), which is the indirect parent corporation of RJRT. As a result of the Business Combination: (a) B&W discontinued the active conduct of any tobacco business in the US; (b) B&W contributed to RJRT all of its assets other than the capital stock of certain subsidiaries engaged in non-US businesses and other limited categories of assets; (c) RJRT assumed all liabilities of B&W (except liabilities to the extent relating to businesses and assets not contributed by B &W to RJRT and other limited categories of liabilities) and contributed subsidiaries or otherwise to the extent related to B&W's tobacco business as conducted in the US on or prior to 30 July 2004; and, (d) RJRT agreed to indemnify 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 such assumed liabilities or the assets contributed by B&W to RJRT (the RJRT Indemnification). The scope of the RJRT Indemnification includes all expenses and contingent liabilities in connection with litigation to the extent relating to or arising from B&W's US tobacco business as conducted on or prior to 30 July 2004, including smoking and health tobacco litigation, whether the litigation is commenced before or after 30 July 2004 (the tobacco litigation). Pursuant to the terms of the RJRT Indemnification, RJRT is liable for any possible judgments, the posting of appeal bonds or security, and all other expenses of and responsibility for managing the defence of the tobacco litigation. RJRT has assumed control of the defence of the tobacco litigation involving 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 represent both B&W and RJRT in any single or similar case (except in certain limited circumstances) as RJRT's interests are typically aligned with B&W's interests, and RJRT has substantial experience in managing recognised external legal counsel in defending tobacco litigation, and external counsel have independent professional responsibilities to represent the interests of B&W. In addition, in accordance with the terms of the RJRT Indemnification, affiliates of B&W have retained control of the defence in certain tobacco litigation cases with respect to which such affiliates are entitled to indemnification. In addition to US litigation involving Group companies which is covered by the RJRT Indemnification, RAI group companies are named in litigation which does not involve Group companies. While it is impossible to be certain of the outcome of any particular case or of the amount of any possible adverse verdict, it is not impossible that the results of operations or cash flows of RAI in particular quarterly or annual periods could be materially affected by this and by the final outcome of any particular litigation. However, having regard to the contingent liability disclosures on litigation made by RAI in its public financial reports, the Directors are satisfied with the carrying value for RAI as stated in the consolidated audited annual accounts of the Group for the financial year ended 31 December 2006. US litigation The total number of US product liability cases pending at 31 December 2006 involving 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 in some seven of those cases (2005: 965). The reduction in this figure is primarily in consequence of the dismissal of B.A.T Industries p.l.c. as defendant in the West 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 Group companies were tried in 2006. Only perhaps five cases are likely to come to trial in 2007, some involving amounts ranging possibly into the hundreds of millions and even billions of dollars. Since many of these pending cases seek unspecified damages, it is not possible to quantify the total amounts being claimed, 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 and other third party providers on healthcare and welfare costs claimed to result from illnesses associated with smoking. Although B&W continues to be a defendant in healthcare cost recovery cases involving plaintiffs such as hospitals, Native American tribes, and foreign governments, the vast majority of such cases have been dismissed on legal grounds. At 31 December 2006, one reimbursement suit was pending against B&W by an Indian tribe, and no suits were pending against B&W by county or other political subdivisions of the states. The Master Settlement Agreement (MSA) with the 46 states includes a credit for any amounts paid in suits brought by the states' political subdivisions; nevertheless, RJRT intends to defend and is defending these cases vigorously. Based on somewhat different theories of claim are two non-governmental medical reimbursement cases and health insurers' claims. One third party reimbursement case (City of St. Louis), consists of more than 60 public and non-profit hospitals in Missouri seeking reimbursement of past and future alleged smoking related healthcare costs. No trial date is currently set for this case. At 31 December 2006, B&W was named as a defendant in two (2005: two) cases brought by foreign government entities in a single US court (Republic of Panama and State of Sao Paolo) seeking reimbursement of medical costs which they incurred for treatment for persons in their own countries who are alleged to have smoked imported cigarettes, including those manufactured by B&W. These two cases, originally filed in state court in Louisiana, were consolidated and then dismissed by the trial court on the basis that Louisiana was the inappropriate forum. These plaintiffs filed new cases in the Superior Court for the State of Delaware on 19 July 2005. On 13 July 2006, the Delaware Superior Court granted defendants' motion to dismiss. Plaintiffs filed notices of appeal to the Supreme Court of Delaware on 19 July 2006. Oral argument on plaintiffs' appeal was heard on 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) separate actions attempting to assert claims on behalf of classes of persons allegedly injured or financially impacted through smoking or where classes of tobacco claimants have been certified. Even if the classes remain certified and the possibility of class-based liability is eventually established, it is likely that individual trials will still be necessary to resolve any actual claims. Class-action suits have been filed in a number of states against individual cigarette manufacturers and their parent corporations, alleging that the use of the terms 'lights' and 'ultralights' constitutes unfair and deceptive trade practices. A class action complaint (Schwab) was filed in the US District Court for the Eastern District of New York on 11 May 2004 against B&W and certain UK-based Group companies. The complaint challenges the practices of defendants with respect to the marketing, advertising, promotion and sale of 'light' cigarettes. The court granted plaintiffs' motion for class certification on 25 September 2006. By order dated 17 November 2006, the Second Circuit Court of Appeals granted defendants' motion to stay the district court proceedings in this case, and further granted defendants' petition for leave to appeal the district court's class certification order. Other types of class-action suits assert 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 to environmental 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 class representatives, and in a later stage of this three phase trial process, a jury assessed US$17.6 billion in punitive damages against B&W. In November 2000, B&W posted a surety bond in the amount of US$100 million (the amount required by Florida law) to stay execution of this punitive damages award. On 21 May 2003, the intermediate appellate court reversed the trial court's judgment and remanded 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 22 September 2003. On 12 May 2004, the Florida Supreme Court agreed to review this case and, on 6 July 2006, it upheld the intermediate appellate court's decision to decertify the class, and vacated the jury's punitive damages award. Further, the Florida Supreme Court permitted the judgments entered for two of the three Engle class representatives to stand, but dismissed the judgment entered in favour of the third Engle class representative. Finally, the Court has permitted putative Engle class members to file individual lawsuits against the Engle defendants within one year of the Court's decision. The Court's order precludes defendants from litigating certain issues of liability against the putative Engle class members in these individual actions. On 7 August 2006, defendants filed a motion for rehearing before the Florida Supreme Court, which was granted in part, and denied in part, on 21 December 2006. The Florida Supreme Court's 21 December 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 one verdict will be applicable to the individual lawsuits that were permitted to stand. 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's share: US$8.4 million). On 1 April 2003, the jury award was reduced to US$25.125 million (B&W's share: US$5.65 million) but no final judgment will be entered until the Engle appeal is fully resolved. Therefore the time to appeal this case has 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 on the medical monitoring claim but made findings against defendants with respect to claims relating to fraud, conspiracy, marketing to minors and smoking cessation. On 21 May 2004, the jury returned a verdict in the amount of US$591 million 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 September 2004, defendants posted a US$50 million bond (legislation in Louisiana limits the amount of a bond to prevent execution upon such a judgment to US$50 million collectively for signatories to the MSA). RJRT posted US$25 million (i.e. the portions for RJRT and B&W) towards the bond. On 12 April 2006, the Louisiana Fourth Circuit Court of Appeal heard argument on defendants' appeal. The appellate court issued a decision on 7 February 2007 that affirmed class certification and upheld the smoking cessation program for certain smokers who began smoking before 1988, but reduced the US$591 million jury award by US$312 million and rejected any award of prejudgement interest. Defendants are in the process 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 the certification ruling, which was denied on 25 October 2002. On 14 February 2003, the US Court of Appeals for the Second Circuit granted defendants' petition to review the class certification decision. Oral argument was heard on 20 November 2003. On 6 May 2005, the Second Circuit Court of Appeals vacated the district court's class certification order. The district court permitted plaintiffs to voluntarily dismiss this action on 8 December 2005. The district court entered its 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 that diseases or deaths have been caused by cigarette smoking or by exposure to environmental tobacco smoke (ETS). Of these cases: (a) approximately 75% are ETS cases brought by flight attendants who were members of a class action (Broin) that was settled on terms that allow compensatory but not punitive damages claims by class members; (b) approximately 20% of the individual cases against B &W are cases brought in consolidated proceedings in West Virginia; and (c) only about 5% are cases filed by other individuals. Of the individual cases that went to trial or were decided or remained on appeal during 2006, several resulted in verdicts against B&W: In November 2003, a Missouri jury (Thompson) awarded US$210,000 damages against B&W. A notice of appeal was filed on 8 March 2004. Oral argument before the Missouri Court of Appeals was heard on 3 November 2005. The Missouri Court of Appeals affirmed the judgment on all points on 22 August 2006. B&W moved before the Missouri Court of Appeals to transfer this appeal to the Missouri Supreme Court on 6 September 2006. B&W's motion was denied by the Missouri Court of Appeals on 26 September 2006. On 10 October 2006, B&W filed an application with the Missouri Supreme Court for transfer of this action to the Missouri Supreme Court. 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 compensatory damages against B&W and two industry organisations. In January 2004, the same jury awarded US$20 million punitive damages. On 22 June 2004, the trial judge granted a new trial unless the parties agreed to an increase in compensatory damages to US$500,000 and a decrease in punitive damages to US$5 million, of which US$4 million would be assigned to B&W. Plaintiffs agreed to a decrease in punitive 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 appellate court. Oral argument was heard on 8 May 2006. The appellate court affirmed the judgment on 5 July 2006. B&W filed a motion for leave to reargue, or in the alternative, for leave to appeal to the New York Court of Appeals, on 3 August 2006. The intermediate appellate court denied this motion on 5 October 2006. On 8 December 2006, the trial judge granted plaintiff's application for entry of judgment, and granted plaintiff's motion to vacate that part of the 2004 order granting a new trial unless the parties agreed to an increase in compensatory damages to US$500,000. B&W intends to seek further appellate review of the trial court's judgment. On 1 February 2005, a Missouri jury (Smith) awarded US$500,000 in compensatory damages against B&W and then, on 2 February 2005, awarded US$20 million in punitive damages, also against B&W. On 1 June 2005, B&W filed its notice of appeal. B&W filed its opening appellate brief on 28 April 2006. Oral argument was 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 compensatory damages against B&W. On 18 August 2005, B&W filed its notice of appeal. RJRT posted 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 intermediate New 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 and became a group subsidiary following the restructuring of Imasco Limited (now Imperial Tobacco Canada Limited (Imperial)) in 2000. Soon after this acquisition, and as part of the acquisition plan, Genstar began to sell most of its assets, including the non-asbestos related operations and subsidiaries of Flintkote. The liquidation of Flintkote assets produced cash proceeds and, having obtained legal and financial advice that sufficient assets would remain to satisfy liabilities, Flintkote and Imasco authorized the payment of two dividends. In 2003, Imperial divested Flintkote and then, in 2004, Flintkote filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware. In 2006, Flintkote, certain representatives of both the present and future asbestos claimants as well as certain individual asbestos claimants were permitted by the bankruptcy court to file a complaint against Imperial and numerous other defendants for the recovery of the dividends and other compensation under various legal theories. The parties are presently engaged in case management discussions to establish the scope and manner of discovery in this case. This litigation is expected to take several years to proceed to trial. At 31 December 2006, no cases (2005: 1) were pending against B&W on behalf of asbestos companies. In these cases, certain asbestos companies sought reimbursement for costs and judgments paid in litigation brought by third parties against them. These companies claimed that, but for the smoking of the claimants, their damages would have been less. The final asbestos contribution claim (Fibreboard) was voluntarily dismissed by plaintiffs on 28 July 2006. In Wisconsin, the authorities have identified potentially responsible parties to fund the clean up of the Fox River, Wisconsin. The pollution was caused by discharges of toxic material from paper mills operating close to the river. The cost of the clean up work is currently estimated to be in the order of US$600 million. Among the potentially responsible parties are NCR Corporation and Appleton 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 Division from NCR Corporation and spun off this business in 1990, obtaining full indemnities from Appleton Papers Inc. for past and future environmental claims. Disputes between NCR Corporation and B.A.T Industries p.l.c. as to the indemnities given and received under the purchase agreement in 1978 have been the subject of arbitration in 1998 and 2006. Under the terms of the arbitration awards, B.A.T Industries p.l.c. has an obligation to share the costs of environmental claims with NCR Corporation, but has never been required to pay any 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 met directly by Appleton Papers Inc. by self-funding or insurance cover and no demand 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 to MSA calculations based on 1999 and 2000 sales. This agreement resulted in a benefit of Â£27 million which is excluded from the 2003 costs shown in the consolidated audited annual accounts of the Company for the financial year ended 31 December 2004. In other developments, after an Independent Auditor found that the terms of the MSA were a "significant factor" in market share losses experienced by signatories to the MSA in 2003, several US tobacco companies, including B&W, asserted their rights under the NPM (or Non-Participating Manufacturer) Adjustment provision of the MSA to recover a payment credit or offset - against their April 2006 payment obligations - for MSA payments made in April 2004 in respect of cigarettes shipped or sold in the US in 2003. The amount at stake exceeds US$1 billion. The settling states oppose these MSA payment reduction claims and, in late April 2006, began filing motions in MSA courts across the country seeking enforcement of certain MSA provisions and a declaration of the parties' rights under the NPM Adjustment provision of the MSA. Defendants have opposed these motions, arguing that their NPM Adjustment claims must go instead to arbitration. To date, the overwhelming majority of MSA courts 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 one class action, the Schwab case mentioned previously. In that case, B.A.T Industries p.l.c. was substituted for British American Tobacco p.l.c. as a defendant. In the West Virginia consolidated smoking and health cases, the court so-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 significant decision as B.A.T Industries p.l.c. was previously a defendant in around 1,000 consolidated individual cases in West Virginia. British American Tobacco (Investments) Limited has been dismissed from those West Virginia consolidated smoking 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 (Cleary and Schwab), and three individual actions. Conduct based claims On 22 September 1999, the US Department of Justice brought an action in the US District 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 of personal jurisdiction on 28 September 2000. The Government sought to recover federal funds expended in providing healthcare to smokers who have developed diseases 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 a consequence of a RICO 'enterprise.' On 28 September 2000, the portion of the claim which sought recovery of federal funds expended in providing healthcare to smokers who have developed diseases and injuries alleged to be smoking-related was dismissed. The bench (non-jury) trial of the RICO portion of the claim began on 21 September 2004, and ended on 9 June 2005. On 17 November 2004, the Washington DC Circuit Court of Appeals heard an appeal by defendants against an earlier District Court decision that disgorgement of profits is an appropriate remedy to the RICO violations alleged by the Government. On 4 February 2005, the Court of Appeals allowed the appeal, ruling that the Government could not claim disgorgement of profits. On 17 October 2005, the US Supreme Court declined to hear the appeal by the US Government in respect of the claim for disgorgement of U.S.$280 billion of past profits from the US tobacco industry. The disgorgement claim was a centrepiece of the Government's claim. On 17 August 2006, the district court issued its final judgment, consisting of some 1600 pages of factual findings and legal conclusions. The court found in favour of the Government, and against certain defendants, including B&W and British American Tobacco (Investments) Limited. The court also ordered a wide array of injunctive relief, including a ban on the use of "lights" and other similar descriptors with effect from 1 January 2007. Compliance with the court-ordered remedies may cost RJRT and British American Tobacco (Investments) Limited millions of dollars. In addition, the Government is seeking the recovery of roughly US$1.9 million in litigation costs. Defendants filed a motion to stay enforcement of the judgment shortly after the judgment was issued. The court denied defendants' stay motion on 28 September 2006. Defendants, including B&W and British American Tobacco (Investments) Limited, filed their notices of appeal to the Washington DC Circuit Court of Appeals on 11 September 2006, and filed an emergency motion to stay the judgment before the same court on 29 September 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 various tobacco companies including B&W and other UK-based group companies alleging that defendants engaged in cigarette smuggling and money laundering in their territories. Each of these actions sought compensatory, punitive and treble damages. Defendants' motion to dismiss the complaint was granted in 2002 and plaintiffs appealed. The US Court of Appeals for the Second Circuit affirmed the dismissals, 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 brought a class action in the Kansas state court against B&W, British American Tobacco (Investments) Limited and certain other tobacco companies seeking injunctive relief, treble damages, interest and costs. The allegations are that the defendants participated in a conspiracy to fix or maintain the price of cigarettes sold in the US, including the state of Kansas, in violation of the Kansas 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 active claims were Argentina, Brazil, Canada, Chile, Italy, and the Republic of Ireland. At 31 December 2006, there were some 1,142 (2005: 1,097) pending individual cases in Italy. Some 1,113 (2005: 1,077) of these cases are pending before Justice of the Peace courts, the majority of which relate to claims of alleged fraud in connection with 'light' cigarettes. Because of the type of court involved, the most that any individual plaintiff can recover is 1,033 Euros. 678 of these cases have been suspended or decisions given in favour of British American Tobacco Italia S.p.A. There are around 27 smoking and health cases pending before Italian Civil Courts filed by or on behalf of individuals in which it is contended that diseases or deaths have been caused by cigarette smoking. There are also two labour cases for alleged occupational exposure pending in Italy. In Canada, the government of the Province of British Columbia brought a claim pursuant to the provisions of the Tobacco Damages and Health Care Costs Recovery Act 2000 against domestic and foreign 'manufacturers' seeking to recover the plaintiff's costs of health care benefits. The constitutionality of the 2000 Act was challenged by certain defendants and, on 5 June 2003, the British Columbia Supreme Court found the Act to be beyond the competence of the British Columbia legislature and, accordingly, dismissed the government's claim. The government appealed that decision to the British Columbia Court of Appeal which, on 20 May 2004, overturned the lower court's decision and declared the Act to be constitutionally valid. Defendants appealed to the Supreme Court of Canada in June and that court gave its judgment in September 2005 dismissing the appeals and declaring the Act to be constitutionally valid. Non-Canadian defendants challenged the personal jurisdiction of the British Columbia Court and those motions were heard in the Supreme Court of British Columbia. On 23 June 2006, the court dismissed all defendants' motions, finding that there is a "real and substantial connection" between British Columbia and the foreign defendants. Subsequently, defendants were granted leave to appeal. The appeal was dismissed on 15 September 2006. Defendants filed leave to appeal to 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 also being 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 a class of all consumers of cigarettes bearing "light" or "mild" descriptors since 1974 manufactured in British Columbia by Imperial, the Group's operating company in Canada. Imperial filed an appeal against the certification which was heard in February 2006. The Appeal Court confirmed the certification of the class but has limited 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 light and mild cigarettes is deceptive because it conveys a false and misleading message that those cigarettes are less harmful than regular cigarettes. Although the claim arises from health concerns, it does not seek compensation for personal injury. Instead it seeks compensation for amounts spent on "light and mild" products and a disgorgement of profits from Imperial. The motion of the Federal Government to strike out the third party notice issued against them by Imperial was heard in February 2006 and a decision is awaited. A similar "lights" and "mild" class action claim has been filed in Newfoundland. Imperial has filed a third party notice against the Federal Government. No hearing date has been set. Page 35 Contingent liabilities cont... There are currently two class actions in Quebec. On 21 February 2005, the Quebec Superior Court granted certification. The court certified two classes, which include residents of Quebec who suffered from lung, throat and laryngeal cancer or emphysema, and residents who were addicted to nicotine at the time the proceedings were filed and who have since remained addicted. There is no right of appeal. Plaintiffs have served a Statement of Claim. This litigation is expected to take several years to proceed to trial. The other class action is an attempt to establish a class claiming for personal injury or damage to property from fires caused by cigarettes that did not automatically extinguish on being dropped or left unattended. Certification of such a class was denied in October 2005. 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 to search and seize business records and documents at the head office of Imperial in Montreal. The affidavit filed by the RCMP to obtain the search warrant made allegations in relation to the smuggling of cigarettes in Canada between 1989 and 1994, naming Imperial, British American Tobacco p.l.c., B.A.T. Industries p.l.c., and certain former directors and employees. No charges have yet been laid. Imperial believes that it has conducted itself appropriately at all times, but cannot predict the outcome of any such investigation, or whether additional investigations will occur. Two actions have been started in Russia by a minority shareholder in OJSC Company British American Tobacco-Yava (BAT-Yava), a Russian incorporated subsidiary of British American Tobacco Holdings (Russia) B.V. The minority shareholder, Branston Holdings, issued a claim in Moscow seeking to have a contract between BAT-Yava and its sister company invalidated, and issued another claim in the Stavropol region alleging that certain of the directors of BAT-Yava, and other parties, took various unlawful steps. The Moscow Court has dismissed the claim and the Stavropol Court has ordered the transfer of the case filed there to Moscow. An appeal of the dismissed Moscow case has been sent to the Moscow Appellate Court. Branston has also threatened actions in the Netherlands and England but has not yet commenced these. The Company considers these 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 of the amount of any possible adverse verdict, the Company believes that the defences of the Group companies to all these various claims are meritorious both on the law and the facts, and a vigorous defence is being made everywhere. If an adverse judgment is entered against any of the Group companies in any case, an appeal will be made. Such appeals could require the appellants to post appeal bonds or substitute security in amounts which could in some cases equal or exceed 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 aggregate and despite the quality of defences available to the Group, it is not impossible that the results of operations or cash flows of the Group in particular quarterly or annual periods could be materially affected by this and by the final outcome of any particular litigation. Having regard to all these matters, the Directors (i) do not consider it appropriate to make any provision in respect of any pending litigation and (ii) do not believe that the ultimate outcome of this litigation will significantly impair the financial condition of the Group. SHARE BUY-BACK PROGRAMME The Group initiated an on-market share buy-back programme at the end of February 2003. By the close of business on 1 March, we expect that some 35 million shares will have been bought back since 1 January 2006 at a cost of Â£500 million (see page 28). During the year to 31 December 2005, 45 million shares were bought at a cost of Â£501 million. Page 36 ANNUAL REPORT AND ACCOUNTS The financial information in this preliminary announcement does not constitute statutory accounts within the meaning of section 240 of the Companies Act (as amended). The figures contained herein have been extracted from the Group's full IFRS financial statements for the year ended 31 December 2006, which will be delivered to the Registrar of Companies. The Group's full IFRS financial statements for the year ended 31 December 2005 have been delivered to the Registrar of Companies. The auditors' report on both these sets of financial statements 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 Mermaid Conference & 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 obtained during normal business hours from the Company's Registered Office at Globe House, 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

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Another day and another round of takeover talk with Hargreaves Lansdown being eyed by private equity suitors. AJ Bell also advances on upbeat earnings news whilst QinetiQ upgrades its profit guidance, too.

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