directors report and accounts 2006 - Summary financial statement and notes

 
 

 Summary financial statement and notes

The Summary Financial Statement is a summary of information in the Annual Report and Accounts and should be read with the Operating and Financial Review. Reference should also be made to the Summary Remuneration Report.

The Annual Review and Summary Financial Statement does not contain sufficient information to allow for as full an understanding of the results of the Group and the state of affairs of the Company, or of the Group, and their policies and arrangements concerning Directors’ remuneration, as would be provided by the full Annual Report and Accounts. Shareholders requiring more detailed information have the right to obtain, free of charge, a copy of the full Annual Report and Accounts for 2006, or for future years, by contacting British American Tobacco Publications as set out on the inside back cover.

Report of the auditors
The auditors’ report on the full annual accounts of the Group for the year ended 31 December 2006 is unqualified and does not contain any statement concerning accounting records or failure to obtain necessary information and explanations.

Going concern
After reviewing the Group’s annual budget and plans, the Directors consider that the Group has adequate resources to continue in operational existence for the foreseeable future and that it is therefore appropriate to continue to adopt the going concern basis in preparing the accounts.

Accounting policies
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.

Changes in accounting policies are as described in Changes in accounting policies.

Dividends and share buy-back
The dividends are as described in Adjusted diluted earnings per share and Dividends per share declared.

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 £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 presented as a dividend payment the Group statement of changes in total equity.

Between 22 September 2006 and 4 December 2006, the Company sought to repurchase 6,927,790 shares for an aggregate consideration of £100 million, which are included in the purchase of own shares in the Group statement of changes in total equity. 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. 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. (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.

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. As a result of these transactions: (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 to30 July 2004; and, (d) RJRT agreed to indemnify B&W and each of its affiliates (other than Reynolds American Inc. 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. 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.

US litigation
1. 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. As at 31 December 2006, a reimbursement suit brought by an Indian tribe and two non-governmental reimbursement suits were pending against B&W. The vast majority of other such claims have been dismissed on legal grounds.

As at 31 December 2006, B&W was named as defendant in two US cases brought by foreign government entities (São Paulo and Panama) seeking reimbursement of medical costs. In July 2006, the Delaware Superior Court granted defendants’ motion to dismiss these cases. Plaintiffs appealed to the Supreme Court of Delaware, which heard oral argument in December 2006 and reserved decision.

2. Class actions
As at 31 December 2006, B&W was named as a defendant in some 15 separate actions attempting to assert claims on behalf of classes of persons allegedly injured by smoking. In the Engle case (Florida), one jury awarded compensatory damages totalling US$12.7 million and assessed US$17.6 billion in punitive damages against B&W. The intermediate appellate court reversed the trial court’s judgment. In July 2006, the Florida Supreme Court upheld the intermediate appellate court’s decision to decertify the class, and vacated the jury’s punitive damages award. In Scott, the jury returned a verdict of US$591 million on the class’s claim for a smoking cessation programme. Defendants’ appeal to the Louisiana Fourth Circuit Court of Appeal resulted in the reduction of the award by US$312 million. In the Schwab class action complaint, the court granted plaintiffs’ motion for class certification. By order in November 2006, the Second Circuit Court of Appeals granted defendants’ motion to stay proceedings in this case, and further granted defendants’ petition for leave to appeal the class certification order.

3. Individual cases
Approximately 3,471 cases were pending against B&W at 31 December 2006, 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).

4. Consolidated claims
In the West Virginia consolidated smoking and health cases, the court so-ordered the parties' stipulation 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.

5. Conduct-based claims
In 1999, the US Department of Justice brought an action against various industry members, including RJRT and B&W. British American Tobacco (Investments) Limited is a co-defendant in the action. The trial of this claim was completed in June 2005. In August 2006, the District Court issued its final judgment, finding 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. Defendants filed a motion to stay enforcement of the judgment shortly after the judgment was issued. The court denied the stay motion, but defendants filed a notice of appeal and an emergency motion to stay the judgment before the Washington DC Circuit Court of Appeals in September 2006. In October 2006, the Court of Appeals granted defendants’ motion to stay enforcement of the judgment pending the outcome of the appeal.

6. Settlement of State Health Care Reimbursement Cases
After an Independent Auditor found that the terms of the Master Settlement Agreement (MSA) were a ‘significant factor’ in market share losses experienced by signatories to the MSA in 2003, several US tobacco companies asserted their rights under the MSA to recover a payment credit or offset for MSA payments made in April 2004. The amount at stake exceeds US$1 billion. The settling states have filed motions seeking enforcement of certain MSA provisions and defendants have opposed these motions, arguing instead for arbitration.

7. Other claims
The Flintkote Company (Flintkote), a US asbestos production and sales company, was included in the acquisition of Genstar Corporation by Imasco Limited (now Imperial Tobacco Canada Limited (Imperial)) in 1986 and became a Group subsidiary following the restructuring of Imasco in 2000. In 2003, Imperial divested Flintkote and then, in 2004, Flintkote filed for bankruptcy in the US. 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 other defendants for the recovery of dividends paid 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.

In Wisconsin, the Authorities have identified potentially responsible parties to fund the clean up of the Fox River after pollution from paper mills operating nearby, a task currently estimated to cost in the order of US$600m. Among the potentially liable parties are NCR Corporation and Appleton Papers Inc. B.A.T Industries p.l.c. purchased what was then NCR’s Appleton Papers Division from NCR Corporation, and B.A.T Industries p.l.c. spun off the Appleton Paper business in 1990 having obtained full indemnities from Appleton Papers Inc. for past and future environmental claims. Disputes have arisen between NCR Corporation and B.A.T Industries p.l.c. as to the indemnities given and received under the purchase agreement in 1978 which disputes 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, although it has never been required to do this because Appleton Papers Inc. has paid any sums demanded. It is our belief 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.

Other foreign litigation
At 31 December 2006, active claims against Group companies existed in 18 countries outside the United States but the only countries with more than five active claims were Argentina, Brazil, Canada, Chile, Italy and the Republic of Ireland. As at 31 December 2006, there were some 1,142 pending individual cases in Italy. 1,113 cases are pending before the 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 an individual plaintiff can recover is €1,033. There are around 27 smoking and health cases filed by or on behalf of individuals. There are also two labour cases for alleged occupational exposure pending in Italy.

The Supreme Court of Canada has upheld the constitutionality of the British Columbian Tobacco Damages and Health Care Costs Recovery Act. Non-Canadian defendants challenged the personal jurisdiction of the British Columbia Court but these motions were dismissed. The Court found a ‘real and substantial connection’ between British Columbia and the foreign defendants. Defendants’ appeal to this decision was dismissed in September 2006. Defendants then filed leave to appeal to the Supreme Court in November 2006.

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 Imperial manufactured cigarettes in British Columbia, not just British Columbia residents. Defendant’s appeal was heard in February 2006, and the Appeal Court confirmed the certification of the class but limited any liability, if proved, to the period from 1997. In Quebec, in February 2005, two smoking and health class actions were certified. There is no right of appeal against class certification.

Imperial is currently being investigated by the Royal Canadian Mounted Police relating to its business records and sales of products exported from Canada between 1989 and 1994. No action has been commenced against Imperial. 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 were 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 judgment. 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 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 all this litigation will significantly impair the financial condition of the Group.