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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
(Mark One)
| ☐ |
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 |
OR
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended 31 December 2018
OR
| ☐ |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
OR
| ☐ |
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Date of event requiring this shell company report
For the transition period from to
Commission file number 001-38159
British American Tobacco p.l.c.
(Exact name of Registrant as specified in its charter)
(Translation of Registrant’s name into English)
England and Wales
(Jurisdiction of incorporation or organization)
Globe House, 4 Temple Place, London WC2R 2PG, United Kingdom
(Address of principal executive offices)
Paul McCrory, Company Secretary
Tel: +44 (0)20 7845 1000
Fax: +44 (0)20 7240 0555
Globe House, 4 Temple Place, London WC2R 2PG, United Kingdom
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
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Title of each class |
Name of each exchange on which registered |
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| American Depositary Shares (evidenced by American Depositary Receipts) each representing one Ordinary Share | New York Stock Exchange | |
| Ordinary Shares, nominal value 25 pence per share | New York Stock Exchange* | |
| * |
Application made for registration purposes only, not for trading, and only in connection with the registration of the American Depositary Shares pursuant to the requirements of the Securities and Exchange Commission. |
Securities registered or to be registered pursuant to Section 12(g) of the Act.
None
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
None
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.
2,456,415,884 Ordinary Shares
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ☒ Yes ☐ No
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. ☐ Yes ☒ No
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☒ | Accelerated filer | ☐ | |||
| Non-accelerated filer | ☐ | Emerging growth company | ☐ | |||
If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act. ☐
† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
| U.S. GAAP ☐ |
International Financial Reporting Standards as issued by the International Accounting Standards Board ☒ |
Other ☐ |
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. ☐ Item 17 ☐ Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
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Transforming
Tobacco
Annual Report and Form
20-F
2018
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British American Tobacco p.l.c. (No. 3407696) Annual Report 2018
This document constitutes the Annual Report and Accounts of British American Tobacco p.l.c. (the Company) and the British American Tobacco Group prepared in accordance with UK requirements and the Annual Report on Form 20-F prepared in accordance with the US Securities Exchange Act of 1934 (the Exchange Act) for the year ended 31 December 2018. Moreover, the information in this document may be updated or supplemented only for purposes of the Annual Report on Form 20-F at the time of filing with the SEC or later amended if necessary. Any such updates, supplements or amendments will also be denoted with a ‘»’ symbol. Insofar as this document constitutes the Annual Report and Accounts, it has been drawn up and is presented in accordance with, and reliance upon, applicable English company law and the liabilities of the Directors in connection with this report shall be subject to the limitations and restrictions provided by such law.
This document is made up of the Strategic Report, the Governance Report, the Financial Statements and Notes, and certain additional information. Our Strategic Report, pages 1 to 52, includes our vision and strategy, global market overview, business model, global performance, as well as our financial performance and principal group risks. The Strategic Report has been approved by the Board of Directors and signed on its behalf by Paul McCrory, Company Secretary. Our Governance Report on pages 53 to 114 contains detailed corporate governance information and our Committee reports. The Directors’ Report on pages 53 to 72 (the Governance pages) and 253 to 321 (the Additional disclosure and Shareholder information pages) has been approved by the Board of Directors and signed on its behalf by Paul McCrory, Company Secretary. Our Financial Statements and Notes are on pages 115 to 252. The Other Information section commences on page 253.
This document provides alternative performance measures (APMs) which are not defined or specified under the requirements of International Financial Reporting Standards (IFRS). We believe these APMs provide readers with important additional information on our business. This year, we have included a Non-GAAP measures section on pages 258 to 266 which provides a comprehensive list of the APMs that we use, an explanation of how they are calculated, why we use them and a reconciliation to the most directly comparable IFRS measure where relevant.
BAT has shares listed on the London Stock Exchange (BATS) and the Johannesburg Stock Exchange (BTI), and, as American Depositary Shares, on the New York Stock Exchange (BTI).
The Annual Report is published on www.bat.com. A printed copy is mailed to shareholders on the UK main register who have elected to receive it. Otherwise, shareholders are notified that the Annual Report is available on the website and will, at the time of that notification, receive a short Performance Summary (which sets out an overview of the Group’s performance, headline facts and figures and key dates in the Company’s financial calendar) and Proxy Form.
Specific local mailing and/or notification requirements will apply to shareholders on the South Africa branch register.
References in this publication to ‘British American Tobacco’, ‘BAT’, ‘Group’, ‘we’, ‘us’ and ‘our’ when denoting opinion refer to British American Tobacco p.l.c. and when denoting tobacco business activity refer to British American Tobacco Group operating companies, collectively or individually as the case may be.
The material in this Annual Report is provided for the purpose of giving information about the Company to investors only and is not intended for general consumers. The Company, its directors, employees, agents or advisers do not accept or assume responsibility to any other person to whom this material is shown or into whose hands it may come and any such responsibility or liability is expressly disclaimed. The material in this Annual Report is not provided for product advertising, promotional or marketing purposes. This material does not constitute and should not be construed as constituting an offer to sell, or a solicitation of an offer to buy, any of our products. Our products are sold only in compliance with the laws of the particular jurisdictions in which they are sold.
References in this document to information on websites, including the web address of BAT, have been included as inactive textual references only. These websites and the information contained therein or connected thereto are not intended to be incorporated into or to form part of the Annual Report and Form 20-F.
Cautionary statement
This document contains forward-looking statements. For our full cautionary statement, please see page 296.
| www.bat.com/reporting www.bat.com/investors BAT IR app |
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Strategic Report Governance Financial Statements Other Information British American Tobacco (BAT) is one of the world’s leading consumer goods companies, with nicotine and tobacco brands sold around the globe. We employ over 55,000 people, partner with over 90,000 farmers and have factories in 48 countries, with offices in even more. Transforming Tobacco At BAT, we have been satisfying adult consumers, delivering shareholder value and creating valued employment for over a century. Today we find ourselves in one of the most dynamic periods of change our industry has ever encountered. Rapid product innovation, along with advances in societal attitudes and public health awareness, has given us the opportunity to make a substantial leap forward in our long-held ambition to positively impact the lives of millions of our consumers by providing them with lower-risk tobacco and nicotine products. We call this ambition ‘transforming tobacco’ and we are fully committed to leading the transformation of our industry and our company.
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In 2012, we articulated a clear vision that places adult consumers at the centre of our strategy. Our Transforming Tobacco ambition builds on this vision as we grow our business based on offering our consumers a broad range of outstanding products, informed consumer choice, and a drive towards a reduced-risk portfolio. More choice, more innovation, less risk. Empowering consumers through choice It is widely accepted that most of the harm associated with cigarettes is caused by inhaling the smoke produced by the combustion of tobacco, and that cigarette smoking is the most dangerous way of consuming tobacco. While smokers have historically had very few alternatives to combustible cigarettes, innovation is now providing adult consumers with a greater choice of tobacco and nicotine products that are potentially less risky than cigarettes. BAT is at the forefront of the development and sale of a whole range of potentially reduced-risk products that provide much of the enjoyment of smoking without burning tobacco. Our growing portfolio of potentially reduced-risk products (which we call PRRPs) includes vapour, tobacco heating products (THPs), modern oral products, as well as traditional oral products such as Swedish-style snus and American moist snuff. Our acquisition of Reynolds American has transformed us into one of the world’s leading vapour companies and has also allowed us to significantly increase the size of our oral tobacco and nicotine products range. Never before have so many of our consumers around the world had access to so many alternatives to combustible cigarettes. We continue to develop new and ever more innovative products to add to this range of potentially less risky choices.
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Strategic Report Governance Financial Statements Other Information In addition to our commitment to developing and offering a range of high-quality alternative products, we are also committed to working with governments and other stakeholders around the world to develop supportive regulatory regimes. While we cannot be certain how many smokers will switch to our alternative products, we have already seen several countries dismantle barriers to these new products, which has given millions of additional adult consumers greater choice. …supported by pro-active external engagement We recognise that our ambition to ‘transform tobacco’ relies not only on our development and commercialisation of new products, but on the support of regulators and society as well. Greater consumer choice is at the heart of our strategy, but its effects require amplification from sensible regulations that allow adult consumers access to alternative choices, as well as from public health bodies and the media to drive informed consumer decision making. By working with key stakeholders around the world, we strive to maximise the potential for reduced-risk products: safer choices for our consumers, benefits for public health, and a more sustainable and profitable business for our shareholders.
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Consumer preferences are diverse and constantly evolving. Our increasingly broad range of potentially reduced-risk products allows us to meet these varied preferences and create a better tomorrow for our consumers. An unrivalled range of innovative products Today, we have industry-leading products in vapour, in tobacco heating products, in modern oral products, as well as in the traditional oral category. Notwithstanding the successes of our new categories, this is just the beginning, and innovation and technology will increasingly be at the heart of our business. Our research and development facility, comprising hundreds of scientists, is focused on the continued developme of new and innovative potentially reduced-ris products and categori In 2018, we filed 130 patents and expect that number to significantly increase in the coming years. Of course, expertise in this area is not solely within BAT and, consequently, we have a number of collaborations, partnerships and investments with third parties with a broad range of specialisms to help us drive and develop our pipeline of future products.
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Strategic Report Governance Financial Statements Other Information BAT’s ongoing transformation is supported by its strong global combustibles business, and every day more than 150 million adult consumers choose BAT brands. The revenues from this business are vital to provide the investment for our PRRP business, while our global supply chain and worldwide distribution network of over 11 million retail outlets are powerful assets that drive our ambition to offer millions of adult consumers new and potentially less risky choices. …underpinned by a strong global business As we develop new and potentially reduced product categories, our conventional cigarette business remains strong and continues to grow. This enables us to invest in the development of better and more innovative products, while continuing to deliver strong results and dividends to our shareholders. As a global business operating in over 200 markets, we are using our significant presence and distribution networks to offer our full range of potentially reduced-risk product choices to as many adult consumers as possible. We are often asked why we don’t simply stop selling cigarettes. In short, immediately stopping our sales of cigarettes would be neither commercially sensible nor practical: the ongoing consumer demand for these products would either transfer straight to our competitors or, more worryingly, the black market. We are proud of all our brands and believe that all our products have a role to play in our business success and our ambition to transform tobacco.
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Overview Our potentially reduced-risk product business has seen outstanding growth. Our tobacco heating, vapour, and modern oral products are now available in 29 markets and used by six million adult consumers around the world. However, this is just the beginning, and with a growing consumer base of over one billion smokers and nicotine users in the world, the opportunities presented by these new categories are huge. Another step on an exciting journey While we cannot be certain whether all smokers will switch to potentially reduced-risk products, we are committed to improving the lives of smokers by making a range of high-quality, innovative products as widely available as we practically can. We believe that by doing this, and working with regulators to establish supportive regulatory regimes, many millions of smokers will increasingly make the choice to switch. If we can all work successfully together, we can drive a scenario in which our consumers will have a range of potentially safer choices, our shareholders will own an even more sustainable and profitable business, and society could benefit from real progress in tobacco harm reduction.
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“I am very pleased to report another strong set of results with market share, revenue, and profit from operations all growing”
Richard Burrows Chairman |
Another strong set of results
Welcome to our combined Annual Report and Form 20-F for 2018. Yet again, I am very pleased to report another strong set of results with market share, revenue and profit from operations all growing.
Our 2018 results demonstrate not only that our combustible business is in good shape, but that our investment in a multi-category approach to our potentially reduced risk-product business is starting to pay off with encouraging results across all categories.
While the business is continuing to perform well, it is impossible for us to ignore investor sentiment, which has been negatively impacted by the regulatory threats in the US and competitor dynamics in the potentially reduced-risk product categories. However, we are confident that our strategy of continuing to deliver shareholder returns today while investing in the future remains the right one.
Dividends
The Board has declared a dividend of 203.0p per ordinary share, payable in four equal instalments of 50.75p per ordinary share, to shareholders registered on the UK main register or the South Africa branch register and to American Depository Shares (ADS) holders, each on the applicable record dates.
The dividends receivable by ADS holders in US dollars will be calculated based on the exchange rate on the applicable payment dates.
Further information on dividends can be found on page 38 of the Financial Review and page 298 in the Shareholder information section.
A sustainable and well-governed business
As we work to transform our business, we remain equally focused on our Sustainability Agenda, which forms an integral part of our group strategy.
Given the important role that sustainability plays in securing the future of our business, we are constantly seeking new ways to further improve our practices. For example, in 2018 we updated our Supplier Code of Conduct with new human rights provisions for responsible sourcing of conflict minerals, as well as wages, benefits and working hours.
Additionally, good governance has long been a key priority for the Group, and we continue to strengthen our internal compliance programmes to ensure transparent and responsible corporate behaviour. For instance, in 2018 we enhanced our anti-bribery and corruption procedures with initiatives including a new third-party assessment procedure and a ‘Speak Up’ hotline, which empowers employees and business units to better identify and mitigate risks in key compliance areas.
Our efforts in these areas continue to be recognised externally, and I am proud to report that we were once again the only company in our industry to have been included in the Dow Jones Sustainability Indices’ prestigious World Index in 2018, while our Modern Slavery Act Statement has been ranked 3rd in the Global Governance FTSE 100 League Table.
Board composition and outlook
Our Chief Executive, Nicandro Durante, retires at the beginning of April 2019. During his eight years in the role he has grown the business substantially, delivering consistent and strong growth in both earnings and dividends. Importantly, he was the architect of the current strategy to transform the business and, with the successful establishment of BAT’s potentially reduced-risk products business and the acquisition of Reynolds American Inc., has created a stronger, truly global tobacco and nicotine company.
On behalf of the Board, I would like to thank him for his tremendous work, which has left BAT well positioned for future growth and success.
I would like to welcome Jack Bowles, our current CEO Designate, to the role of Chief Executive effective 1 April 2019. The Board was delighted to have been able to appoint such an experienced and dynamic successor from within BAT. In his most recent roles – as Director of the Asia Pacific Region and as Chief Operating Officer – Jack demonstrated excellent strategic leadership, delivering strong business growth including in vapour and tobacco heating products, as well as building very strong management teams. His track record of innovating and his experience across so many geographies and areas of the business position him extremely well to build on Nicandro’s achievements and write the next successful chapter in BAT’s history.
Ben Stevens, the Group’s Finance Director since 2008, will also retire from the Board in August of this year. Throughout his 30-year career at BAT, Ben contributed an enormous amount to the Company, and as an outstanding Finance Director he has been instrumental in ensuring the Company’s consistent earnings growth. On behalf of the Board, I would like to thank Ben for his leadership and invaluable contributions.
I am very pleased that Tadeu Marroco will be bringing his 26 years of experience within the Group to the Board when he succeeds Ben this summer. Given his broad experience as a Director of Western Europe, Director of Business Development, and Director of Group Transformation, the Board has full confidence that he will play a key role in continuing to deliver our ambition to transform our Company and our industry.
Additionally, Lionel Nowell, III, retired from the Board of British American Tobacco p.l.c. with effect from 12 December 2018. Lionel had served as a Non-Executive Director since July 2017 and had been a member of the Audit and Nominations Committees since October 2017.
Richard Burrows
Chairman
| BAT Annual Report and Form 20-F 2018 | 07 | |
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for transforming tobacco
Our strategy remains as relevant today to drive our transforming tobacco ambition as it was when it was first rolled out in 2012. It enables us to continue delivering value growth while driving the investment required to deliver our transformational agenda.
Our vision remains clear: while combustible tobacco products will remain at the core of our business for some time to come, we understand that long-term sustainability will be delivered by our transforming tobacco ambition.
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| 08 | BAT Annual Report and Form 20-F 2018 | |
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Our vision
World’s best at satisfying
consumer moments in
tobacco and beyond.
Our consumers are at the core of everything we do and our success depends on addressing their preferences, concerns and behaviours.
We know that consumer preferences are fragmenting and evolving at an unprecedented pace, and consequently, we are focusing on providing a range of tobacco and nicotine products across the risk spectrum. In addition, we understand that to succeed in this space we need to continue enhancing our understanding of our consumers’ preferences in order to drive development of new and innovative products.
Our mission
Delivering our commitments
to society, while championing
informed consumer choice.
We have long known that, as a major international business, we have a responsibility to address societal issues with our tobacco products, and that, as our business continues to grow, so does our influence and the responsibility that comes with it.
We are also clear that we have a duty to our shareholders to ensure we continue to deliver today and invest for a sustainable future and to our consumers to provide, in addition to our combustible products, a range of potentially reduced-risk products (PRRPs).
Our transforming tobacco ambition, with its core objective of providing adult consumers with more choice, more innovation and less risk will allow us to: satisfy these consumers; address societal concerns through the growth of multiple categories of potentially reduced-risk tobacco and nicotine products; and provide a sustainable, profitable future for our shareholders.
Strategic focus areas
Our four key focus areas remain fundamental to our strategy as we focus on our transforming tobacco ambition.
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Growth | page 20 | ||
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Constantly developing our portfolio of potentially reduced-risk products and new technologies while continuing to drive revenue growth from our traditional combustible products.
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Productivity | page 22 | ||
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Effectively deploying resources between product categories and managing our cost base to release funds for investment.
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Winning organisation | page 24 | ||
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Ensuring we have great people with the right skill sets in the right teams to drive the transformation of our business.
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Sustainability | page 28 | ||
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Ensuring a sustainable business that meets the expectations of all our various stakeholders.
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Read about our industry | page 15 | ||
Guiding Principles
Our Guiding Principles provide clarity about what we stand for.
They form the core of our culture and guide how we deliver our strategy.
Enterprising spirit
We value enterprise from all of our employees across the world, giving us a great breadth of ideas and viewpoints to enhance the way we do business. We have the confidence to pursue growth and new opportunities while accepting the considered entrepreneurial risk that comes with it. We are bold and strive to overcome challenges. This is the cornerstone of our success.
Freedom through responsibility
We give our people the freedom to operate in their local environment, providing them with the benefits of our scale but also the ability to succeed locally. We always strive to do the right thing, and this freedom enables us to act in the best interests of our consumers while exercising our responsibility to society and other stakeholders.
Open minded
Our corporate culture is a great strength of the business and one of the reasons we have been, and will continue to be, successful. We are forward-looking and anticipate consumer preferences, winning with innovative, high-quality products. We listen to, and genuinely consider, other perspectives and changing social expectations. We are open to new ways of doing things.
Strength from diversity
Our management population comprises people from over 140 nations, giving us unique insights into local markets and enhancing our ability to compete across the world. We respect and celebrate each other’s differences and enjoy working together. We harness diversity – of our people, cultures, viewpoints, brands, markets and ideas – to strengthen our business. We value what makes each of us unique.
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Notes: To supplement our results of operations presented in accordance with IFRS, the information presented also includes several non-GAAP measures used by management to monitor the Group’s performance. See the section Non-GAAP measures beginning on page 258 for information on these non-GAAP measures, including their definitions and reconciliations from the most directly comparable IFRS measure, where applicable. Certain of our measures are presented based on constant rates of exchange, on an adjusted basis, on a representative basis and on an organic basis.
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Where measures are presented ‘at constant rates’, the measures are calculated based on a re-translation, at the prior year’s exchange rates, of the current year results of the Group and, where applicable, its segments. See page 42 for the major foreign exchange rates used for Group reporting. |
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Where measures are presented as ‘adjusted’, they are presented before the impact of adjusting items. Adjusting items represent certain items of income and expense which the Group considers distinctive based on their size, nature or incidence. |
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Where measures are presented as ‘organic’ or ‘org’, they are presented before the impact of the contribution of brands and businesses acquired during the comparator period, including Reynolds American, Bulgartabac, Winnington and Fabrika Duhana Sarajevo in 2017. There were no material acquisitions or disposals in 2018. |
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Where measures are presented as ‘representative’, ‘rep’ or ‘on a representative basis’, they are presented inclusive of the acquired businesses in the 2017 comparator period as though those businesses had been included in the consolidated results for the whole of that comparator period and including certain additional adjusting items related to the acquired companies. |
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Operating margin
Definition: Profit from operations as a percentage of revenue. |
Diluted earnings per share (EPS)
Definition: Profit attributable to owners of BAT p.l.c. over weighted average number of shares outstanding, including the effects of all dilutive potential ordinary shares. |
Net cash generated from operating activities (£m)
Definition: Movement in net cash and cash equivalents before the impact of net cash used in financing activities, net cash used in investing activities and differences on exchange.
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Adjusted
2
operating margin
Definition: Adjusted profit from operations as a percentage of adjusted revenue. |
Change in adjusted
2
diluted EPS
Definition: Change in diluted earnings per share before the impact of adjusting items.
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Total shareholder return (TSR) of the
The FMCG group comparison is based on three months’ average values
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Change in adjusted
2
diluted EPS
Definition: Change in diluted earnings per share before the impact of adjusting items and the impact of fluctuations in foreign exchange rates.
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Cash conversion
Definition: Net cash generated from operating activities as a percentage of profit from operations. |
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Total dividends per share
Definition: Dividend per share in respect of the financial year. Target: To increase dividend in sterling terms, based upon the Group’s policy to pay dividends of 65% of long-term sustainable earnings. |
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Nicandro Durante
Chief Executive
A winning strategy
After 37 years at BAT, eight of them as CEO, I will retire in April 2019. I have seen BAT evolve and grow throughout my career, and am confident that this will continue during the dynamic period of change the industry is going through today.
When I became CEO in 2011, we articulated a strategy to put the consumer at the heart of our business, and a vision to be the best at satisfying consumer moments in tobacco and beyond. This strategy has enabled us to deliver consistent outstanding year-on-year growth and shareholder returns, while at the same time establishing a successful and diverse potentially reduced-risk products (PRRP) business designed to meet the evolving and varied preferences of today’s consumers.
Thanks to this strategy, the Group continues to perform well. Our 2018 reported revenue and profit from operations are up 25% and 45% respectively, and while this is of course due primarily to our first full year’s inclusion of results from the US, we have nonetheless again exceeded our target of high single figure adjusted diluted constant currency EPS growth with an increase of 11.8%. This was driven not only by the strong performance of our combustible business, but also by the near-doubling of THP and vapour revenue.
Notwithstanding these results, it is clear that the market has concerns in relation to the impact of the changes the industry is going through and in respect of threatened regulatory developments. I am, however, confident that the business is in extremely good shape and that these changes, in reality, present significant opportunities for future growth. With our core combustibles business outperforming the industry, and with a strong and broad multi-category portfolio of PRRPs capable of meeting the evolving preferences of consumers around the world, I believe we are in a good position to deliver long-term sustainable growth.
A strong portfolio of both combustibles and PRRPs
Our results in 2018 reflect the successful performance of all elements of our portfolio, and highlight the importance of expanding consumer choice across all of our categories.
In combustibles, Group market share was up 40 basis points, driven by another strong performance from the Strategic Cigarette and THP brands, which grew volume by 5.8%.
In THP, our revenue increased to £565 million or £576 million, at constant rates. Our glo brand has achieved 4.7% market share (20% category share) in Japan, and continues to grow market share in South Korea, Romania and Italy.
The Group’s vapour portfolio performed strongly with significant growth in both volume and revenue across our 15 vapour markets. Momentum increased, with growth weighted towards the second half of the year driven by new market and product launches. Total vapour volume was up by 35% on a representative basis with good performances in the world’s three largest vapour markets – the US, the UK and France.
In oral tobacco we continue to grow value with strong performances from modern oral products such as Epok in Sweden, Norway and Switzerland, as well as traditional products such as Grizzly in the US, where revenues were £931 million, an increase of 3.1% on an adjusted representative basis.
Reynolds American Inc. (RAI)
RAI is delivering strong financial results for the Group. In 2018, revenue was up 128% (as a result of the full year effect). This was an increase of 1.5% on a representative constant currency basis, and was driven by robust price mix and a 25 basis points growth in value share, despite a decline in total volume. With adjusted operating margin up 180 bps, adjusted profit from operations was up 5.8% on a representative, constant rate basis. Annualised cost savings resulting from the acquisition are now running at over US$300 million per year, and we are on track to deliver at least US$400 million per year in cost synergies by the end of 2020.
While FDA regulatory proposals have driven some uncertainty in the US operating environment, our long track record of success in the face of regulatory change and our strong portfolio of brands give us confidence that we will be able to manage these issues. We are additionally reassured by the fact that, in order to withstand judicial review, any regulation of menthol in cigarettes must be developed through a comprehensive rule-making process, be based on a thorough scientific review and consider all unintended consequences.
Handing over
I am extremely pleased that the Board has chosen Jack Bowles as my successor. I have no doubt that his broad-ranging experience and expertise, combined with his energy, passion and drive for success, will help ensure the future growth of the Company.
I am tremendously proud of what we have achieved in the last eight years, and would like to thank all of my colleagues across the Group for their part in this.
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Jack Bowles
Chief Executive Designate
An exciting time for BAT
It is an exciting time for me to take over as CEO. Our industry is evolving and with this comes great opportunity.
With our depth of talent, our iconic brands and our range and pipeline of PRRPs, I am confident that we will take full advantage of these opportunities as we accelerate the transformation of BAT into a stronger multi-category tobacco and nicotine products company.
Strong foundations
It gives me great comfort to know that the fundamentals of our business are in such good shape. Our combustible business continues to deliver strong year-on-year growth. Our acquisition of RAI has made us a truly international tobacco and nicotine products business, and our PRRP business is firmly established and growing.
Our current strategy, with its aim of being the world’s best at satisfying consumer moments in tobacco and beyond, remains as relevant today as it was when it was first rolled out in 2012. The consumer is, and will continue to be, at the heart of everything we do. We know that our consumers’ tastes and preferences are evolving and fragmenting, and it is to satisfy these varied preferences that we have developed a broad range of different products with the potential to provide lower risks than combustible cigarettes.
Accelerating the delivery of our strategy
With confidence in our multi-category approach, we are now focused on our need to accelerate the delivery of our transforming tobacco ambition. Notwithstanding our great success to date in establishing our PRRP business, we acknowledge that we are at the start of a long journey. As the number of our consumers grows, our focus will be on accelerating our strategy to ensure that our products are able to satisfy the preferences of those many millions of adult smokers who are still looking for a satisfying but less risky alternative to their current products.
In order to further enhance the focus on our consumers we have created two new Management Board roles. Our new Director of New Categories will have end-to-end accountability for driving growth, innovation, world-class brand building and consumer insights for our PRRPs, while our new Director of Digital and Information is tasked with responsibility for enhancing our digital consumer capabilities.
Vision for success
I am excited about the challenges and opportunities that lie ahead for us. We have the right strategy, the right foundations, the right vision, and, most importantly, employees with the right skills and attitude to enable us to keep growing the Company for many years to come.
| BAT Annual Report and Form 20-F 2018 | 13 | |
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Strategic Management
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“The Group again delivered growth across all key performance indicators”
Ben Stevens Finance Director |
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Strong performance across all measures
Despite external challenges, translational foreign exchange headwinds of approximately 6% on revenue and profit from operations, and further investment in PRRPs, the Group again delivered growth across all key performance indicators in 2018.
Since the Group’s 2018 results are, on a reported basis, influenced by the full year inclusion of RAI (compared against five months in 2017), the results are also provided with a comparison on a representative basis, as though the Group had owned RAI and other acquisitions for the whole of the 2017 comparator period. This will provide readers with an understanding of the Group’s performance inclusive of RAI and other acquisitions in both 2017 and 2018.
Increase revenue and profit from operations
Revenue grew by 25.2% in 2018 to £24,492 million (2017 was up 38.5% at £19,564 million) largely due to the acquisition of RAI, concluded in July 2017. Adjusting for the impact of acquisitions, excise on bought-in goods and the impact of currency, adjusted revenue grew by 3.5% in 2018 on a representative constant rate basis, while 2017 had seen an increase of 2.9% (on an organic basis). This 2018 growth was driven by price mix (6% on combustibles) and the growth of vapour, THPs and modern oral, which more than offset a decline in combustible volume.
Profit from operations was up 45.2% (2017: up 38%), as the inclusion of 12 months of results from RAI and growth in revenue more than offset the ongoing investments in THP and vapour, the amortisation of acquired brands and the costs incurred as part of the Group’s restructuring programme.
Adjusted profit from operations grew by 4.0% on a constant currency representative basis (2017: up 3.7% organic, at constant rates).
A full reconciliation of our results under IFRS to adjusted revenue and adjusted profit from operations is provided on pages 258 to 261.
Against a backdrop of challenging conditions, notably the foreign exchange headwind, all regions performed well (as described on pages 43 to 47), growing adjusted profit from operations at constant rates of exchange on a representative basis, while investing in THP and vapour. This continues to demonstrate the ability of the Group, due to its geographic diversity, to offset the challenging environment in a number of markets.
Our operating margin increased by over 500 bps. This was driven by the positive mix effect from the consolidation of a full year’s results from RAI, while certain purchase price accounting adjustments that affected 2017 did not repeat. On an adjusted, representative basis, operating margin increased by 40 bps, as the Group continued to drive margin improvements while investing in the roll-out of PRRPs.
EPS movements reflect strong fundamentals
Net finance costs increased by £287 million to £1,381 million driven by the full year interest charge incurred in the year on borrowings of £47,509 million. Our banking facilities require a gross interest cover of at least 4.5 times. In 2018, our gross interest cover was 7.2 times (2017: 7.8 times, 2016: 12.2 times).
On a reported basis, basic EPS was 86% lower than 2017 at 264.0p, as the prior period (up 633% against 2016 at 1,833.9p) was materially affected by a deemed gain (£23.3 billion) on the disposal of the Group’s holding in RAI, required as part of the acquisition accounting. In 2017, the Group also recognised a deferred tax credit (£9.6 billion) related to the tax reforms in the US. Excluding these and other adjusting items, including those related to the acquisition of RAI, and the effect of foreign exchange on the Group’s results, adjusted diluted earnings per share, at constant rates, increased by 11.8% to 315.5p, with 2017 ahead of 2016 by 9.1%.
Cash flow generation drives deleveraging
In 2018, net cash generated from operating activities grew by 93% to £10,295 million. This was principally due to the inclusion of a full year’s cash flow from RAI, the timing of payments related to the Master Settlement Agreement (MSA) in the US, the cessation in 2017 of payments in relation to the Quebec Class Action and the ongoing cash generation in the rest of the Group.
Adjusted cash generated from operations (as defined on page 264) was £8,071 million, which represents an increase of 146% over 2017, or 158% on a constant rate basis. Excluding the timing of the early payment of the 2017 MSA liability, paid in 2017 and tax deductible at 2017 tax rates, adjusted cash generated from operations would have increased by over 43%.
Based upon net cash generated from operating activities, the Group’s cash conversion ratio increased from 83% in 2017 to 111% in 2018.
Adjusted net debt to adjusted EBITDA, as defined on page 266 provides a measure to assess the Group’s ability to meet its borrowing obligations. The Group continues to focus on a balanced approach of deleveraging, while investing for the future and providing a return via dividends to shareholders.
Delivering today and investing in the future
The Group continues to deliver against the financial imperatives, which supports the growth in dividends while deleveraging and investing in PRRPs for tomorrow’s success.
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Other Information
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Today’s total tobacco and nicotine market comprises a growing user
pool of over one billion individual adult consumers.
While the decline in combustible cigarette consumption is expected to continue, it is predicted to be, at least partially, offset by the increasing
consumption of PRRPs, in particular vapour, tobacco heating and modern oral products.
Global potentially reduced-risk products (PRRP) market
The global tobacco and nicotine market is increasingly diversifying beyond traditional combustible tobacco with the growth of vapour and tobacco heating products (THPs), as well as the oral tobacco and nicotine market. The latest global figures (2017) suggest that the THP and vapour market is worth an estimated US$18 billion, while the oral tobacco and nicotine market is worth an estimated US$12.5 billion.
Vapour products have developed quickly across the world, with particularly strong growth in the US, France and the UK. While the overall prevalence of THPs is less than that of vapour, these products have emerged strongly in Japan and South Korea.
While traditional oral products show steady incremental growth, the modern oral category is quickly establishing itself and is expected to show accelerated volume expansion.
PRRP regulation
The THP and vapour market is relatively nascent, and regulation is in its early stages. Globally, there is a mix of attitudes between regulators who aim to encourage THPs and vapour as products that are potentially lower risk for smokers and those who view them with greater scepticism – including some countries where they are banned.
Although many jurisdictions have yet to implement clear regulations concerning PRRPs, an increasing number of governments are passing laws that allow and encourage the growth of these categories. As the science continues to move in the direction of confirming the potential of these products to offer lower risk, more permissive regulations are expected to follow.
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see pages 48 to 52 to learn more about our Principal Group risks
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for further discussion regarding the regulation of our business, please see pages 274 to 279 |
The UK is an example of what can happen with the support of regulators and public health bodies. Driven by influential reports from Public Health England and the Royal College of Physicians on the reduced risk of vapour products, the UK Government has implemented a supportive regulatory regime which is a contributing factor to category growth in the country.
Global combustible market
The most recent estimates for the global tobacco market (2017) indicate it is worth approximately US$785 billion (excluding China). More than US$700 billion of this comes from the sale of conventional cigarettes, with over 5,400 billion cigarettes consumed per year.
While combustible cigarettes remains the largest category, their volumes have seen a gradual fall over many years driven by increased regulation and changing societal attitudes. Although this is a trend which is predicted to continue, the growth of new categories of potentially reduced-risk tobacco and nicotine products is expected to, at least partially, offset this decline in combustible tobacco products.
Illicit tobacco
A contributing factor to the decline of legal tobacco volumes is the rise in the consumption of illicit products. Cigarettes are a reliable source of tax revenue for governments worldwide, and price differentials between markets, regulatory changes and broader macroeconomic pressures have driven the establishment of a significant illicit cigarette trade. The World Health Organization (WHO) estimates that one in every ten cigarettes and tobacco products consumed globally is illicit, with the market supported by various players, ranging from individuals to organised criminal networks involved in arms and human trafficking.
It is generally accepted that there is a direct correlation between steep and ad hoc increases in taxes and an increase in illicit sales, with the current sanctions doing little to deter criminals for whom profits from the illegal sale of tobacco remain an appealing prospect. For example, following successive excise increases, the Australasia region has seen legal volumes decline substantially. However, in markets where effective action has reduced the prevalence of illegal tobacco, legal volumes have been restored.
Combustible regulation
Tobacco is one of the world’s most regulated and most taxed industries. Manufacturers are required to comply with a swath of regulations that vary considerably across markets.
Legislation and subsequent regulation is focused mainly on the introduction of plain packaging, product-specific regulation, graphic health warnings on packs, tougher restrictions on smoking in enclosed public places and bans on shops displaying tobacco products at the point of sale.
In more recent years, governments have begun considering and adopting regulations aimed at menthol flavourings, as well as environmental concerns resulting from the litter associated with cigarette consumption.
Litigation
Legal and regulatory court proceedings continue in a number of forms against the tobacco industry, with the most common being third-party reimbursement cases, class actions and individual lawsuits.
Special factors that led to product liability litigation in the US and Canada are not typically replicated in other countries, which is why large volume and high-value litigation has not generally spread to other parts of the globe. The industry has a proven track record of defending its rights and managing risks such as these.
| * |
All data sources on this page are from Euromonitor International unless otherwise stated. |
| BAT Annual Report and Form 20-F 2018 | 15 | |
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British American Tobacco is a leading, multi-category consumer goods company that provides tobacco and nicotine products to millions of consumers around the world.
Our portfolio reflects our commitment to meeting the preferences of today’s adult smokers while transforming tobacco with a choice of potentially reduced-risk products.
These include vapour, tobacco heating products, modern oral products including tobacco-free nicotine pouches, as well as traditional oral products such as snus and moist snuff.
Our products are sold in over 200 markets with a balanced presence in high-growth emerging markets and highly profitable developed markets. Our business is divided into four regions across six continents.
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Our Strategic Portfolio comprises our key brands in both the combustible and PRRP categories. This drives focus and investment on the brands and categories that will underpin the Group’s future growth.
We also have a portfolio of international and local brands which, while not the focus of our investment, contribute valuable returns across several key markets.
| * |
Our vapour product Vuse, and oral products Grizzly, Camel Snus and Kodiak, which are only sold in the US, are subject to FDA regulation and no reduced-risk claims will be made as to these products without agency clearance. |
| BAT Annual Report and Form 20-F 2018 | 17 | |
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At the centre of our global business, operating in over 200 markets, is the manufacture and marketing of superior combustible tobacco products and
potentially reduced-risk products (PRRPs).
These include vapour, tobacco heating products (THPs), modern oral as well as traditional oral products, such as moist snuff and
traditional snus.
Our sustainable approach to sourcing, production, distribution and marketing helps us to create value for a wide group of stakeholders, from farmers to
consumers.
We use our unique strengths and employ our resources and relationships to deliver sustainable growth in earnings for our shareholders. For more information
on the structure of the Group, see page 254
Non-financial
information
Our people and culture: pages 24 to 27
Respect for human rights: pages 28 to 32
Anti-corruption and anti-bribery:
pages 30 and 31
Environmental matters: page 32
Community and social matters: page 32
| 18 | BAT Annual Report and Form 20-F 2018 | |
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Consumers
We place consumers at the centre of our business. We invest
in world-class research to understand changing consumer preferences and buying behaviour. This drives our leaf sourcing, product development, innovations, brands and trade activities. We aim to satisfy consumers with a range of inspiring
products across the risk spectrum and address expectations about how we should market them.
Produce
What we do
We manufacture high-quality cigarettes, THP consumables and oral products in facilities all over the
world. We also ensure that these products and the tobacco leaf we purchase are in the right place at the right time. Our vapour and tobacco heating product devices are manufactured in a mix of our own and third-party factories. We work to ensure
that our costs are globally competitive and that we use our resources as effectively as possible.
What makes us different
• In 2018, we had 55 factories, 47 of which produce cigarettes. These strategically placed factories enable us to maximise efficiency and ensure products are where they need to be at
the right time.
• Our production facilities producing cigarettes and the consumables for our THPs are designed to meet the needs of an agile and flexible supply chain,
providing a world-class operational base that is fit for the future.
• For our vapour and tobacco heating product devices, we expect our contract manufacturers to
comply with the same high standards that exist on our own sites.
see pages 22 and 23 for more details
Distribute
What we do
We distribute
our products around the globe effectively and efficiently using a variety of different distribution models suited to local circumstances and conditions. Around half of our global cigarette volume is sold by retailers, supplied through our direct
distribution capability or exclusive distributors. We continuously review our route to market for both combustible and PRRPs, including our relationships with wholesalers, distributors and logistics providers.
What makes us different
• Our relationships with, and efficient distribution to, retailers worldwide ensure
we can offer the products our adult consumers wish to buy, where and when they want them.
• Our global footprint and direct distribution capabilities enable new product
innovations to be distributed to markets quickly and efficiently.
Resources for success
Innovation
We make significant investments in research and development to deliver innovations
that satisfy or anticipate consumer preferences and generate growth for the business across all categories. The main focus of this investment is in our PRRPs. We continue to invest in the development and commercialisation of potentially
lower-risk alternatives to smoking. We also conduct R&D into our conventional cigarette innovations such as capsule products, additive-free products, slimmer products, tube filters and Reloc, our resealable pack technology.
World-class science
We have an extensive scientific research programme in a broad spectrum of scientific fields
including molecular biology, toxicology and chemistry. We are transparent about our science and publish details of our research programmes on our dedicated website,
www.bat-science.com,
and the results of
our studies in peer-reviewed journals.
You can take a video tour inside our
state-of-the-art
plant biotechnology labs and meet some of the scientists behind the science at www.bat.com/labtour or at
www.youtube.com/ welcometobat
see pages 21, 22 and 28 for more information
BAT Annual Report
and Form
20-F
2018
| BAT Annual Report and Form 20-F 2018 | 19 | |
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Growth | |
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Our multi-category portfolio of brands continued to deliver in 2018, driven by our Strategic Portfolio.
Highlights during the year
– Group revenue grew by 25% at current rates of exchange, 3.5% adjusted representative at constant rates;
– Group market share in Key Markets up by 40 bps;
– Strategic Portfolio cigarette and THP volume grew 17.9% (+5.8% representative).
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Business performance
Group cigarette and THP volume from subsidiaries was 708 billion, an increase of 3.3%, with revenue up 25.2% at £24,492 million against the previous year due to the inclusion of a full year’s volume from RAI. On a representative basis, volume was 3.5% lower as growth in Pakistan, Japan (driven by THP), Turkey, Poland, Romania and Egypt was more than offset by declines in the GCC, US, Russia and Brazil.
Adjusted revenue, on a constant rate representative basis grew 3.5%, as pricing and the growth in PRRPs more than offset the decline in volume.
The Group’s cigarette and THP market share in its Key Markets continued to grow, up 40 basis points (bps). This was driven by another excellent performance by our Strategic Cigarette and THP portfolio with volume up 5.8% on a representative basis.
The Group’s THP and vapour portfolio contributed £883 million of revenue, or £901 million at constant rates of exchange, due to the expansion in the geographic footprint and the inclusion of a full year’s revenue from the acquired RAI portfolio. On a representative, constant rate basis the increase was over 95%, demonstrating the strong underlying growth in the year.
Strategic Portfolio
Our Strategic Portfolio comprises leading brands across the combustible and PRRP categories. This drives focus and investment on the brands and categories that will underpin the Group’s future growth.
Strategic Cigarette and THP brands
Our eight Strategic Combustible Brands account for over 60% of the cigarettes we sell and play a key role in our growth strategy.
Dunhill: Market share was stable as strong performances in Indonesia, Brazil and South Africa were offset by the effect of down-trading in Saudi Arabia and South Korea. Volume was 6.1% lower as the continued growth in Indonesia was more than offset by the effect of the down-trading noted above and market size contraction in Brazil, South Africa and Malaysia.
Kent: Market share was up 50 bps, with volume increasing 1.7%, driven by Japan (including Kent Neo Sticks for glo), Turkey, Brazil and Ukraine. This more than offset lower volume in the Middle East and Russia (despite an increase in market share as volume was affected by trade inventory movements).
Lucky Strike: Market share grew 20 bps, which was driven by Indonesia, Japan, Colombia, Spain, France, Argentina and Mexico. Volume was 1.0% down as growth in Germany, Colombia, Japan and Argentina was more than offset by declines due to industry contraction in Indonesia and France.
Pall Mall: Market share grew 10 bps, with volume up 20.4% partly due to the inclusion of Pall Mall in the US following the acquisition of RAI. This was an increase of 9.9% on a representative basis, partly due to the strong volume and market share growth in Saudi Arabia that followed the market down-trading arising from the excise-led price increases in 2017. Pakistan continued to grow volume and market share after the revision to excise, with higher volume and market share also achieved in Mexico, Egypt and Australia.
Revenue
(£m)
Definition: Revenue recognised, net of duty, excise and other taxes.
In 2018, revenue includes £17,257 million of revenue from the Strategic Portfolio, an increase of 49% on 2017 (on a reported and representative basis).
Change in adjusted revenue
at constant rates (%)
Definition: Change in revenue before the impact of adjusting items and the impact of fluctuations in foreign exchange rates.
Change in adjusted revenue from the
Strategic Portfolio at constant rates (%)
Definition: Change in revenue from the Strategic Portfolio before the impact of adjusting items and the impact of fluctuations in foreign exchange rates.
This measure was introduced in 2018, with no comparators provided.
Strategic Cigarette and THP volume
2017: +17.9% (+7.6% organic)
2016: +7.5%
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Group market share of key markets
2017: +40 bps
2016: +50 bps
Total shareholder return (TSR) of the FMCG group – 1 January 2016 to 31 December 2018 (%)
The FMCG group comparison is based on three months’ average values
Rothmans: Market share continued to grow, increasing a further 110 bps with volume up 19.7% driven by Ukraine, Russia, Nigeria, Bulgaria and migrations in Poland, Brazil and Colombia.
Newport: Market share grew 10 bps in the US. Volume declined 4.6%, on a representative basis, partly due to inventory movements within the supply chain, with the US market down 4.5-5.0% due to higher gasoline prices, 2017 excise-led price increase in California and the growth of vapour.
Camel: Market share was flat in the US. Volume was lower by 4.4%, on a representative basis, partly due to a strong comparator period.
Natural American Spirit: Share momentum continued in the US, up 20 bps, with volume higher by 3.5% on a representative basis, outperforming the market (estimated to be 4.5-5.0% down) due to a strong performance in the premium segment.
Potentially reduced-risk products (PRRPs)
A key component of our Strategic Portfolio are our PRRPs, which comprise vapour, THPs, and modern white oral products as well as traditional oral products such as moist snuff and snus. We are seeking to lead the entire category and have a suite of products to cater to consumers’ many and varying preferences.
Vapour products
The Group’s vapour portfolio performed strongly with significant growth in both volume and revenue across our 15 vapour markets. Momentum increased throughout 2018, with much of the growth weighted towards the second half of the year driven by new market and new product launches.
Total vapour volume was up by 100%, partly due to the acquisition of RAI. On a representative basis this was an increase of 35% with good performances in the world’s three largest vapour markets – the US, the UK and France.
More specifically, US vapour volume of consumables grew by 36%, on a representative basis, with the market rapidly expanding (up 120% in volume terms). This was driven by the expansion of Vuse following the expansion of Alto and re-launch of Vibe.
Vype and the Group’s other vapour brands in the rest of world (including Ten Motives and VIP in the UK) grew volume by 34%, driven by market-leading performances in the UK and France.
Our new Vype ePen3 is performing extremely well in launch markets such as Canada and the UK, where it was voted Vapour Product of the Year in the UK’s largest consumer survey of product innovation, and is indicative of the strong product pipeline we have in place to cater to changing preferences in this category.
Tobacco heating products (THPs)
The Group delivered significant growth in the THP category in 2018. In Japan, which accounts for 70% of global industry volume, our launch of neosticks returned us to growth, reaching a total market share of 4.7% in December 2018 and a 20% share of the category.
Across our 15 THP markets, we have grown total THP revenue, at constant rates, by over 180% to £576 million, and have increased consumables volumes by 217% to 7 billion sticks. While the majority of growth has been in Japan, glo is increasing market share in roll-out markets including South Korea, Romania and Italy, and is showing good initial results in recent launch markets including Croatia.
Modern oral products
Our modern oral category comprises the brands EPOK and Lyft, which both experienced significant growth in 2018. Total revenue grew 127% to £34 million, a 140% increase on a representative, constant rate basis.
EPOK performed well, achieving, in December 2018, 8% and 17% share of the total oral market in Norway and Switzerland respectively, being the fastest growing brand in the category.
Lyft, the Group’s tobacco-free product, was launched in Sweden, achieving 4.5% total oral market share in handlers.
Traditional oral products
Our traditional oral category, comprising snus and moist snuff, grew revenue from the Strategic Brands by 128% in 2018, a representative constant rate increase of 9%. While US volumes were down 2.3%, on a representative basis, in part due to a decline in the total market and a reduction in Grizzly market share over the year of 40 bps as the brand lapped a tough comparator which benefited from a competitor’s product recall, returning to growth in the final quarter of 2018. This was more than offset by total pricing and a 40 bps increase in total value share, with revenue from the strategic portfolio growing 8% to £893 million, on a constant rate, representative basis.
Local and international cigarette brands
In addition to the brands comprising our Strategic Portfolio, we have many other international and local cigarette brands including Vogue, Viceroy, Kool, Peter Stuyvesant, Craven A, Benson & Hedges, John Player Gold Leaf, State Express 555 and Shuang Xi.
In addition to revenue and the other measures discussed in this Annual Report and Form 20-F, BAT management focuses on volume as a key measure to evaluate performance. Volume is an unaudited operating measure and is calculated as the total global cigarette, THP, vapour or oral volume of the Group’s brands sold by its subsidiaries. The Group believes that volume is a measure commonly used by analysts and investors in the industry. Accordingly, this information has been disclosed to permit a more complete analysis of the Group’s operating performance.
The Group also uses market share to evaluate its performance. The Group evaluates changes in its key market offtake share (as measured by retail audit agencies (including Nielsen), shipment share estimates and share of retail for the US business) for tobacco products, based on the latest available data from a number of internal and external sources. Key markets consist of approximately 40 territories across all geographical segments, and represent approximately 80% of the Group’s global volume. Growth in these markets is largely driven by the Strategic Portfolio. The Group also highlights drivers for change in specific markets (e.g., volume, market share or value share (being the customer sales price earned as a proportion of the industry total customer sales price)). For PRRPs, the Group monitors its performance in select countries (e.g., UK, France, Germany, Italy) based upon category retail market share, based on the latest available data from a number of internal and external sources.
In addition, the Group’s performance is affected by global pricing, which is impacted by discounts, terms of credit with customers, excise taxes and other competitive, market-driven and regulatory factors. In certain markets, the Group has experienced increases or decreases in average prices resulting from changes in product mix, also referred to as price mix. The Group believes that pricing and market share are measures commonly used by analysts and investors in the industry.
| BAT Annual Report and Form 20-F 2018 | 21 | |
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Strategic Management
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Delivering our strategy continued
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Productivity |
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We have continued our drive towards a more effective and efficient globally-integrated organisation by leveraging global systems and new ways of working. This global integration allows for the lowest possible overheads cost, the most cost-effective and responsive supply chain and that productivity opportunities are fully exploited.
Highlights during the year
– Another year of substantial productivity savings and RAI acquisition savings on track;
– Consolidation of our Global Supply Chain Service Centre;
– Vapour and THP operations integration completed.
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Globalising operations and improving efficiency
Global systems and ways of working across the Group are utilised to minimise our cost base and maximise expertise. Furthermore, by ensuring back-office activities are carried out efficiently and effectively, the end markets are free to focus their efforts on consumer-focused activities. This drive to a globally-integrated enterprise is most apparent in our Supply Chain, Talent and Culture, Finance, Procurement and Information Technology functions.
In line with this strategy, in 2017 the Group undertook a migration to a single Enterprise Resource Planning system, and in 2018 focused on delivering data and analytic capabilities globally to identify new sources of productivity savings, while also making progress on our complexity-reduction agenda.
Additionally, the implementation of Integrated Working Systems across our factories has generated important efficiency gains, reducing waste and loss in our manufacturing processes and enabling better service levels. This has been complemented by important manufacturing footprint reviews across our regions, which have optimised asset utilisation.
The completion of our Global Supply Chain Service Centre has resulted in the synchronisation of our end-to-end supply network, which now operates as a demand-driven enterprise. This, along with significant improvements in the efficiency of equipment and machinery, has improved the reliability of our supply network and has released cash by reducing our inventory of leaf, materials and finished goods.
This investment in machinery has also led to capital expenditure being targeted to the areas of the business with the greatest return on the investment. This global view also enhances our ability to react quickly, particularly within the PRRP space. Supply Chain integration also better allows the Group to leverage capabilities and scale to improve speed-to-market, which in turn generates savings and supports the rapid deployment of cutting-edge innovations.
These continued strategic investments in new machinery in 2018, supported by our global planning systems and integrated business model, enable us to deliver ‘on time and in full’ in all our Key Markets at optimal cost, with speed and scale.
With the RAI integration complete we have established a best-practice sharing model that is performing above expectations, with futher savings being delivered in procurement, manufacturing and supply chain.
On the PRRP front, the revision of supplier contracts has led to significant savings, as has integrating the growth of our vapour, tobacco heating and oral product portfolios, which has allowed the Group to both leverage economies of scale and reduce complexity.
As a result, annualised cost savings from the acquisition are now totalling over US$300 million per year, and we are on track to deliver at least US$400 million per year in cost synergies by the end of 2020.
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Profit from operations
(£m) |
Definition: Profit for the year before the impact of net finance costs/income, share of post-tax results of associates and joint ventures and taxation on ordinary activities.
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Change in adjusted profit from
operations at constant rates (%) |
Definition: Change in profit from operations before the impact of adjusting items and the impact of fluctuations in foreign exchange rates.
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Net cash generated from operating activities (£m)
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Definition: Movement in net cash and cash equivalents before the impact of net cash used in financing activities, net cash used in investing activities and differences on exchange.
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Operating margin (%) |
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Definition: Profit from operations as a percentage of revenue.
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Adjusted operating margin (%) |
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Definition: Adjusted profit from operations as a percentage of adjusted revenue.
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Continued optimisation of manufacturing locations and leaf growing
In 2018, we continued to optimise our manufacturing footprint and at the end of the year had 55 factories in 48 countries.
This includes two new factories, one in Zambia and one in Malaysia.
The German factory’s refocus on Other Tobacco Products (OTP), Dry Ice Expanded Tobacco (DIET) and Casing/Flavours Manufacture was completed in 2018, which marks the end of its manufacture of cigarettes. Additionally, it was announced in October 2018 that the Russian factory (Saratov) will close in Q4 2019.
We are continually looking to improve the efficiency of our entire supply chain with opportunities to improve our manufacturing operations being a particular focus. We are realising the benefits of our Integrated Work Systems, a programme that is designed to maximise equipment efficiency while ensuring we maintain high standards of product quality.
The improved equipment efficiency is delivering real benefits through improved productivity and lower maintenance costs together with reduced waste. An additional positive by-product is the release of capital expenditure which can be used to invest in further innovation.
While the Group does not own tobacco farms or directly employ farmers, it sources over 400,000 tonnes of tobacco leaf each year directly from over 90,000 contracted farmers and through third-party suppliers mainly in developing countries and emerging markets.
We continually strive to improve farmer sustainability and viability with a focus on improved quality, reduced costs of production and increased yield. As a result, we review our contracts on an annual basis to ensure that production is aligned to the needs of both the farmer and the Group.
The Group also purchases a small amount of tobacco leaf from India where the tobacco is bought over an auction floor. The price of tobacco in US dollars varies from year-to-year driven by domestic inflationary pressures, supply, demand and quality. The Group believes there is an adequate supply of tobacco leaf in the world markets to satisfy its current and anticipated production requirements.
Ongoing productivity savings
By operating globally, exploiting our systems and striving for results, the Group delivered substantial productivity savings in 2018, supported in large part by the acquisition of Reynolds American which will continue to provide further opportunities for productivity savings.
These savings are returned to the business for re-investment and to increase shareholder return. The following examples show how the Group considers all opportunities in the supply chain, including procurement, international logistics and leaf operations:
Procurement
Global visibility of forward demand and product specifications in one system has delivered significant benefits with the tender at a global level of print materials and tow being notable examples. In addition to the benefits of lower product cost, the development of long-term supplier relationships with key suppliers has improved security of supply and enabled higher flexibility in the supply chain.
International logistics
Whether by road, air or sea, our logistics are organised and controlled centrally. This facilitates opportunities to negotiate globally with third-party providers and allows us to benefit from our scale. Furthermore, this maximises the use of return shipments and economic order quantities to allow for maximum efficiency while maintaining the flexibility for fast response to market opportunities.
Leaf operations
These are similarly managed globally to ensure that the Group works with reliable, efficient and responsible farmers in our source countries. Our Global Leaf Pool operation aggregates demand to meet supply across all internationally traded tobacco. This approach balances the lowest possible working capital investment while reducing our exposure to crop failure (from changes in climate) and guaranteeing the best quality leaf to meet consumer demands.
In 2018, while transactional foreign exchange rates again had a negative effect on our cost base, we continued to improve our productivity in all areas of our supply chain and elsewhere in the Group. As a result, we have increased our profitability and continue to deliver returns to our shareholders today and invest in the future.
| BAT Annual Report and Form 20-F 2018 | 23 | |
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Delivering our strategy continued
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Winning organisation | |
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We enable growth by having a winning organisation: by investing in our people, by attracting the best, and by developing high-performing leaders who inspire diverse teams of committed and engaged people in a fulfilling, rewarding and responsible work environment.
Highlights during the year
– Accelerated talent development and attraction in growth markets and growth categories including tobacco heating products, vapour and modern oral;
– Launched Parents@BAT: a Group-wide pay and benefits programme for new parents;
– Top Employer recognition in Europe, Africa, and Asia-Pacific.
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Investing in leaders
The quality of our people is a key contributing factor to the Group’s performance. As a result, we commit to investing in our people as much as we do in our brands, and continuing to attract and retain the best people remains a key priority.
The long-term culture of the Group has been about developing talent from within, stretching and supporting high-performing managers who will lead the delivery of our strategy. This year, over 92% of our senior appointments, including our CEO Designate, were drawn from people already within the business – moves that have helped to deliver stronger and more diverse leadership teams and succession plans.
We continually update our capability frameworks and learning portfolio to enable development of new skills and knowledge to drive business performance. In June 2018, we offered our employees access to a new e-learning platform – Lynda.com – which provides a video library with over 6,500 courses on a variety of topics including leadership and core business skills, taught by well-known business leaders. Currently, Lynda is available to BAT employees worldwide in English, French, Spanish and German. More languages are in the pipeline for next year.
To improve understanding of our new and growing portfolio of potentially reduced-risk products, we launched a microlearning initiative that has been utilised by over 2,000 members of our sales force teams since its launch in 2018.
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You can read about our Group risk factor related to talent on page 272 |
Attracting the best talent
When we do recruit externally, we actively seek those who will provide additional knowledge and skills that will strengthen our teams and ultimately make us a stronger business. In 2018, we continued to enhance our internal capabilities to engage and recruit those people who will help us succeed in growth markets and growth categories, including potentially reduced-risk products.
We also continued the digital growth of our employer brand – ‘Bring your Difference’ – across core social media channels, where we are now an industry leader with over 600,000 followers on LinkedIn (a 45% increase from 2017).
As competition for talented employees intensifies, people increasingly want to work for businesses with a good corporate reputation. We are proud to have been ranked among the top employers around the world and have been named as a Top Employer for Europe, Africa, Middle East, Latin America, and Asia-Pacific by the Top Employer Institute, an independent global certification company. We also received similar accolades in many of the countries in which we operate including ‘Great Place to Work’ in the US and Brazil.
In 2018, we hosted the largest-ever Global Graduate Academy, with over 200 participants gathering in London for an interactive learning experience supported by senior business leaders. Also during 2018, we held the Group’s first global graduate competition, which saw people compete to win a London internship, and received a global social media reach of 35 million people.
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You can learn more about our Global Graduate Programme at www.bat-careers.com/graduates |
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Group diversity as at 31 December 2018 |
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Total
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Male
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Female
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| Main Board | 10 | 7 | 3 | |||||||||
| Senior management | 629 | 491 | 138 | |||||||||
| Total Group employees | 56,710 | 41,842 | 14,868 | |||||||||
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Growth through diversity
Diversity matters to the Group because it makes good commercial sense – having a diverse workforce means we are better able to understand and meet the varied preferences of our global consumers.
We are proud of our Diversity and Inclusion Strategy, which is built on the three pillars of:
1. driving ownership and accountability,
2. building diverse talent pools, and
3. creating enablers,
all of which are underpinned by an inclusive culture.
1. Driving ownership and accountability
Ensuring ownership of and accountability for our Diversity and Inclusion Strategy across all business areas and levels of the Group is key to driving progress.
This is why all of our regions and all functions worldwide have a Diversity Champion, who is a member of the applicable Leadership Team. They are responsible for driving the agenda, including ensuring that agreed-upon diversity action plans are implemented and that development and retention plans for high-potential employees are executed with a strong focus on gender and nationality diversity.
For example, our IT Function is partnering with our major IT suppliers to provide cross-company mentoring for women in technology. Additionally, our Operations Function has identified a number of global ‘location agnostic roles’, that would previously have required relocating but can instead be carried out from the employee’s home country.
This approach helps ensure that diversity is embedded across the Group and that our pipeline of diverse talent is strong and healthy.
The Director, Group Human Resources, has overall responsibility for all employee and human resources (HR) matters, while our Management Board oversees the development and management of talent within the Group’s regions and functions, and monitors progress against our key objectives and performance indicators.
Our Main Board reviews progress on our diversity activity and performance twice a year, and diversity reporting forms a key part of all Functional and Regional Leadership Team meetings, with quarterly reviews.
2. Building diverse talent pools
We are a diverse employer. There are 147 nationalities represented at management level within our Group, and we are pleased with the continuous progress we are making and the sustainable pipeline we are building in terms of nationality diversity.
We are also continuing to work hard to improve gender diversity within the Group. Women represent 30% of our Board, and in 2018 we increased female representation in senior management to 22%.
In 2019, two of our five new Management Board members are women. We also have female executives on all our senior functional and geographical leadership teams, and 46% of our 2018 graduate intake were women, ensuring a sustainable pipeline of women for senior management roles. These women have the opportunity to participate in our Global Graduate Academy: an intensive two-week programme focusing on accelerating the development of the Group’s next generation of leaders.
We require all recruitment agencies we work with to provide gender-balanced shortlists of candidates. We also focus on developing talent from within and one of the ways we are supporting women’s development into senior roles is through our Women in Leadership programme.
This provides training, mentoring and other types of career support for high-potential female employees and, over the last two years, has supported over 250 delegates. For the last four years, our most senior women have taken part in the Women Leaders Programme, run in conjunction with INSEAD business school.
We also provide mentoring, coaching and sponsorship programmes and have participated in the 30% Club for five years. This provides external support for our senior women, as well as mentoring women from other organisations.
In 2018, 51% of our senior recruits and 33% of internal promotions were women, moves that have helped deliver stronger and more diverse leadership teams. And we are having success in retaining our very best female talent, with turnover of senior women reducing dramatically from 15% in 2013 to just 1.7% in 2018.
3. Creating enablers
To realise our diversity ambitions, we know we must develop enablers to provide a supportive environment for people to thrive. One of the ways we do this is by providing women and other diverse groups with an opportunity to connect, engage and share experiences. At the moment we support 12 women’s networks across the Group that cut across all levels of the organisation, including our Women in BAT UK network, which currently has nearly 400 members.
Complementing these networks, the 12 most senior women in the business have established a panel with the aim of developing and mentoring women, as well as to encourage and support the Group’s leadership on its approach to gender diversity and the way in which talent pipelines are developed and managed.
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Further details of our Group policies and principles can be found at www.bat.com/principles. |
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In 2018, we launched Parents@BAT – a range of benefits to support new parents employed by Group companies worldwide to balance their home and work lives. This offers significantly better terms than existing legal requirements for over 20,000 of our employees in 26 countries, including a minimum of 16 weeks’ fully paid maternity leave for new mothers and adoptive parents as well as a return-to-work guarantee, flexible working opportunities and an online advice service offering coaching support for all parents whenever they need it.
In many countries, BAT’s support for new parents already goes far beyond these minimum guidelines and local statutory requirements. For example, in the UK, we provide maternity leave with six months’ full pay with a pro rata bonus, statutory pay for three months and a return-to-work guarantee.
Inclusive culture
We can only truly harness the benefits of a diverse workforce if we have an inclusive culture that enables all our employees to flourish regardless of their gender, culture or other differences.
Our Inclusive Leadership and Understanding Bias training workshop is designed to make sure managers not only recognise they may have personal or organisational bias, but that they also understand how to develop inclusive teams and harness the viewpoints of others.
In 2018, we partnered with the International Women’s Day Association on the #PressforProgress campaign. Sponsored by our Management Board, the campaign focused on raising awareness and reinforcing the importance of gender parity. Activities were held across the Group, including inspirational talks from internal and external female leaders and opportunities for individuals to make their own commitments.
Equal opportunities for all
We are committed to providing equal opportunities to all employees. We do not discriminate when making decisions on hiring, promotion or retirement on the grounds of race, colour, gender, age, social class, religion, smoking habits, sexual orientation, politics or disability. We are committed to providing training and development for employees with disabilities.
Employee engagement index
Definition: Results from our ‘Your Voice’ employee opinion survey, carried out in 2017, enabled us to calculate our employee engagement index – a measure that reflects employee satisfaction, advocacy and pride in the organisation. The Group’s next employee opinion survey will take place in 2019.
Objective: To achieve a more positive score than the norm for FMCG companies in our comparator benchmark group.
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Our other key performance indicators in this area include: |
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– Employee retention: In 2018, total turnover of management-grade employees was 1,963, representing 15% of the total management population. |
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– Diversity: Representation of women in senior management roles increased from 16% in 2016, and 21% in 2017, to 22% in 2018.
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Workforce engagement
The Group has a range of well-established workforce engagement channels worldwide to ensure the Board, including through updates provided by management, understands the views of the Group’s workforce across all jurisdictions in which the Group operates.
Group engagement channels include works councils, meetings with the European Employee Council, town hall sessions, global, functional and regional webcasts, and CEO webcasts, implemented at market, business unit, functional and/or regional level as appropriate for the composition of local workforce populations.
Additionally, the Board undertakes a Group market or site visit on an annual basis, including meeting with local employees, and the Executive Directors regularly visit markets and local sites across the Group. We also undertake a Group global employee opinion survey (‘Your Voice’) every two years.
From 1 January 2019, the Group has adopted an enhanced approach to workforce engagement worldwide in order to ensure meaningful and regular dialogue is maintained between the Board and our workforce given its geographical spread, scale and diversity.
In addition to this range of engagement channels, we have implemented new reporting channels to enable regular reporting to the Board on workforce views on key topics at all levels across the Group. Board feedback and associated action planning, as appropriate, is cascaded back to the workforce and the Board is kept updated on progress against identified actions during the year. We will report on these arrangements in our 2019 Annual Report and Form 20-F.
Our Employment Principles
Our Employment Principles set out a common approach for our Group companies’ policies and procedures, recognising that each Group company must take account of local labour law and practice, and the local political, economic and cultural context.
In developing our Employment Principles, we have sought the views of a cross-section of internal and external stakeholders, and have consulted with employee representatives and (where relevant) with our works councils.
All Group companies have committed to our Employment Principles and, through our internal audit processes, are required to demonstrate how these are embedded into the work place.
In addition to our Employment Principles, our Board Diversity Policy specifically applies to our Board and Management Board and is discussed further at page 60.
Rewarding people
Reward is a key pillar in ensuring that we have the right people to drive the business forward. Reward is necessarily local and we strongly support this through global frameworks to ensure leading-edge policies, processes and technology are available to all markets. Base pay rewards core competence relative to skills, experience and contribution to the Group, while annual bonuses, recognition schemes and ad hoc incentives provide the right mix to ensure that high performance is recognised and rewarded. The Long-Term Incentive Plan (LTIP) has been established to make annual awards of free shares to senior managers provided certain challenging long-term performance conditions are met. The LTIP is one element of senior executives’ reward package aiming to align the interests of the Group’s senior managers with those of shareholders. Further information on the Group’s Remuneration Policy for the Executive Directors and the Non-Executive Directors can be found on pages 73 to 113.
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We also offer our UK employees the chance to share in our success via our Sharesave Scheme, Partnership Share Scheme and Share Reward Scheme, and operate several similar schemes for senior management in our Group companies.
Gender pay
In 2018, we began publishing data relating to UK gender pay in line with statutory requirements.
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You can learn more about our published data relating to UK gender pay in line with statutory requirements at www.bat.com/genderpayreport
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Safe place to work
Operating in challenging environments
Providing a safe working environment for all our employees and contractors is paramount. As a global business, operating in diverse markets including some of the world’s most volatile regions, this can also be challenging.
Safety risks vary across our business. Our manufacturing sites, for example, carry fewer risks, while the vast majority of all Group accidents are in Trade Marketing & Distribution (TM&D), which involves the distribution and sale of our products. We have close to 30,000 vehicles and motorcycles out on the road every day, often in environments with difficult social or economic conditions. Our goods have a high street value, and in a small number of markets this carries high risk of armed robbery and assault. Poor road infrastructure and wide variations in driving standards and behaviour provide further challenges.
Although these challenges will always exist, our goal is zero accidents across the Group. To help achieve this, we have a comprehensive approach based on risk management and assessments, employee training and awareness, and tailored initiatives for specific issues.
In 2017, we implemented a range of initiatives, such as ensuring drivers carry less stock, together with extra security measures for route planning and vehicle tracking. We use in-vehicle ‘telematics’ monitoring systems to analyse driver behaviour data, and use the insights to tailor our training programmes and improve driving skills and hazard perception.
In markets where we have recently introduced motorcycles, we provide training programmes to reduce risk. These provide practical techniques for different road conditions and types of traffic, safe speeds and distances, and how to spot a potential problem and take action to deal with it safely.
We are pleased to say that our actions are producing improvements. Vehicle-related incidents fell in 2018 from 73 to 47, primarily due to a reduction in motorcycle incidents. In particular, we saw a notable reduction in injuries reported across TM&D, down 27%.
Nevertheless, the number of fatalities remained unchanged at 12 in 2018. This was partly a result of changing local conditions, such as increased levels of violence and civil unrest in certain markets where no workforce fatalities had occurred for many years.
We deeply regret this loss of life and the suffering caused to friends, family and colleagues. We liaise closely with the relevant authorities and conduct our own detailed investigations to determine the root cause of each accident, identify any lessons that can be learned and implement action plans, the outcomes of which are reviewed at Board level.
We are making every effort to further address these challenges in 2019, notably through sharing best-practice examples across our regions.
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You can read about our Principal Group risk relating to Health and Safety on page 51 |
Health and Safety Policy
Our Health and Safety Policy recognises the importance of the health, safety and welfare of all our employees and third-party personnel in the conduct of our business operations. We are committed to the prevention of injury and ill-health, and strive for continual improvement in health and safety management and performance. This policy is supported by our Environmental, Health and Safety (EHS) management system, outlined on page 32.
Overall responsibility for Group health and safety is held by the Director, Operations. The Director, Group Talent and Culture, has overall responsibility for all employee and human resources matters.
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Our key performance indicators* in this area include: |
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– Lost Workday Case Incident Rate (LWCIR): There was a decrease in our LWCIR from 0.36 in 2017 to 0.27 in 2018. |
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– Lost workday cases (LWC): The number of work-related accidents (including assaults) resulting in injury to employees and to contractors under our direct supervision, causing absence of one shift or more, decreased from 248 in 2017 to 195 in 2018. |
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– Serious injuries and fatalities: The total number of serious injuries and fatalities to employees and contractors decreased from 78 in 2017 to 53 in 2018.
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2017 data has been restated to include Health and Safety data for RAI employees and contractors under our direct supervision. |
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Sustainability
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Sustainability is a key pillar of our Group strategy and plays a fundamental role in all aspects of our business.
Our sustainability agenda was developed through a detailed assessment process that identified the three key areas that have the greatest significance to our business and our stakeholders.
– Harm reduction: we are committed to working to reduce the public health impact of smoking, through offering adult consumers a range of potentially reduced-risk products;
– Sustainable agriculture and farmer livelihoods: we are committed to advancing sustainable agriculture and working to enable prosperous livelihoods for all farmers who supply our tobacco leaf; and
– Corporate behaviour: we are committed to operating to the highest standards of corporate conduct and transparency.
Highlights during the year
– Launch of the new global Anti-Bribery and Corruption Procedure that mandates both pre-contractual and retrospective due diligence for third-party business providers;
– Implementation of a new set of consolidated International Marketing Principles that combine our standards for all our product categories; and
– Deployment of a Farmer Sustainability Monitoring tool that identifies and addresses problems in real time.
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Read more about our sustainability performance in each area at www.bat.com/sustainabilityreport
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Harm reduction
Tobacco harm reduction is about encouraging adult smokers, who wish to continue using tobacco or nicotine products, to switch to potentially lower-risk sources of nicotine as compared to conventional cigarettes. We are committed to working to reduce the public health impact of smoking through offering adult consumers a range of potentially reduced-risk products (PRRPs).
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Read about our progress in potentially reduced-risk products on page 21 |
Cutting-edge science
We are always on the lookout for the next cutting-edge technology that will enable us to provide adult smokers with more advanced, better-performing PRRPs.
We are also highly focused on testing and validating the reduced-risk potential of these products. To this aim, and to complement widely-available third-party science, we have developed a framework of scientific tests to assess the health risks of PRRPs relative to smoking cigarettes.
In 2018, we embarked on one of our most ambitious and large-scale clinical studies, examining risk indicators among adult smokers who continue smoking, switch to glo or stop completely. We expect to publish initial study results in 2019.
We openly share our scientific framework and publish peer-reviewed journal articles. To date, we have published 25 peer-reviewed articles on THPs, 23 on vapour products and six manuscripts that review them jointly. We will also continue presenting at conferences and to government technical advisory committees. In 2018, we presented at 24 scientific conferences and external meetings.
High standards and enabling responsible growth
Following high standards to ensure quality and consumer safety is at the heart of everything we do in the design, development and manufacturing of our products. We would like to see the same approach across the whole industry, so, in 2018, we continued to advocate for, and collaboratively contributed to the development of, consistent national and international standards and proportionate regulation for PRRPs.
This is essential for giving more smokers the assurances they need to support take-up of PRRPs, which can ultimately help to realise potential benefits for public health.
Marketing responsibly
As tobacco consumption presents serious health risks, and nicotine is an addictive substance, we need to ensure that our marketing is aimed only at adult consumers and is not designed to engage or appeal to youth.
To support this we have International Marketing Principles (IMP) in place that are applied consistently everywhere we operate, even when they are stricter than applicable local tobacco laws.
In light of our shift to being a multi-category business, in 2018 we compiled our responsible marketing standards for each of our product categories into one set of principles under our revised IMP, which govern all our product marketing. All Group companies are required to comply with the IMP and compliance is reported and monitored through our Control Navigator process, detailed on page 68.
In 2018, we also launched our revised Youth Access Prevention (YAP) guidelines that now cover all our product categories, and broadened their scope to also include markets where our products are distributed through third parties. It is now also mandatory for all our markets – unless there is a government ban in place – to provide retailers with point-of-sale materials with YAP messaging.
Sustainable agriculture and farmer livelihoods
Tobacco leaf remains at the core of our products, even with the growth of PRRPs, so the farmers who grow it are crucial to the continued success of our business.
We have traceability down to the farm level and centralised management of our tobacco leaf supply chain. This enables an agile, efficient and reliable supply of high-quality tobacco leaf to meet consumer demand, while also enhancing the sustainability of rural communities and agriculture.
In 2018, the Group purchased more than 400,000 tonnes of tobacco leaf:
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68% from 18 Group leaf operations, which source from over 90,000 farmers; and |
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32% from more than 20 third-party suppliers, which source from over 260,000 farmers. |
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Read more about Sustainable Agriculture and Farmer Livelihoods at www.bat.com/ sustainabilityreport |
Supporting our farmers
Through our global leaf research and development, we develop new and innovative farming technologies and techniques, which are made available to farmers as part of comprehensive agri-support packages.
We have a network of expert field technicians who provide on-the-ground support, technical assistance and capacity building for all our 90,000+ directly contracted farmers, helping them to run successful and profitable farms. Our third-party suppliers provide their own support for all the 260,000+ farmers they source from.
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By supporting farmers in this way, we can help them maximise the potential of their farms and enhance the livelihoods and resilience of rural communities.
They and future generations are then more likely to feel motivated to remain in agriculture, look after the environment and see the value of growing tobacco as part of a diverse range of crops.
Setting standards and driving change
We use the industry-wide Sustainable Tobacco Programme (STP) to conduct due diligence on 100% of our own tobacco leaf operations and third-party suppliers, which covers issues such as safe working conditions, preventing child and forced labour, and environmental protection.
We use the results of the self-assessments and on-site reviews to work with suppliers to drive corrective action and improvements. In the event of any serious or persistent issues, or where suppliers fail to demonstrate a willingness to improve performance, we reserve the right to terminate the business relationship.
We continue to collaborate with the industry to refine this programme, and in 2018 the STP Steering Committee carried out a comprehensive review of the STP’s requirements and outcomes to create more effective processes.
Since implementation in 2016, three rounds of self-assessment have been completed, with 62 independent on-site reviews, covering 100% of our total supply base.
Our ‘Thrive’ programme is based at the farm level and takes a more holistic and collaborative approach to identifying and addressing root causes and long-term challenges, such as rural poverty. It is based on the internationally-recognised ‘five capitals’ framework, with strength in all five demonstrating resilience and enabling farmers and rural communities to prosper.
Since introducing Thrive, we have assessed over 280,000 farmers who supply nearly 90% of our total tobacco leaf purchases. We are now using the results to inform our approach to selecting and developing new partnerships and community-based projects that will have a demonstrably positive impact for farmers and their communities.
Respect for human rights
The Group has a long-standing commitment to respect fundamental human rights, as affirmed by the Universal Declaration of Human Rights.
The most significant challenges for human rights abuses are in our tobacco leaf supply chain which, as with the wider agricultural sector, is recognised by the International Labour Organization to be particularly vulnerable to these issues due to the sheer scale and characteristics, such as large numbers of casual and temporary workers, family labour in small-scale farming and high levels of rural poverty.
Human rights challenges in our non-agricultural supply chain depend on the nature of the sector, the type of goods and services supplied, and the country of operation.
With the majority of our employees working in business areas where we have robust oversight and control, human rights challenges in our own operations are substantially avoided. The challenges that do exist are mitigated by a suite of robust policies, practices and compliance and governance procedures that we have in place across all Group companies.
However, we recognise that we need to continually work to ensure these are effectively applied and that we carefully monitor the situation, particularly in higher-risk countries, such as where regulation or enforcement are weak, or there are high levels of corruption, criminality or unrest.
Our due diligence processes for our business operations and supply chains enable us:
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to monitor the effectiveness of, and compliance with, our Human Rights Policy commitments under our Standards of Business Conduct (SoBC) and our Supplier Code of Conduct; and |
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to identify, prevent and mitigate human rights challenges, impacts and abuses. |
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Our key performance indicators in this area focus on the number and results of reviews and audits conducted as part of our due diligence processes for our suppliers and business operations. In 2018:
– Independent on-site reviews were conducted by an external firm on 26 of our tobacco leaf suppliers;
– Independent audits were conducted by external firm Intertek on 88 non-agricultural suppliers in 29 countries; and
– Group business operations in 26 higher-risk countries underwent enhanced due diligence to confirm compliance with applicable Group policies, standards and controls, and to provide details of any additional local measures in place to enhance human rights management.
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Safeguarding human rights
With operations and supply chains in many diverse and challenging environments around the world, human rights are particularly important for our business and an area we have long focused on addressing.
In recent years, we have strengthened our approach to further align to the United Nations Guiding Principles on Business and Human Rights (UNGPs).
This began with a review of our existing policies and approach to human rights management, informed by an independently-facilitated stakeholder dialogue.
As a result, in 2014, we incorporated our Human Rights Policy into our SoBC. In early 2016, we complemented this with the introduction of our Supplier Code of Conduct, which defines the minimum standards expected of all our suppliers worldwide, including the respect of human rights.
Having established a strong policy base, we have continued to focus in 2018 on enhancing due diligence across our business and supply chains. Because of the nature of agricultural supply chains, the greatest risk of human rights abuses is within our tobacco leaf supply chain; as a result, we have extensive due diligence processes in place, as detailed on page 30.
For our non-agricultural supply chain, we have long had due diligence processes in place for strategic direct product materials suppliers.
However, to more closely align with the UNGPs and to better manage supply chain challenges and opportunities, we expanded the scope in 2016 to include all our direct materials suppliers, as well as strategic indirect suppliers.
All these suppliers are now assessed according to independent human rights indices and those with the highest risk exposure are prioritised for enhanced due diligence.
As a result, 77% of all our strategic global direct materials suppliers have been independently audited in the last three years.
In 2018, a total of 88 non-agricultural suppliers in 29 countries underwent independent on-site audits. As well as directly-contracted tier 1 direct suppliers, these also included 17 tier 2 strategic suppliers (those from whom our directly-contracted suppliers buy) for vapour and tobacco heating products, and eight strategic indirect suppliers of factory machinery and point-of-sale marketing materials in high-risk countries.
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Further details of our approach to human rights and our Modern Slavery statement can be found at www.bat.com/msa |
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Human rights in tobacco growing
Agricultural supply chains are particularly susceptible to issues relating to child labour and, in 2000, as part of our long-running commitment to end the practice within tobacco farming, we became a founding board member of the Eliminating Child Labour in Tobacco Growing (ECLT) Foundation. We remain an active member today, alongside other major tobacco companies and leaf suppliers. ECLT helps to strengthen communities and bring together key stakeholders to develop and implement local and national approaches to tackle child labour.
We provide training and communications to farmers and rural community members to raise awareness of human rights issues, which reached over 134,000 beneficiaries in 2018. As discussed on page 28, we also run on-the-ground projects in farming communities to address root causes, such as rural poverty, in collaboration with local partners.
Our operational standard on child labour prevention was developed with inputs from the ECLT and the International Labour Organization. This complements our long-standing Child Labour Policy and provides detailed guidance regarding our requirements, including the provision of regular training, the conduct of farm monitoring and spot-checks, and the reporting of any incidents of child labour.
Sustainability reporting
Corporate behaviour
Our actions and behaviour impact all areas of our business – which is why corporate behaviour is such an important focus for our long-term sustainability strategy. Our commitment to good corporate behaviour is underpinned by our Group Standards of Business Conduct (SoBC), or localised equivalent, which require every Group company and all staff worldwide, including senior management and the Board, to act with a high degree of business integrity, comply with applicable laws and regulations, and ensure that our standards are not compromised for the sake of results.
Corrupt practices are illegal, cause distortion in markets and harm economic, social and political development, particularly in developing countries. Our SoBC make it clear that it is wholly unacceptable for Group companies, our employees or our business partners to be involved or implicated, in any way, in corrupt practices.
Our SoBC are continually kept under review, are fully aligned with the provisions of key corporate compliance laws including the UK Bribery Act, the US Foreign Corrupt Practices Act, the UK Criminal Finances Act, and are designed to meet the standards of the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions.
In 2018, all employees across the Group completed their annual sign-off of the SoBC, received SoBC-related compliance training and declared any conflicts of interest. Of this, over 26,000 management-grade and office-based employees completed these steps through the online SoBC portal, including completing a tailored online training course focusing on ethical decision making and data security.
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Further details of our Group policies and principles can be found at www.bat.com/principles |
Further details of our Strategic Framework for Corporate Social Investment can be found at www.bat.com/csi
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Delivery with integrity
In 2017, we introduced the Group’s updated compliance programme, ‘Delivery with Integrity’, which focused on strengthening and driving a globally-consistent approach to compliance across the Group.
The programme is led by our Business Conduct & Compliance department, reporting directly to the Director, Legal
& External Affairs and General Counsel.
In 2018, this department oversaw the successful deployment of several key initiatives to empower employees and business units across the Group to better identify and mitigate challenges related to key compliance areas such as anti-bribery and anti-corruption (ABAC) laws. To raise awareness of these issues with employees, an e-learning was delivered to a targeted cross-functional global audience selected on the basis of their potential interaction with government officials. Over 2,500 hours of mandatory ABAC training were logged as a result. To complement this, employee webcasts were also hosted for BAT managers across the world.
Additionally, to assist business units in identifying SoBC-related issues (in particular relating to bribery and corruption) in connection with third parties retained by the Group, a new Third-Party Procedure was launched in Q2 2018. This procedure mandates a consistent methodology across the Group for pre-contractual due diligence on prospective third-party business partners, and is complemented by mandatory mitigation packages (such as training and contractual clauses) for medium and high-risk third parties.
This due diligence also provides a retrospective review of third parties with which the Group did business before the Third-Party Procedure came into effect. In addition, given the challenges associated with intermediaries engaged to interface with public officials on the Group’s behalf, the review for these service providers has been conducted centrally, with external input and independent oversight. By August 2019, all relevant third parties with which the Group does business globally will have been reviewed.
|
|
Read more about our Group risk factor related to corporate behaviour on page 278 |
Group Standards of Business Conduct (SoBC)
The SoBC require all staff to act with a high degree of integrity, comply with applicable laws and regulations, and ensure that standards are never compromised for the sake of results.
All Group companies have adopted the SoBC or local equivalent. RAI Companies adopted their localised version of the SoBC with effect from 1 January 2018, and any instances of suspected improper conduct contrary to their localised SoBC, and established breaches, have been reported on an aggregated Group basis from 2018 onwards.
Information on compliance with the SoBC is gathered at a regional and global level and reported to the Regional Audit and CSR Committees, Corporate Audit Committee and to the Audit Committee.
In the year ended 31 December 2018, 266 instances of suspected improper conduct contrary to the SoBC were reported to the Audit Committee (2017: 183).
Of the instances reported, 98 were established as breaches and appropriate action taken (2017: 78). In 99 cases, an investigation found no wrongdoing (2017: 75). In 69 cases, the investigation continued at the year-end (2017: 30), including investigation, through external legal advisers, of allegations of misconduct.
Please refer to page 70 for more information about the Audit Committee’s oversight and monitoring of compliance with the SoBC in 2018.
The SoBC, and information on the total number of incidents reported under it, are available at www.bat.com/sobc.
BAT Group SoBC reported incidents
Year to 31 December 2018
‘Speak Up’ channels
To increase the accessibility of, and strengthen, our long-standing whistleblowing policy and procedures, in early 2018 we launched a new third-party managed ‘Speak Up’ system, which followed from a review of the Group’s existing whistleblowing procedures undertaken in 2017.
The system includes a website available in multiple languages, and local language hotlines for our markets, and enables improved global oversight of all reported issues in real time.
The SoBC also includes the Group’s whistleblowing policy, which enables staff and others to raise concerns, including regarding accounting or auditing matters, in confidence (and anonymously where they wish), without fear of reprisal. The Group’s whistleblowing policy is supplemented by local procedures throughout the Group and at the Group’s London headquarters, providing staff with further guidance on reporting matters and raising concerns, and the channels through which they can do so.
Of the total number of SoBC incidents reported in 2018 set out above, 138 were brought to management’s attention through whistleblowing reports from employees, ex-employees, third parties or unknown individuals reporting anonymously (2017: 131).
|
|
Our ‘Speak Up’ channels – www.bat.com/ speakup enable anyone working for, or with, our Group to raise concerns in their local language, in confidence and without fear of reprisal. |
| BAT Annual Report and Form 20-F 2018 | 31 | |
Table of Contents
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Strategic Management
|
||||||||||||||
|
Delivering our strategy
continued
|
||||||||||||||
CO 2 e emissions
(in ‘000 tonnes)
Definition: Group Scope 1 and Scope 2 carbon dioxide equivalent (CO 2 e) emissions
Target: To reduce our Scope 1 and Scope 2 CO 2 e emissions by 30% by 2030 compared to our 2017 baseline.
Water use
(total water withdrawn in mn metres 3 )
Definition: Group water use in million cubic metres.
Objective: To reduce water use to 3.38 mn metres 3 by 2030, 35% lower than our 2017 baseline.
Recycling
(percentage of waste recycled)
Definition: Total percentage of Group waste re-used or recycled against total waste generated.
Objective: To recycle 95% or more by 2030 in each year.
|
|
Read about our Group risk factor relating to environmental laws on page 276
|
|
|
|
Further details of our approach to our reporting methodology can be found at www.bat.com/corporatebehaviour/scope |
Environment
We are committed to reducing our environmental impact across our supply chain and operations and our Director, Operations, has overall responsibility for environmental management.
Our Environment Policy applies across all our activities including our supply chain.
The Policy is supported by our comprehensive Environmental, Health and Safety (EHS) management system, which has been in place for many years and is based on international standards, including ISO 14001.
Each of our Group companies has an EHS Steering Committee, with overall environmental responsibility held by the applicable General Manager or site manager. EHS is also a standing agenda item for management meetings and governance committees at area, regional and global levels. Our governance structures raise awareness of environmental challenges across our business and our aim is to create a consistent approach across our Group to manage them.
The primary environmental focus areas for our business include energy use, carbon dioxide (CO 2 ) emissions, water use and availability, and waste and recycling. In our supply chain, the primary focus areas relate to the environmental impacts of tobacco farming.
Our approach to reducing the environmental impacts of our operations is long established and we have an internal reporting system in place for monitoring Group environmental performance.
During 2018 and following on from our acquisition of Reynolds American Inc. (RAI), we took the opportunity to review our long-term targets to reflect our new operations portfolio. Having undertaken a full analysis of our Scope 1, 2 and 3 carbon emissions we have now established a new 2017 baseline reflective of our enlarged operations and established new long-term targets including a commitment to setting science-based emissions targets.
Our new targets have gained Science-Based Targets initiative (SBTi) formal approval, and we join the ever-growing number of companies that have committed to making significant emissions reductions, in line with the most up-to-date climate science.
Community and social initiatives
As an international business, we play an important role in countries around the world and have built close ties with local communities. We encourage our employees to play an active role both in their local and business communities.
Our charitable contributions policy in our SoBC is supported by the Group Strategic Framework for corporate social investment (CSI), which sets out our Group CSI strategy and how we expect our local operating companies to develop, deliver and monitor community investment programmes within three themes:
| – |
Sustainable Agriculture and Environment; |
| – |
Empowerment; and |
| – |
Civic Life. |
Our Group Head of Sustainability has oversight of the Group CSI Strategy, and Board-level governance is managed through our Audit Committee, which reviews the strategy and an analysis of activities (including investment and alignment to the Group’s priorities) at least once a year.
Our key performance indicator in this area relates to the total amount of money invested in charitable giving and CSI projects. In 2018, the Group invested a total of £14.4 million in cash, and a further £1.2 million in-kind charitable contributions and CSI projects, including £1.04 million given for charitable purposes in the UK. Much of this investment is delivered through partnerships with external stakeholders including communities, NGOs, governments, development agencies, academic institutions, industry associations and peer companies.
|
* As we have expanded our Scope 3 reporting to fully align with the Greenhouse Gas (GHG) Protocol, consolidation and verification for 2018 data is ongoing and is not practical to report at this time. The consolidated and verified data will be reported in the 2019 Annual Report and Form 20-F. |
Emissions*
|
|
||||||||||
|
|
||||||||||||
| 2018 | 2017 | |||||||||||
|
|
||||||||||||
| Scope 1 CO 2 e emissions (’000 tonnes) | 415 | 427 | ||||||||||
| Scope 2 CO 2 e emissions (’000 tonnes) | 426 | 438 | ||||||||||
| Scope 3 CO 2 e emissions (’000 tonnes)* | n/a | 8,254 | ||||||||||
|
|
||||||||||||
| Total statutory emissions (Scope 1 and 2 in ’000 tonnes) | 841 | 864 | ||||||||||
|
|
||||||||||||
| Intensity (tonnes per £ million of revenue) | 32.6 | 34.7 | ||||||||||
|
|
||||||||||||
| 32 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
“A good year of
progress in our key
Ben Stevens Finance Director |
|
Highlights
– Group revenue was up 25% or 3.5% on an adjusted, representative basis at constant rates of exchange;
– Profit from operations increased by 45% or 4.0% on an adjusted, representative basis at constant rates of exchange;
– Diluted earnings per share fell 86%. Adjusted diluted earnings per share up 5.2% or 11.8% at constant rates;
– Dividend per share up 4.0% at 203.0p;
– Net cash generated from operating activities up 93%;
– Cash conversion at 111%. |
Non-GAAP measures
In the reporting of financial information, the Group uses certain measures that are not defined by IFRS, the generally accepted accounting principles (GAAP) under which the Group reports. The Group believes that these additional measures, which are used internally, are useful to users of the financial information in helping them understand the underlying business performance.
The principal non-GAAP measures which the Group uses are adjusted revenue, adjusted revenue from the Strategic Portfolio, adjusted profit from operations and adjusted diluted earnings per share. Adjusting items are significant items in revenue, profit from operations, net finance costs, taxation and the Group’s share of the post-tax results of associates and joint ventures which individually or, if of a similar type, in aggregate, are relevant to an understanding of the Group’s underlying financial performance. As an additional measure to indicate the results of the Group before the impact of exchange rates on the Group’s results, the movement in adjusted revenue, adjusted revenue from the Strategic Portfolio, adjusted profit from operations and adjusted diluted earnings per share are shown at constant rates of exchange. The Group also includes, where appropriate, measures termed ‘representative’ or ‘organic’ to provide the user with the Group’s performance without the potentially distorting effects of acquisitions, particularly RAI. These non-GAAP measures are explained on pages 258 to 266.
Revenue
Revenue
(£m)
Definition: Revenue recognised, net of duty, excise and other taxes.
In 2018, revenue includes £17,257 million of revenue from the Strategic Portfolio, an increase of 49% on 2017 (on a reported and representative basis).
In 2018, revenue was £24,492 million, an increase of 25.2% on 2017 (2017: £19,564 million, up 38.5% on 2016). The revenue growth in both years was mainly due to the inclusion of RAI as a wholly-owned subsidiary from the acquisition date, with 2018, 2017 and 2016 including 12 months, approximately five months and nil months of revenue from RAI respectively. Revenue was also up, driven by price mix of 6% (on the combustible brands) and the growth of the PRRP portfolio. Revenue was affected by the sale of products bought in on short-term contract manufacturing arrangements inclusive of excise. Revenue was also affected by the movements of foreign exchange on our reported results which was a headwind in 2018 of approximately 6%, compared to a tailwind of 4% in 2017.
Change in adjusted revenue
at constant rates (%)
Definition: Change in revenue before the impact of adjusting items and the impact of fluctuations in foreign exchange rates.
After adjusting for the revenue from acquisitions, including RAI, the short-term uplift to revenue due to the treatment of excise on bought-in goods and the effect of exchange on the reported result, on a representative, constant currency basis, adjusted revenue was up by 3.5% (2017: 3.0% on an adjusted organic basis) as pricing and the growth in THP, vapour and modern oral more than offset the decline in combustible volume on a representative basis (2017: down 2.6% on an organic basis).
Reconciliation of revenue to adjusted revenue at constant rates
| 2018 | 2017 | 2016 | ||||||||||||||||||||||
| £m | Change % | £m | £m | Change % | £m | |||||||||||||||||||
|
(vs 2017 Rep)
|
Repres
|
Organic
|
(vs 2016 Org)
|
£m
|
||||||||||||||||||||
| Revenue | 24,492 | +25% | 19,564 | 19,564 | +39% | 14,130 | ||||||||||||||||||
|
Adjusting items |
(180 | ) | – | (258 | ) | (258 | ) | – | – | |||||||||||||||
|
Add/(subtract) impact of acquisition (for representative/organic calculation) |
– | – | 5,577 | (4,050 | ) | – | – | |||||||||||||||||
| Adjusted revenue | 24,312 | -2.3% | 24,883 | 15,256 | +8% | 14,130 | ||||||||||||||||||
|
Impact of exchange |
1,448 | – | (700 | ) | – | |||||||||||||||||||
| Adjusted revenue at constant rates | 25,760 | +3.5% | 14,556 | +3% | ||||||||||||||||||||
| BAT Annual Report and Form 20-F 2018 | 33 | |
Table of Contents
|
Financial Review
|
|
Adjusted revenue growth from the Strategic Portfolio
|
|
|||
| Change in adjusted revenue from the | ||||
| Strategic Portfolio at constant rates (%) | ||||
|
|
||||
|
Definition: Change in revenue from the Strategic Portfolio before the impact of adjusting items and the impact of fluctuations in foreign exchange rates.
This measure was introduced in 2018, with no comparators provided. |
Reconciliation of revenue to adjusted revenue at constant rates of exchange, by product category
|
2018 £m
|
Adjusting items £m
|
Impact of exchange £m
|
Adjusted at constant 2018 £m
|
Adjusted at constant vs 2017 %
|
Adjusted at constant vs 2017 repres %
|
2017 £m
|
Acquisitions £m
|
2017 repres £m
|
||||||||||||||||||||||||||||
| Strategic Portfolio comprises: | ||||||||||||||||||||||||||||||||||||
| Combustible portfolio | 15,457 | – | 816 | 16,273 | +50.1% | +5.7% | 10,842 | 4,553 | 15,395 | |||||||||||||||||||||||||||
| Potentially reduced-risk products (PRRPs) | ||||||||||||||||||||||||||||||||||||
|
Vapour |
318 | – | 7 | 325 | +93.5% | +26.0% | 168 | 90 | 258 | |||||||||||||||||||||||||||
|
THP |
565 | – | 11 | 576 | +185.1% | +183.7% | 202 | 1 | 203 | |||||||||||||||||||||||||||
|
NGP |
883 | – | 18 | 901 | +143.5% | +95.4% | 370 | 91 | 461 | |||||||||||||||||||||||||||
|
Modern Oral |
34 | – | 2 | 36 | +140.0% | +140.0% | 15 | – | 15 | |||||||||||||||||||||||||||
|
Traditional Oral |
883 | – | 33 | 916 | +136.7% | +9.0% | 387 | 453 | 840 | |||||||||||||||||||||||||||
|
Oral |
917 | – | 35 | 952 | +136.8% | +11.3% | 402 | 453 | 855 | |||||||||||||||||||||||||||
| Total PRRPs | 1,800 | – | 53 | 1,853 | +140.0% | +40.8% | 772 | 544 | 1,316 | |||||||||||||||||||||||||||
| Strategic Portfolio | 17,257 | – | 869 | 18,126 | +56.1% | +8.5% | 11,614 | 5,097 | 16,711 | |||||||||||||||||||||||||||
| Other | 7,235 | (180 | ) | 579 | 7,634 | -0.8% | -6.6% | 7,692 | 480 | 8,172 | ||||||||||||||||||||||||||
| Revenue | 24,492 | (180 | ) | 1,448 | 25,760 | +33.4% | +3.5% | 19,306 | 5,577 | 24,883 | ||||||||||||||||||||||||||
Revenue from the Strategic Portfolio and adjusted revenue from the Strategic Portfolio grew by 49% at current rates and by over 56% at constant rates, benefiting from the acquired brands from RAI in 2017. On a representative basis this was a growth of 8.5% at constant rates.
This performance was driven by the strategic combustible brands, up 43% or 50% at constant rates of exchange, or 5.7% on a constant rate, representative basis, due to the volume performance described on pages 20 and 21 and pricing across the major markets.
PRRP revenue grew 133% in total, to £1,800 million (2017: £772 million). Adjusting for the enhancement from the acquisitions and the impact of foreign exchange, this was an increase of 41%, largely due to THP and vapour (together delivering £901 million on an adjusted, representative, constant currency basis).
Vapour grew to £318 million from £168 million in 2017, an increase of over 26% to £325 million on an adjusted constant currency, representative basis), with THP (up over 180% to £565 million or £576 million at constant rates of exchange).
Also included in PRRP are traditional oral, delivering revenue of £883 million, an increase of 9% to £916 million on an adjusted constant currency, representative basis, and modern oral, (increasing adjusted revenue by 140% to £36 million at constant rates of exchange).
THP growth was due to an increase in consumables volume of 217% to 7 billion, largely in Japan as described on page 21.
The 26% representative, constant currency growth in vapour revenue was supported by a 35% increase (on a representative basis) in consumable volume with growth in the world’s three largest vapour markets (US, UK and France), as discussed on page 21.
The increase in revenue was despite the impact of the product recall in the US.
Modern oral adjusted revenue increased, up 140% at £36 million on a constant currency, representative basis, due to the growth of EPOK and Lyft, notably in the Nordics and Switzerland.
Traditional oral grew adjusted revenue by 9% on a representative, constant rate basis, as a 2.3% volume decline in the US, partly due to the impact in the prior period of a competitor product recall which positively affected volume in 2017, was more than offset by pricing.
| 34 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
Profit from operations
Profit from operations
(£m)
Definition: Profit for the year before the impact of net finance costs/income, share of post-tax results of associates and joint ventures and taxation on ordinary activities.
Profit from operations grew by 45.2% to £9,313 million and by 37.8% to £6,412 million in 2017. This was driven by the inclusion of RAI mid-way through 2017, and the improved revenue in 2018 and 2017 as described earlier, partly offset by:
Raw materials and other consumables costs increased by 3.2% to £4,664 million in 2018, and by 19.7% to £4,520 million in 2017, mainly due to the higher volume following the acquisition in 2017 of RAI as well as an increase in THP volume. 2017 included a charge of £465 million related to the purchase price allocation adjustment to inventory which did not repeat in 2018.
Employee benefit costs increased by £326 million or 12.2% to £3,005 million in 2018 and by £405 million to £2,679 million in 2017. The movement was largely due to the acquisition of RAI in 2017.
Depreciation, amortisation and impairment costs increased by £136 million to £1,038 million in 2018 and by £295 million to £902 million in 2017.
This includes the amortisation and impairment charges of £377 million (2017: £383 million, 2016: £149 million) largely related to the trademarks and similar intangibles capitalised following the acquisitions (including RAI, TDR and Skandinavisk Tobakskompagni A/S (ST)). The charge in 2018 includes the full year effect of RAI, with depreciation increasing in 2017 due to the higher depreciation charges following the consolidation of RAI in that year. 2018 was a lower charge than 2017, as 2017 included the impairment of trademarks acquired in Europe and North Africa (ENA) and migrated to the Group’s Strategic Portfolio, more than offsetting the full year effect of the amortisation of trademarks acquired as part of RAI.
Other operating expenses increased by £1,986 million to £6,668 million in 2018 (2017 up by £1,645 million) mainly due to the consolidation of RAI, including charges in relation to the Master Settlement Agreement.
Expenditure on research and development was £258 million in 2018 (2017: £191 million, 2016: £144 million) with a focus on products that could potentially reduce the risk associated with smoking conventional cigarettes.
Included in profit from operations are a number of adjusting items related to restructuring and integration costs and one-off charges, provisions and income. Adjusted items are defined in note 1 in the Notes on the Accounts.
Total adjusting items were £1,034 million in 2018 (2017: £1,517 million, 2016: £825 million), including the charges related to trademark amortisation and impairment (discussed above), and £363 million (2017: £600 million, 2016: £603 million) of restructuring and integration costs.
Change in adjusted profit from operations at constant rates (%)
Definition: Change in profit from operations before the impact of adjusting items and the impact of fluctuations in foreign exchange rates.
These restructuring and integration costs relate to the implementation of the new operating model, integration costs associated with the acquisition of RAI and factory rationalisations (in Germany, Russia and in Asia-Pacific and Middle East (APME)), the £110 million impairment of assets following the accounting revaluation in Venezuela (related to hyperinflationary accounting) and £178 million charge due to Engle in the US. Adjusting items in 2017 also included the release of the purchase price allocation adjustment to inventory (£465 million) and the impairment of certain assets related to Agrokor in Croatia.
We call the underlying profit before these items ‘adjusted profit from operations’.
In 2018, adjusted profit from operations at constant rates grew by 38% to £10,924 million, largely driven by the full year effect of RAI on the Group’s performance. On a representative basis, adjusted profit from operations at constant rates increased by 4.0%. This compares to an organic, constant rate, growth in 2017 of 3.7%, with the growth driven by the improved revenue as pricing combined with the continued management of the cost base more than offset the impact of lower volume.
Analysis of profit from operations, net finance costs and results from associates and joint ventures
| 2018 | 2017 | |||||||||||||||||||||||||||||||||||||||||
|
Reported £m |
Adjusting items £m |
Adjusted £m |
Impact of exchange £m |
Adjusted at CC £m |
Reported £m |
Adjusting items £m |
Adjusted £m |
Uplift to include acq £m |
Adjusted repres £m |
|||||||||||||||||||||||||||||||||
| Profit from operations | ||||||||||||||||||||||||||||||||||||||||||
| US | 4,006 | 505 | 4,511 | 175 | 4,686 | 1,165 | 763 | 1,928 | 2,502 | 4,430 | ||||||||||||||||||||||||||||||||
| APME | 1,858 | 90 | 1,948 | 151 | 2,099 | 1,902 | 147 | 2,049 | 25 | 2,074 | ||||||||||||||||||||||||||||||||
| AmSSA | 1,544 | 194 | 1,738 | 184 | 1,922 | 1,648 | 134 | 1,782 | 22 | 1,804 | ||||||||||||||||||||||||||||||||
| ENA | 1,905 | 245 | 2,150 | 67 | 2,217 | 1,697 | 473 | 2,170 | 29 | 2,199 | ||||||||||||||||||||||||||||||||
| Total regions | 9,313 | 1,034 | 10,347 | 577 | 10,924 | 6,412 | 1,517 | 7,929 | 2,578 | 10,507 | ||||||||||||||||||||||||||||||||
| Net finance costs | (1,381 | ) | (4 | ) | (1,385 | ) | (30 | ) | (1,415 | ) | (1,094 | ) | 205 | (889 | ) | |||||||||||||||||||||||||||
| Associates and joint ventures | 419 | (32 | ) | 387 | 33 | 420 | 24,209 | (23,197 | ) | 1,012 | ||||||||||||||||||||||||||||||||
| Profit before tax | 8,351 | 998 | 9,349 | 580 | 9,929 | 29,527 | (21,475 | ) | 8,052 | |||||||||||||||||||||||||||||||||
| BAT Annual Report and Form 20-F 2018 | 35 | |
Table of Contents
|
Financial Review
|
Income statement continued
Operating margin
Operating margin
(%)
Definition: Profit from operations as a percentage of revenue.
Operating margin in 2018 was ahead of 2017 by over 500 bps to 38.0%, as the Group’s performance and the full year impact of RAI more than offset the increased spend related to the PRRP portfolio, restructuring and integration costs incurred. 2017 (down 10 bps to 32.8% against 2016) was affected by the purchase price allocation adjustments arising as part of the RAI acquisition, including the £465 million uplift to inventory, dilutive effects of excise on bought-in goods and higher investment in PRRP.
In 2018, adjusted operating margin grew by 150 bps largely due to the full year effect of RAI. On a representative basis, this was an increase of 40 bps as the impact of pricing more than offset the investment into PRRP and inflation on the cost base.
In 2017, adjusted operating margin increased by 230 bps as the inclusion of RAI, the growth in adjusted organic revenue (driven in part by pricing) and ongoing cost savings (including the US$70 million of synergies achieved), more than offset the impact of inflation and transactional foreign exchange. Adjusted organic operating margin increased by 40 bps in 2017.
Adjusted operating margin
(%)
Definition: Adjusted profit from operations as a percentage of adjusted revenue.
Net finance costs
In 2018, net finance costs increased by £287 million to £1,381 million, largely due to the full year effect of servicing a higher level of debt following the acquisition of RAI. In 2017, net finance costs increased by £457 million to £1,094 million, largely due to the additional financing, including pre-financing charges of £153 million, required to acquire RAI and the finance costs associated with the RAI debt now consolidated within the Group.
In both 2018 and 2017, the Group recognised interest of £25 million in relation to FII GLO.
In 2018, the Group also recognised a monetary gain arising from the revaluation of the Group’s operations in Venezuela in line with hyperinflation (£45 million), which has been treated as an adjusting item.
Before the impact of adjusting charges related to FII GLO, the monetary gain in Venezuela, the 2017 pre-financing noted above and the translation impact of foreign exchange, adjusted net finance costs were 59.2% higher in 2018, with 2017 up 57.5% on 2016.
The Group’s average cost of debt in 2018 was 3.0%, ahead of 3.3% achieved in 2017 (2016: 3.1%).
Associates and joint ventures
Associates in 2018 largely comprised the Group’s shareholding in its Indian associate, ITC. The Group’s share of post-tax results of associates and joint ventures, included at the pre-tax level under IFRS, declined 98% to £419 million (2017 up £21,982 million on 2016, to £24,209 million) as the prior period included the results of RAI prior to the acquisition, after which it was consolidated as a wholly-owned subsidiary. Also in 2017, the Group recognised a gain of £23,288 million, which arose as the Group was deemed, under IFRS, to have disposed of RAI as an associate in that period.
Excluding the effect of the gain noted above and other adjusting items, the Group’s share of associates and joint ventures on an adjusted, constant currency basis was 58.5% lower in 2018 at £420 million as the Group ceased to recognise the results of RAI as an associate, while the Group’s share of ITC’s post-tax results grew by 8.0%. In 2017, the Group’s share of results of associates and joint ventures on an adjusted constant currency basis fell to £951 million, a decline of 28.3% due to RAI’s contribution as an associate for only part of the year, while the Group’s share of ITC’s post-tax results grew by 16.7%.
Analysis of profit from operations, net finance costs and results from associates and joint ventures
| 2017 | 2016 | |||||||||||||||||||||||||||||||||||||||||
|
Reported
£m |
Adjusting
£m |
Adjusted
£m |
Impact of exchange £m |
Adjusted at CC £m |
Impact of acquisitions £m |
Adjusted organic at CC £m |
Reported £m |
Adjusting items £m |
Adjusted £m |
|||||||||||||||||||||||||||||||||
|
Profit from operations |
||||||||||||||||||||||||||||||||||||||||||
|
US |
1,165 | 763 | 1,928 | (101 | ) | 1,827 | (1,827 | ) | – | – | – | – | ||||||||||||||||||||||||||||||
|
APME |
1,902 | 147 | 2,049 | (87 | ) | 1,962 | (31 | ) | 1,931 | 1,774 | 198 | 1,972 | ||||||||||||||||||||||||||||||
|
AmSSA |
1,648 | 134 | 1,782 | 17 | 1,799 | (27 | ) | 1,772 | 1,422 | 262 | 1,684 | |||||||||||||||||||||||||||||||
|
ENA |
1,697 | 473 | 2,170 | (153 | ) | 2,017 | (36 | ) | 1,981 | 1,479 | 345 | 1,824 | ||||||||||||||||||||||||||||||
|
Total regions |
6,412 | 1,517 | 7,929 | (324 | ) | 7,605 | (1,921 | ) | 5,684 | 4,675 | 805 | 5,480 | ||||||||||||||||||||||||||||||
|
Non-tobacco litigation: |
||||||||||||||||||||||||||||||||||||||||||
|
Fox River/Flintkote |
– | – | – | – | – | (20 | ) | 20 | – | |||||||||||||||||||||||||||||||||
|
Profit from operations |
6,412 | 1,517 | 7,929 | (324 | ) | 7,605 | 4,655 | 825 | 5,480 | |||||||||||||||||||||||||||||||||
|
Net finance (costs)/income |
(1,094 | ) | 205 | (889 | ) | 56 | (833 | ) | (637 | ) | 108 | (529 | ) | |||||||||||||||||||||||||||||
|
Associates and joint ventures |
24,209 | (23,197 | ) | 1,012 | (61 | ) | 951 | 2,227 | (900 | ) | 1,327 | |||||||||||||||||||||||||||||||
|
Profit before tax |
29,527 | (21,475 | ) | 8,052 | (329 | ) | 7,723 | 6,245 | 33 | 6,278 | ||||||||||||||||||||||||||||||||
| 36 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
Tax
In 2018, the tax charge in the Income Statement was £2,141 million, against a credit of £8,129 million in 2017 and a charge of £1,406 million in 2016. The 2017 credit was largely due to the impact of the change in tax rates in the US which led to a credit of £9.6 billion related to the revaluation of deferred tax liabilities arising on the acquired net assets of RAI, and described below. The tax rates in the Income Statement are therefore a charge of 25.6% in 2018, against a credit of 27.5% in 2017 and a charge of 22.5% in 2016. These are also affected by the inclusion of adjusting items described earlier and the associates and joint ventures’ post-tax profit in the Group’s pre-tax results. Excluding these items and the deferred tax credit in 2017, the underlying tax rate for subsidiaries was 26.4% in 2018, 29.7% in 2017 and 29.8% in 2016. See the section Non-GAAP measures on page 262 for the computation of underlying tax rate for the periods presented.
Tax strategy
The Group’s global tax strategy is reviewed regularly by the Board. The operation of the strategy is managed by the Finance Director and Group Head of Tax with the Group’s tax position reported to the Audit Committee on a regular basis. The Board considers tax risks that may arise as a result of our business operations. In summary, the strategy includes:
| – |
complying with all applicable laws and regulations in countries in which we operate; |
| – |
being open and transparent with tax authorities and operating to build mature professional relationships; |
| – |
supporting the business strategy of the Group by undertaking efficient management of our tax affairs in line with the Group’s commercial activity; |
| – |
transacting on an arm’s-length basis for exchanges of goods and services between companies within the Group; and |
| – |
engaging in pro-active discussions with tax authorities on occasions of differing legal interpretation. |
The publication of this strategy is considered to constitute compliance with the duty under paragraph 16(2) Schedule 19 Part 2 of the UK Finance Act 2016.
The taxation on ordinary activities for 2018 was a charge of £2.1 billion, while 2017 was a credit of £8.1 billion and 2016 was a charge of £1.4 billion. Corporation tax paid (due to the timing of corporation tax instalment payments which straddle different financial years) was £1.9 billion (2017: £1.7 billion, 2016: £1.2 billion).
Our tax footprint extends beyond corporation tax, including significant payment of employment taxes and other indirect taxes including customs and import duties. The Group also collects taxes on behalf of governments (including tobacco excise, employee taxes, VAT and other sales taxes). The total tax paid in 2018 of £39.9 billion (2017: £37.4 billion, 2016: £33.2 billion) therefore consists of both taxes borne and taxes collected as shown in the table provided.
In addition to the major taxes, there are a host of other taxes the Group bears and collects such as transport taxes, energy and environmental taxes, and banking and insurance taxes.
In 2017, as part of the acquisition of RAI, the Group acquired the assets and liabilities of the RAI Companies. These are required to be fair valued at the date of acquisition. The fair value of the net assets acquired created a deferred tax liability, valued at the prevailing rate of corporation tax at the date of acquisition, being 25 July 2017. Subsequently, on 22 December 2017, the US federal corporate tax rate was changed to 21%, effective from 1 January 2018. This revised rate was used to revalue the deferred tax liability at the balance sheet date, reducing the liability and providing a credit to the income statement in 2017 of £9.6 billion. Due to the scale of the impact, this credit was treated as an adjusting item in that period.
Major taxes paid 2018
(£bn)
Major taxes paid
| 2018 | 2017 | |||||||||
| £bn | £bn | |||||||||
|
|
||||||||||
|
|
Tobacco excise (collected) | 31.1 | 29.0 | |||||||
|
|
Net VAT and other sales | |||||||||
| taxes (collected) | 5.9 | 5.9 | ||||||||
|
|
Corporation tax (borne) | 1.9 | 1.7 | |||||||
|
|
Customs and import duties | |||||||||
| (borne) | 0.3 | 0.2 | ||||||||
|
|
Taxes paid by employee | |||||||||
| (collected) | 0.5 | 0.4 | ||||||||
|
|
Employment taxes (borne) | 0.2 | 0.2 | |||||||
| 39.9 | 37.4 | |||||||||
The movements in deferred tax, taken through other comprehensive income, mainly relate to the change in the valuation of retirement benefits in the year, as disclosed in note 13 in the Notes on the Accounts.
|
Where resolution is not possible, tax disputes may proceed to litigation. The Group seeks to establish strong technical tax positions. Where legislative uncertainty exists, resulting in differing interpretations, the Group seeks to establish that its position would be more likely than not to prevail. Transactions between Group subsidiaries are conducted on arm’s-length terms in accordance with appropriate transfer pricing rules and OECD principles.
The tax strategy outlined above is applicable to all Group companies, including the UK Group companies; reference to tax authorities includes HMRC. |
Deferred tax asset/(liability)
|
|
||||||||||||
|
2018 £m |
2017 £m |
2016 £m |
||||||||||||
| Opening balance | (16,796 | ) | (216 | ) | (237 | ) | ||||||||
| Difference on exchange | (1,011 | ) | 852 | (39 | ) | |||||||||
| Recognised on acquisition of RAI | – | (27,065 | ) | – | ||||||||||
| Impact of US tax reforms | – | 9,620 | – | |||||||||||
| Changes in tax rates | 70 | – | – | |||||||||||
| Other (charges)/credits to the income statement | 304 | 152 | (4 | ) | ||||||||||
| Other (charges)/credits to other comprehensive income | (7 | ) | (133 | ) | 70 | |||||||||
| Other movements | 8 | (6 | ) | (6 | ) | |||||||||
| Closing balance | (17,432 | ) | (16,796 | ) | (216 | ) | ||||||||
| BAT Annual Report and Form 20-F 2018 | 37 | |
Table of Contents
|
Financial Review
|
|
Income statement continued
|
||||||||||||||
|
Diluted earnings per share (EPS) (p)
|
Definition: Profit attributable to owners of BAT p.l.c. over weighted average number of shares outstanding, including the effects of all dilutive potential ordinary shares.
|
Change in adjusted diluted EPS (%)
|
|
Definition: Change in diluted earnings per share before the impact of adjusting items.
|
Change in adjusted diluted EPS
|
|
Definition: Change in diluted earnings per share before the impact of adjusting items and the impact of fluctuations in foreign exchange rates.
Earnings per share
Profit for the year was £6,210 million, an 84% decline compared to £37,656 million (up 678% on 2016), largely due to accounting gains related to the acquisition of RAI and the deferred tax credit arising from the US tax reform, which both arose in the prior year. Consequently, and after accounting for the movement in non-controlling interests in the year, basic earnings per share were 86% lower at 264.0p (2017: 1,833.9p, 2016: 250.2p). After accounting for the dilutive effect of employee share schemes, diluted earnings per share were 263.2p, 86% lower than 2017 (2017: 1,827.6p, 2016: 249.2p).
Earnings per share are impacted by the adjusting items discussed above. Adjusted diluted EPS, as calculated in note 7 in the Notes on the Accounts, were up against the prior year by 5.2% at 296.7p, with 2017 ahead of 2016 by 14.0% at 282.1p. Adjusted diluted EPS at constant rates would have been 11.8% ahead of 2017 at 315.5p, with 2017 up 9.1% against 2016.
Dividends
On 26 April 2017, the Group announced its move to quarterly dividends with effect from 1 January 2018. Quarterly dividends provide shareholders with a more regular flow of dividend income and allow the Company to spread its substantial dividend payments more evenly over the year. The dividends align better with the cash flow generation of the Group and so enable the Company to fund the payments more efficiently.
The Board has declared an interim dividend of 203.0p per ordinary share of 25p, payable in four equal quarterly instalments of 50.75p per ordinary share in May 2019, August 2019, November 2019 and February 2020. This represents an increase of 4.0% on 2017, (2017: 195.2p per share), and a payout ratio, on 2018 adjusted diluted earnings per share, of 68.4%.
The quarterly dividends will be paid to shareholders registered on either the UK main register or the South Africa branch register and to ADS holders, each on the applicable record dates.
Under IFRS, the dividend is recognised in the year that it is declared or, if required, approved by shareholders. Therefore, the 2018 accounts reflect the interim dividend declared by the Board in February 2018, of 195.2p per ordinary share, payable in four equal instalments of 48.8p per ordinary share in May 2018, August 2018 and November 2018 and February 2019, in total amounting to 195.2p (£4,463 million), against 218.2p (£4,465 million) in 2017. The total dividend recognised in 2018 and 2017 were comparable despite the increase in dividend per share noted earlier and the increased share capital. This was because, in December 2017, the Group declared an additional interim payment of 43.6p per share as part of the transition to quarterly dividends, to ensure that shareholders receive the equivalent cash amount in both years as they would have under the previous payment policy. Further details of the total amounts of dividends paid in 2018 (with 2017 comparatives) are given in note 8 in the Notes on the Accounts.
Dividends are declared and payable in sterling except for those shareholders on the branch register in South Africa, where dividends are payable in rand. The equivalent dividends receivable by holders of ADSs in US dollars are calculated based on the exchange rate on the applicable payment date.
Further details of the quarterly dividends and key dates are set out under ‘Shareholder information’ on pages 298 and 299.
| 38 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
Treasury, liquidity and capital structure
The Treasury Function is responsible for raising finance for the Group and managing the Group’s cash resources and the financial risks arising from underlying operations. Clear parameters have been established, including levels of authority, on the type and use of financial instruments to manage the financial risks facing the Group. Such instruments are only used if they relate to an underlying exposure; speculative transactions are expressly forbidden under the Group’s treasury policy. All these activities are carried out under defined policies, procedures and limits, reviewed and approved by the Board, delegating oversight to the Finance Director and Treasury Function. See note 23 in the Notes on the Accounts for further detail.
It is the policy of the Group to maximise financial flexibility and minimise refinancing risk by issuing debt with a range of maturities, generally matching the projected cash flows of the Group and obtaining this financing from a wide range of sources. The Group targets an average centrally managed debt maturity of at least five years with no more than 20% of centrally managed debt maturing in a single rolling year. As at 31 December 2018, the average centrally managed debt maturity was 8.8 years (2017: 9.2 years, 2016: 8.2 years) and the highest proportion of centrally managed debt maturing in a single rolling 12-month period was 18.4% (2017: 13.2%, 2016: 18.1%).
The only externally imposed capital requirement the Group has is in respect of its centrally managed banking facilities, which require a gross interest cover of 4.5 times. The Group targets a gross interest cover, as calculated under its key central banking facilities, of greater than 5 times. For 2018, it was 7.2 times (2017: 7.8 times, 2016: 12.2 times).
In order to manage its interest rate risk, the Group maintains both floating rate and fixed rate debt. The Group sets targets (within overall guidelines) for the desired ratio of floating to fixed rate debt on a net basis (at least 50% fixed on a net basis in the short to medium term). At 31 December 2018, the relevant ratios of floating to fixed rate borrowings were 21:79 (2017: 19:81, 2016: 15:85) on a net basis.
As part of the management of liquidity, funding and interest rate risk the Group regularly evaluates market conditions and may enter into transactions, from time to time, to repurchase outstanding debt, pursuant to open market purchases, tender offers or other means.
In addition, the Group has evaluated its floating rate debt maturing after 2021 in connection with the potential discontinuation of LIBOR after 2021 as a result of the UK Financial Conduct Authority’s announcement on 27 July 2017. The Group believes that its contracts with
interest rates based on LIBOR adequately provide for alternate calculations of interest in the event that LIBOR is unavailable.
Although these alternative calculations may cause an administrative burden, the Group does not believe that it would materially adversely affect the Group or its ability to manage its interest rate risk.
The Group continues to maintain investment-grade credit ratings*, with ratings from Moody’s/S&P at Baa2 (stable outlook)/ BBB+ (stable outlook), respectively, with a medium-term rating target of Baa1/BBB+. The strength of the ratings has underpinned debt issuance and the Group is confident of its ability to successfully access the debt capital markets. All contractual borrowing covenants have been met and these covenants are not expected to inhibit the Group’s operations or funding plans.
In 2017, the Group replaced the existing £3 billion revolving credit facility maturing in 2021 with a new two-tranche £6 billion revolving credit facility. This consists of a £3 billion 364-day revolving credit facility (with a one-year extension, that was exercised in July 2018, and a one-year term-out option), and a £3 billion revolving credit facility maturing in 2021. In 2017, the Group also increased the EMTN programme from £15 billion to £25 billion and increased its US and European commercial paper programmes from US$3 billion to US$4 billion and from £1 billion to £3 billion, respectively, to accommodate the liquidity needs of the enlarged Group. At 31 December 2018, the revolving credit facility was undrawn (2017: £600 million drawn) with £536 million of commercial paper outstanding (2017: £1.2 billion, 2016: £254 million). The increase in the short-term funding requirement in 2017 was due to the timing of the payment of the 2017 Master Settlement Agreement (MSA) liability.
Management believes that the Group has sufficient working capital for present requirements, taking into account the amounts of undrawn borrowing facilities and levels of cash and cash equivalents, and the ongoing ability to generate cash.
On 25 July 2017, British American Tobacco p.l.c. acceded as guarantor under the indentures of its indirect wholly-owned subsidiaries RAI and R.J. Reynolds Tobacco Company. The securities issued under these indentures include approximately US$12.2 billion aggregate principal amount of unsecured RAI debt securities and approximately US$231 million aggregate principal amount of unsecured R.J. Reynolds Tobacco Company debt securities.
Cash flow
Net cash generated from operating activities
In 2018, net cash generated from operating activities increased by £4,948 million to £10,295 million, principally due to the full year effect from RAI, compared to approximately five months’ contribution to 2017, the timing of payments related to the MSA in the US and an increase in debtor factoring by approximately £300 million. These more than offset a reduction in dividends from associates following the acquisition of RAI. Other movements include:
| – |
the increase in inventory in 2018 was predominantly related to the timing of leaf purchases and inventory movements in Romania, Turkey and Russia; |
| – |
the increase in trade and other payables was driven by higher excise payables which are impacted by the timing of inventory movements in the supply chain; and |
| – |
the final quarterly payments in relation to the Quebec class-action in 2017. |
Net cash generated from operating activities increased in 2017 by £737 million (or 16.0%) largely due to the cash generated by RAI from 25 July 2017, the profit from operations earned in the period from the rest of the Group (as discussed on pages 44 to 47) and a reduction in inventories. This more than offset an increase in receivables, a reduction in trade and other payables, the payment of the 2017 liability related to the MSA in the US and the final quarterly payments in relation to the Quebec class-action.
Net cash used in investing activities
In 2018, net cash used in investing activities declined by £17,523 million to £1,021 million (2017: £18,544 million, 2016: £640 million) as 2017 included the acquisition of the shares in RAI not already owned by the Group.
Included within investing activities is gross capital expenditure which includes purchases of property, plant and equipment and purchases of intangibles. This includes the investment in the Group’s global operational infrastructure (including, but not limited to, the manufacturing network, trade marketing software and IT systems). In 2018, the Group invested £883 million, an increase of 2.4% on the prior year (2017: £862 million, 2016: £652 million). The Group expects gross capital expenditure in 2019 of £872 million, mainly related to the ongoing investment in the Group’s operational infrastructure including the expansion of PRRPs.
| * |
A credit rating is not a recommendation to buy, sell or hold securities. A credit rating may be subject to withdrawal or revision at any time. Each rating should be evaluated separately of any other rating. |
| BAT Annual Report and Form 20-F 2018 | 39 | |
Table of Contents
|
Financial Review
|
Treasury and cash flow continued
Summary cash flow
|
2018 |
2017 |
2016 |
||||||||||
|
£m
|
£m
|
£m
|
||||||||||
|
Cash generated from operations
|
|
11,972
|
|
|
6,119
|
|
|
4,893
|
|
|||
|
Dividends received from associates
|
|
214
|
|
|
903
|
|
|
962
|
|
|||
|
Tax paid
|
|
(1,891
|
)
|
|
(1,675
|
)
|
|
(1,245
|
)
|
|||
|
Net cash generated from operating activities
|
|
10,295
|
|
|
5,347
|
|
|
4,610
|
|
|||
|
Net cash used in investing activities
|
|
(1,021
|
)
|
|
(18,544
|
)
|
|
(640
|
)
|
|||
|
Net cash (used in)/from financing activities
|
|
(9,630
|
)
|
|
14,759
|
|
|
(4,229
|
)
|
|||
|
Differences on exchange
|
|
(138
|
)
|
|
(391
|
)
|
|
180
|
|
|||
|
(Decrease)/increase in net cash and cash equivalents
|
|
(494
|
)
|
|
1,171
|
|
|
(79
|
)
|
|||
Net cash used in financing activities
Net cash used in financing activities was an outflow of £9,630 million in 2018 (2017: £14,759 million inflow). The 2018 outflow was mainly due to the payment of a € 0.4 billion bond (in March 2018) and three bonds totalling US$2.5 billion (in June 2018) at maturity, the repayment of £0.6 billion, under the revolving credit facility and £1.2 billion of commercial paper outstanding in each case at 31 December 2017.
The 2018 outflow also included the higher dividend payment of £4,347 million (2017: £3,465 million, 2016: £2,910 million) due to the higher dividend per share and the increase in share capital.
The inflow in 2017 noted above, was principally due to the debt taken on related to the acquisition of RAI.
Eight series of US$ denominated unregistered bonds totalling US$17.25 billion were issued in August 2017 pursuant to Rule 144A with registration rights, whereby the Group committed to investors that the bonds would be exchangeable for registered notes. In October 2018, investors were offered to exchange their unregistered bonds for registered bonds in line with the registration rights. The exchange offer was completed in November 2018 with 99.7% of the bonds exchanged.
In March and April 2017, the Group arranged short-term bilateral facilities with some of its core banks for a total of approximately £1.6 billion. In June 2017, a € 1,250 million bond and a US$600 million bond were repaid at maturity. In August 2017, the Group paid on maturity a US$500 million bond.
In July 2017, following the shareholder approvals of the acquisition of RAI, the Group used its US$25 billion acquisition facility provided by a syndicate of relationship banks comprising US$15 billion and US$5 billion bridge facilities with one- and two-year maturities, respectively. In addition, the acquisition facility included two US$2.5 billion term loans with maturity in 2020 and 2022. In August 2017, the bridge facilities were refinanced in the US and European capital markets.
During 2017, four series of bonds were issued pursuant to the EMTN programme and comprised a £450 million bond maturing in August 2025 and three euro-denominated bonds totalling € 3.1 billion comprising a € 1.1 billion bond maturing in August 2021, a € 750 million bond maturing in November 2023 and a € 1.25 billion bond maturing in January 2030.
Cash flow conversion
The conversion of profit from operations to net cash generated from operating activities may indicate the Group’s ability to generate cash from the profits earned. Based upon net cash generated from operating activities, the Group’s conversion rate increased from 83% to 111% in 2018. This was largely due to the timing of the payment for the MSA in December 2017, the costs associated with the acquisition of RAI and other adjusting items.
| 40 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
Borrowings and net debt
Total borrowings decreased to £47,509 million in 2018 (2017: £49,450 million) as the Group repaid, on maturity, a € 400 million bond in March 2018 and three bonds totalling US$2,500 million in June 2018. The increase in 2017 (2016: £19,495 million) was largely due to the US$25 billion debt raised in connection with the acquisition of RAI and the consolidation of RAI’s debt on acquisition.
Total borrowings includes £944 million (31 December 2017: £947 million) in respect of the purchase price adjustments related to the acquisition of RAI.
As discussed on page 39, the Group remains confident about its ability to access the debt capital markets successfully and reviews its options on a continuing basis.
Net debt is a non-GAAP measure and is defined as total borrowings, including related derivatives, less cash and cash equivalents and current available-for-sale investments.
Net debt, at 31 December 2018, was £44,351 million (2017: £45,571 million; 2016: £16,767 million), with the movement in net debt largely due to the repayment of the outstanding bonds described earlier.
The movement in net debt includes dividends paid to owners of the parent of £4,347 million (2017: £3,465 million) and other cash items including investments made, notably in 2017 related to the additional borrowings in relation to RAI.
Also impacting carrying value of net debt at the balance sheet date are non-cash movements including, in 2017, the consolidation of RAI’s net debt (£9,915 million) as part of the acquisition, and in 2018, a negative translational foreign exchange headwind due to the movement in sterling against the reporting currencies, largely US dollar, of £1,963 million (2017: £1,268 million tailwind).
Adjusted net debt to adjusted EBITDA
The Group uses adjusted net debt to adjusted EBITDA, as defined on page 266, to assess its level of adjusted net debt in comparison to the earnings generated by the Group. This is deemed by management to reflect the Group’s ability to service and repay borrowings. In 2018, the ratio of adjusted net debt to adjusted EBITDA was 4.0 times, representing an improvement from 5.3 times at the end of 2017. The increase in 2017 from 2.9 times in 2016 was due to the additional adjusted net debt arising as part of the acquisition of RAI in 2017, while 2017 only included five months of RAI contribution to adjusted EBITDA.
The Group’s adjusted net debt to adjusted EBITDA ratio is subject to the fluctuations in the foreign exchange market by virtue of the Group’s foreign currency denominated earnings and the exposure of the debt portfolio to, predominantly, the US dollar. In 2018, the US dollar appreciated against sterling comparing the reporting date of 31 December 2018 with 31 December 2017. This increased the sterling value of adjusted net debt by £1,694 million.
However, the Group incurred a headwind on the foreign denominated earnings of approximately 7%, leading to a reduction in adjusted EBITDA of £590 million, compared to the 2017 average exchange rates. These headwinds impacted the adjusted net debt to adjusted EBITDA ratio by approximately 0.4 times, and the ratio would have been 3.6 times on a constant rate basis.
Refer to page 266 for a full reconciliation from borrowings to adjusted net debt, profit for the year to adjusted EBITDA and the ratio of adjusted net debt to adjusted EBITDA, at both current and constant rates of exchange.
Retirement benefit schemes
The Group’s subsidiaries operate over 190 retirement benefit arrangements worldwide. The majority of the scheme members belong to defined benefit schemes, most of which are funded externally and many of which are closed to new entrants. The Group also operates a number of defined contribution schemes.
The present total value of funded scheme liabilities as at 31 December 2018 was £11,317 million (2017: £11,868 million; 2016: £7,155 million), while unfunded scheme liabilities amounted to £1,106 million (2017: £1,157 million; 2016: £476 million). The schemes’ assets increased from £7,278 million in 2016 to £12,350 million in 2017 and declined to £11,925 million in 2018. After excluding unrecognised scheme surpluses of £20 million (2017: £23 million; 2016: £18 million), the overall net liability for all pension and healthcare schemes in Group subsidiaries amounted to £518 million at the end of 2018, compared to £698 million at the end of 2017 (2016: £371 million). Contributions to the defined benefit schemes are determined after consultation with the respective trustees and actuaries of the individual externally funded schemes, taking into account regulatory environments.
Litigation and settlements
As discussed in note 28 in the Notes on the Accounts, various legal proceedings or claims are pending or may be instituted against the Group.
Government activity
The marketing, sale, taxation and use of tobacco products have been subject to substantial regulation by government and health officials for many years. For information about the risks related to regulation, see page 49 and pages 274 to 279.
Off-balance sheet arrangements and contractual obligations
Except for operating leases and certain indemnities, the Group has no significant off-balance sheet arrangements. The Group has contractual obligations to make future payments on debt guarantees. In the normal course of business, it enters into contractual arrangements where the Group commits to future purchases of goods and services from unaffiliated and related parties. See page 268 for a summary of the contractual obligations as at 31 December 2018.
| BAT Annual Report and Form 20-F 2018 | 41 | |
Table of Contents
|
Financial Review
|
Accounting policies
The application of the accounting standards and the accounting policies adopted by the Group are set out in the Group Manual of Accounting Policies and Procedures (GMAPP).
GMAPP includes the Group instructions in respect of the accounting and reporting of business activities, such as revenue recognition, asset valuations and impairment testing, adjusting items, the accrual of obligations and the appraisal of contingent liabilities, which include taxes and litigation. Formal processes are in place whereby central management and end-market management confirm adherence to the principles and the procedures and to the completeness of reporting. Central analyses and revision of information are also performed to ensure and confirm adherence.
In order to prepare the Group’s consolidated financial information in accordance with IFRS, management has used estimates and assumptions that affect the reported amounts of revenue, expenses, assets and the disclosure of contingent liabilities at the date of the financial statements.
The critical accounting estimates are described in note 1 in the Notes on the Accounts and include:
| – |
review of asset values, including goodwill and impairment testing; |
| – |
estimation and accounting for retirement benefit costs; |
| – |
estimation of provisions, including as related to taxation and legal matters; and |
| – |
estimation of the fair values of acquired net assets arising in a business combination. |
The critical accounting judgements are described in note 1 in the Notes on the Accounts and include:
| – |
identification and quantification of adjusting items; |
| – |
determination as to whether control (subsidiaries), joint control (joint arrangements), or significant influence (associates) exist in relation to investments held by the Group; and |
| – |
review of applicable exchange rates for transactions with and translation of entities in territories where there are restrictions on the free access to foreign currency or multiple exchange rates. |
Accounting developments
The Group has prepared its annual consolidated financial statements in accordance with IFRS.
Other than as stated below, there were no further material changes to the accounting standards applied in 2018 from those applied in 2017.
IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers became effective from 1 January 2018, and the impact of these changes is also disclosed in note 1 in the Notes on the Accounts.
IFRS 16 Leases was published in January 2016 with a mandatory effective date of 1 January 2019. The effect is that virtually all leasing arrangements are brought on to the balance sheet as financial obligations and ‘right-to-use’ assets. The impact of applying the Standard to the Group’s reported profit in 2018, 2017 or 2016 would not have been material. Had the Standard been applied to the 2018 accounts, non-current assets and liabilities would have each been increased by £564 million at the start of the year. At the end of the year, non-current assets would have been increased by £551 million and non-current liabilities by £558 million. The impact of adopting IFRS 16 with effect from 1 January 2019 is shown in note 31 in the Notes on the Accounts.
Future changes applicable on the accounting standards that will be applied by the Group are set out in note 1 in the Notes on the Accounts.
Foreign exchange rates
The principal exchange rates used to convert the results of the Group’s foreign operations to sterling, for the purposes of inclusion and consolidation within the Group’s financial statements, are indicated in the table below.
Where the Group has provided results at constant rates of exchange this refers to the translation of the results from the foreign operations at rates of exchange prevailing in the prior period – thereby eliminating the potentially distorting impact of the movement in foreign exchange on the reported results.
Going concern
A description of the Group’s business activities, its financial position, cash flows, liquidity position, facilities and borrowings position, together with the factors likely to affect its future development, performance and position, are set out in this Annual Report and Form 20-F.
The key Group risks include analyses of financial risk and the Group’s approach to financial risk management. Notes 20 and 23 in the Notes on the Accounts provide further detail on the Group’s borrowings and management of financial risks.
The Group has, at the date of this report, sufficient existing financing available for its estimated requirements for at least the next 12 months. This, together with the proven ability to generate cash from trading activities, the performance of the Group’s Strategic Portfolio, its leading market positions in a number of countries and its broad geographical spread, as well as numerous contracts with established customers and suppliers across different geographical areas and industries, provides the Directors with the confidence that the Group is well placed to manage its business risks successfully in the context of current financial conditions and the general outlook in the global economy.
After reviewing the Group’s annual budget, plans and financing arrangements for the next three years, the Directors consider that the Group has adequate resources to continue operating and that it is therefore appropriate to continue to adopt the going concern basis in preparing the Annual Report and Form 20-F.
Foreign exchange rates
|
Average
|
Closing
|
|||||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | |||||||||||||||||||||
|
Australian dollar |
1.786 | 1.681 | 1.824 | 1.809 | 1.730 | 1.707 | ||||||||||||||||||||
|
Brazilian real |
4.868 | 4.116 | 4.740 | 4.936 | 4.487 | 4.022 | ||||||||||||||||||||
|
Canadian dollar |
1.730 | 1.672 | 1.795 | 1.739 | 1.695 | 1.657 | ||||||||||||||||||||
|
Euro |
1.130 | 1.142 | 1.224 | 1.114 | 1.127 | 1.172 | ||||||||||||||||||||
|
Indian rupee |
91.227 | 83.895 | 91.022 | 88.916 | 86.343 | 83.864 | ||||||||||||||||||||
|
Japanese yen |
147.376 | 144.521 | 147.466 | 139.733 | 152.387 | 144.120 | ||||||||||||||||||||
|
Russian rouble |
83.677 | 75.170 | 91.026 | 88.353 | 77.880 | 75.429 | ||||||||||||||||||||
|
South African rand |
17.643 | 17.150 | 19.962 | 18.321 | 16.747 | 16.898 | ||||||||||||||||||||
|
US dollar |
1.335 | 1.289 | 1.355 | 1.274 | 1.353 | 1.236 | ||||||||||||||||||||
| 42 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
| Variance | ||||||||||||||||||||||||||||||||||
| United States | Americas and Sub-Saharan Africa | |||||||||||||||||||||||||||||||||
| 2018 | 2018 vs 2017 | 2018 vs 2017 | 2017 vs 2016 | 2018 | 2018 vs 2017 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||||||||||||||||
| Variance | % |
(rep) % |
% | % |
(rep) % |
% | ||||||||||||||||||||||||||||
| Volume (bn) | 77 | +118% | -5.3% | n/a | 157 | -5.4% | -5.4% | -4.2% | ||||||||||||||||||||||||||
| Movement in market share (bps) | -20 bps | n/a | -20 bps | +10 bps | ||||||||||||||||||||||||||||||
| Revenue (£m) | 9,495 | +128% | n/a | 4,111 | -4.9% | +7.1% | ||||||||||||||||||||||||||||
| Adjusted revenue at constant rates (£m) | 9,838 | +137% | +1.5% | n/a | 4,560 | +5.6% | +5.6% | +8.1% | ||||||||||||||||||||||||||
| Profit from operations (£m) | 4,006 | +244% | n/a | 1,544 | -6.3% | +15.9% | ||||||||||||||||||||||||||||
| Adjusted profit from operations at constant rates (£m) | 4,686 | +143% | +5.8% | n/a | 1,922 | +7.9% | +6.5% | +5.2% | ||||||||||||||||||||||||||
| Adjusted organic profit from operations at constant rates (£m) | n/a | +5.2% | ||||||||||||||||||||||||||||||||
| Europe and North Africa | Asia-Pacific and Middle East | |||||||||||||||||||||||||||||||||
| 2018 | 2018 vs 2017 | 2018 vs 2017 | 2017 vs 2016 | 2018 | 2018 vs 2017 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||||||||||||||||
| Variance | % |
(rep) % |
% | % |
(rep) % |
% | ||||||||||||||||||||||||||||
| Volume (bn) | 246 | -4.7% | -5.3% | -1.9% | 228 | +0.7% | +0.7% | -1.0% | ||||||||||||||||||||||||||
| Movement in market share (bps) | FLAT | +20 bps | +110 bps | +50 bps | ||||||||||||||||||||||||||||||
| Revenue (£m) | 6,004 | -1.7% | +14.7% | 4,882 | -1.8% | +4.3% | ||||||||||||||||||||||||||||
| Adjusted revenue at constant rates (£m) | 6,112 | +4.5% | +3.5% | +3.4% | 5,250 | +5.7% | +5.7% | +0.2% | ||||||||||||||||||||||||||
| Profit from operations (£m) | 1,905 | +12.3% | +14.7% | 1,858 | -2.3% | +7.2% | ||||||||||||||||||||||||||||
| Adjusted profit from operations at constant rates (£m) | 2,217 | +2.2% | +0.8% | +10.6% | 2,099 | +2.4% | +1.2% | -0.5% | ||||||||||||||||||||||||||
| Adjusted organic profit from operations at constant rates (£m) | +8.6% | -0.5% | ||||||||||||||||||||||||||||||||
Effective 1 January 2018, the Group, excluding the Group’s associate undertakings, was organised into four regions: The United States (US – Reynolds American Inc.), Asia-Pacific and Middle East (APME), Americas and Sub-Saharan Africa (AmSSA) and Europe and North Africa (ENA). For presentation purposes within this Annual Report and Form 20-F, all prior periods have been revised to be consistent with the current reporting structure.
| BAT Annual Report and Form 20-F 2018 | 43 | |
Table of Contents
|
Financial Review
|
|
United States
“Pricing and value share growth in combustibles, as well as increased Vuse consumables volumes, has more than offset total volume declines”
Ricardo Oberlander President and CEO (RAI)
|
|
Volume and Market Share
The cigarette industry was estimated to be around 4.5% lower in 2018 partly due to the impact of higher fuel prices on disposable income, the growth of the vapour category and the full year effect of the change in excise in 2017 in California. The decline moderated in the second half of the year, from 5.3% to 4.1%.
In 2018, cigarette volume from the US business was 77 billion sticks, which represents an increase of 118% due to the recognition of a full year’s volume from RAI. On a representative basis, this was 5.3% lower than in 2017, with market share declining 20 bps, as continued growth in market share in Natural American Spirit (up 20 bps) and Newport (10 bps higher) and stable Camel share was more than offset by lower market share in Pall Mall (down 20 bps) and declines in the remainder of the portfolio. US volumes were further affected by a strong comparator due to Camel and Newport product launches in the first six months of 2017. Total value share grew 25 bps driven by the performance of the premium brands.
The US vapour market experienced strong growth (up approximately 120% in volume terms) which the Group estimates has contributed to a total volume decline in cigarettes of 0.7% during 2018. While new competitor vapour brands have taken market share, Vuse continued to grow volume of consumables (cartridges) by 36%, on a representative basis, with distribution of Alto reaching over 70,000 outlets, which is estimated to be approximately 70% of the retail universe. Performance was negatively impacted by a product recall, of Vibe, arising from a few isolated issues which have been resolved.
Oral volume declined 2.3% on a representative basis, with market share down against the prior period which, on a representative basis, benefited from a competitor’s product recall.
During 2018, the US Food and Drug Administration’s (FDA) regulatory proposals contributed to increased uncertainty in the US operating environment. Given our long track record of success in the face of regulatory change in the industry, and our strong portfolio of brands, we are confident in our ability to manage the proposals noting that any FDA regulation or proposed ban of menthol in cigarettes must be
developed through a comprehensive rule-making process, be based on a thorough scientific review and consider all unintended consequences in order to withstand judicial review.
In 2017, the FDA accepted and filed for substantive review the Modified Risk Tobacco Products (MRTP) applications for Camel Snus, which were subsequently provided with a favourable recommendation from the Tobacco Products Scientific Advisory Committee (TPSAC). There is no timetable for the FDA to issue a decision on the MRTP applications, however, the Group anticipates a decision during 2019.
In 2017, in the period since acquisition, cigarette volume was 36 billion, outperforming the industry with total cigarette market share at 34.7%, up 20 bps on 2016. Newport and Natural American Spirit continued to grow market share driven by the investment into the trade and, together, were the fastest growing premium brands on the market. Camel market share increased due to the performance of the menthol range. Pall Mall market share decreased due to the price competition in the value-for-money category. Combined, the US strategic combustible portfolio grew market share by 40 bps in 2017. Volume of moist snuff was equivalent to 3.2 billion sticks in the period since acquisition. Total moist market share was up 100 bps on 2016 to 34.4%, primarily due to the performance of Grizzly in the moist snuff category, benefiting from its strength in the pouch and wintergreen categories, as well as the recent national expansion of its Dark Select style and the limited edition packs.
Revenue
Reported revenue was £9,495 million, an increase on 2017 of 128%, largely due to the 12-month inclusion of results from RAI, compared to approximately five months in 2017.
On a constant currency, representative basis, adjusted revenue was up 1.5% as pricing in both the combustibles and oral categories and higher Vuse consumables volume more than offset the reduction in combustibles and oral volume (noted above).
Revenue in 2017 on a representative basis included £94 million of revenue recognised by RAI related to the sale of inventory associated with the international brand rights of Natural
American Spirit. Revenue from vapour grew by 149% to £184 million, an increase of 20% on a representative, constant currency basis.
In 2017, revenue was £4,160 million in the period since acquisition. Prior to July 2017, RAI was an associate and no revenue was recognised by the group in the periods previous to the acquisition.
Profit from operations
Reported profit from operations was £4,006 million, an increase of 244% on 2017, largely due to the full year’s inclusion in the Group’s results. Excluding adjusting items related to Engle and integration costs, profit from operations was £4,511 million, an increase of 1.8% on an adjusted, representative basis, or 5.8% excluding the translational foreign exchange headwind. This increase reflects the growth in revenue from the portfolio and cost reductions since the acquisition of RAI.
Cost synergies are progressing well, with annualised savings of over US$300 million delivered to date. The Group continues to expect to deliver over US$400 million of synergies by the end of 2020.
In 2017, profit from operations was £1,165 million in the period since acquisition. Profit from operations was impacted by the FDA user fees of £62 million and product liability defence costs of £59 million.
Additionally, £865 million was incurred as part of the State Settlement Agreements, with £109 million in credits recognised as part of the non-participating manufacturers’ (NPM) adjustment claims. The US business also incurred other costs that relate to adjusting items, including the Engle progeny cases, tobacco-related or other litigation and other costs associated with the integration with the rest of the Group. Adjusted profit from operations at constant rates was £1,827 million for the period since acquisition.
| 44 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
Americas and Sub-Saharan Africa
|
“Growth was driven by pricing, which more than offset volume declines in a difficult environment”
Luciano Comin Regional Director
Key markets
Argentina, Brazil, Canada, Caribbean, Central America, Chile, Colombia, Kenya, Mexico, Nigeria, Paraguay, Peru, South Africa, Venezuela
|
|
|
Volume and Market Share
In 2018, volume was 5.4% lower at 157 billion sticks, largely driven by the growth of illicit trade in Brazil and South Africa, the termination of a third-party licence agreement in Mexico and market contraction in Canada, Colombia and Venezuela. South African volumes stabilised in the second half of 2018 after a period of decline.
Market share was 20 bps lower as growth driven by Kent (migration from Free) in Brazil, Dunhill in South Africa, Rothmans in Colombia and Brazil (following the migration from Mustang and Minister respectively, to strengthen the consumer proposition) and in Argentina, and Pall Mall in Mexico was more than offset by declines in the local portfolio which was largely due to the growth in illicit trade especially in South Africa and Brazil.
Vype was launched in Canada through exclusive distribution in the top four key accounts, representing over 4,000 retail outlets. In the seven months since launch, it had sold to over 92,000 adult users.
Volume was 4.2% lower in 2017 at 166 billion, as growth in Mexico and Nigeria was more than offset by the difficult economic conditions which led to continued down-trading and industry contraction in Brazil and Argentina, lower volume in South Africa and the growth of illicit trade in Chile. Market share was up as the combined growth in Mexico, Argentina, Colombia and Chile more than offset South Africa and Brazil, which was lower despite the continued success of Minister and Kent (following the migration from Free).
Revenue
In 2018, revenue declined 4.9% to £4,111 million, due to the translational foreign exchange headwind of approximately 10%. On a constant currency, representative basis, adjusted revenue grew by 5.6% to £4,560 million, as pricing across the region (notably in Mexico, Brazil, Chile and Nigeria) more than offset the lower total volume and the negative impact of mix due to the growth of lower-priced products following the significant excise-led price increases in a number of markets.
Revenue grew by 7.1% in 2017, to £4,323 million. This was driven by pricing in a number of markets, with revenue higher in Canada, Mexico, Chile and Colombia, more than offsetting a decline in Brazil and in Venezuela, where the deterioration in the exchange rate more than offset higher pricing due to local inflation. On an organic constant rate basis adjusted revenue was up 8.1% at £4,365 million.
Profit from operations
In 2018, profit from operations was down 6.3% to £1,544 million, as the effect of currency headwinds more than offset growth across the region. Excluding adjusting items (mainly related to a £110 million asset impairment to recoverable value in Venezuela arising from hyperinflationary accounting and costs related to the Group’s ongoing restructuring programme) and the effect of currency, adjusted profit from operations on a representative, constant currency basis grew by 6.5% to £1,922 million, driven by Nigeria, Mexico and Chile, partly offset by the effect of the lower duty paid market and down-trading in South Africa.
In 2017, profit from operations increased by 15.9% to £1,648 million. This was mainly due to the growth in revenue noted above. Excluding adjusting items, which largely relate to the amortisation of acquired trademarks, and the impact of currency, adjusted, organic, profit from operations at constant rates increased by 5.2% to £1,772 million.
| BAT Annual Report and Form 20-F 2018 | 45 | |
Table of Contents
|
Financial Review
|
Regional review continued
Europe and North Africa
|
“PRRPs are gaining a strong foothold with THP now present in 12 markets, while oral volumes have grown 45%”
Johan Vandermeulen Regional Director
Key markets
Austria, Bulgaria, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Italy, Norway, Poland, Russia, Spain, Sweden, Switzerland, Turkey, Ukraine
|
|
Volume and Market Share
In 2018, volume declined 4.7% to 246 billion sticks, which was a reduction of 5.3% on a representative basis, as volume from assets acquired (from Bulgartabac and FDS) in 2017 combined with growth in Turkey, Egypt, Poland and Romania was more than offset by Russia (partly due to inventory movements and the growth of illicit trade), Ukraine (due to market contraction following the excise-led price increase, leading to an increase in illicit trade), Italy (partly due to impact of higher prices) and France (following the excise-led price increase).
Market share was flat as increases in Kent, led by Ukraine, Turkey, Kazakhstan and regaining premium segment leadership in Russia, and Rothmans (Ukraine, Russia, Poland, Spain, Bulgaria and Italy) was offset by both the continued reduction in Pall Mall (Poland, Germany and Belgium) and a decline in the low-priced portfolio in Russia. Total market share in Russia returned to growth in the second half of 2018, as the effects of the trade inventory movements normalised.
Our THP and vapour portfolio continued to expand, with glo now present in 12 countries in ENA, including Russia, Switzerland, Romania, Italy, Poland and Ukraine. Volume of vapour (devices and consumables) grew, notably in the UK (driven by Vype, Ten Motives and VIP), with market share up (in traditional retail) in France and Vype remaining the leading vapour brand in Germany. In November 2018, the Group further enhanced its capabilities with the acquisition of Germany’s leading vapour retail chain, Quantus Beteiligungs-und Beratungsgesellschaft mbH. Further launches and product developments are planned across the portfolio during 2019.
In oral, volume grew 44%, mainly driven by EPOK which is the fastest growing premium oral brand in both Norway (reaching 8% total oral market share in December 2018) and in Switzerland (achieving 17% total oral market share in December 2018). In Sweden, the Group launched Lyft, a tobacco-free product, achieving a 4.5% share of the total oral market in handlers.
In 2017, volume was 258 billion, 1.9% down on 2016. This was due to the contribution from the tobacco assets of Bulgartac and FDS acquired in the year, and higher volume in Spain, Romania, Portugal, Poland and Hungary, which was more than offset by lower volume in Russia, Ukraine, Italy and Greece. On an organic basis, volume fell 3.1%. Market share was up 20 bps, driven by Russia, Turkey, Germany, Spain, Romania and Poland.
Revenue
In 2018, revenue was down 1.7% against 2017 at £6,004 million as pricing across the region (notably in Romania, Russia, Germany and Ukraine) was more than offset by the impact of lower regional volume, continued excise absorption in France and the translational foreign exchange headwinds of approximately 5%.
Adjusted revenue, at constant rates, was £6,112 million, an increase of 3.5% on a representative basis. This excludes excise on bought-in goods, acquired and sold under short-term contract manufacturing arrangements which distorts revenue and operating margin on a temporary basis, and the impact of foreign exchange movements on revenue.
Revenue, in 2017, grew by 14.7% to £6,108 million, as the positive effect of acquisitions in the year and higher revenue in Germany, Romania and Spain offset a decline in the UK due to aggressive pricing in the market, lower revenue in Italy and France, and the down-trading in Russia. Excluding excise on goods acquired under short-term contract manufacturing arrangements, on an adjusted, constant rate basis, revenue was up 3.4% or 1.6% on an organic basis.
Profit from operations
In 2018, profit from operations grew 12.3% to £1,905 million. This was due to an improvement in the operating performance in Germany, Romania and Ukraine and a one-off charge of £69 million in 2017 in relation to a third party in Croatia that does not repeat in 2018. This more than offset a reduction in profit from operations in Russia (largely due to the impact of lower volume), the impact of excise absorption in France, restructuring costs incurred (largely in Germany related to the factory closure), significantly increased investment in PRRPs and the impact of foreign exchange on the reported results. Excluding adjusting items (related to the factory closure in Germany, amortisation of acquired brands, other costs related to the Group’s ongoing restructuring programme and the 2017 impairment in Croatia) and the impact of the foreign currency headwind, adjusted profit from operations at constant rates, on a representative basis was up 0.8%, at £2,217 million.
Profit from operations grew 14.7% in 2017 to £1,697 million, due to improved revenue and devaluation in sterling, with profit from operations up in Germany, Romania, Denmark and Spain. This was partly offset by the costs of the ongoing closure of the factory in Germany and impairment of certain assets related to a third-party distributor (Agrokor) in Croatia, the partial absorption of excise in France, investment behind NGP in the UK, lower profit from operations in Belgium and the Netherlands and the impact of down-trading in Russia. Excluding the acquisitions, adjusting items (including Agrokor, factory closure costs and trademark amortisation) and the impact of foreign exchange, adjusted organic profit from operations at constant rates of exchange increased by 8.6% to £1,981 million.
| 46 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
Asia-Pacific and Middle East
|
“Growth was driven by volume recovery in Pakistan as well as strong performance of glo in Japan”
Guy Meldrum Regional Director
Key markets
Australia, Bangladesh, Cambodia, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, Pakistan, Sri Lanka, Taiwan, Vietnam
|
|
Volume and Market Share
In 2018, volume was up 0.7% at 228 billion sticks driven by the recovery in the combustibles volume in Pakistan (following the revision to the excise structure that negatively impacted the equivalent period in 2017) and the performance of glo in Japan and South Korea with sales of 6.5 billion sticks in the period. This growth in volume was partly offset by lower volume in the Middle East, largely due to the impact of a 2017 excise-led price increase in Saudi Arabia and the difficult trading environment in a number of countries in the Middle East. Volume was lower in Bangladesh due to higher illicit trade following an increase in excise, with Indonesia lower due to market contraction. Volume decreases have slowed in Malaysia after a period of accelerated decline following the excise changes in prior years.
Market share in the region was up 110 bps. Kent (including THP sticks) was up in Japan (which was partly due to a growing share of glo, up 340 bps), with Dunhill and Lucky Strike higher in Indonesia. Pall Mall grew in Pakistan, Australia and particularly in Saudi Arabia, where the Group became market leader. The Group also grew Rothmans in Malaysia and increased total market share in Bangladesh. This growth was partially offset by lower market share in South Korea, due to a reduction in Dunhill partly driven by the growth of the THP segment and a reduction in Taiwan driven by Dunhill and Pall Mall.
Volume was lower in 2017 (down 1.0% at 226 billion). glo was launched nationally in Japan and South Korea, performing well with national market share in Japan reaching 3.6% in December 2017. Volume from glo and cigarette volume growth in Bangladesh and Gulf Cooperation Council countries (GCC) was more than offset by the lower combustible volume in Japan and industry volume decline in Malaysia, Pakistan and South Korea. Market share was higher, up 50 bps, with growth in Bangladesh, Japan, Pakistan and Australia, driven by Lucky Strike, Pall Mall and Rothmans, more than offsetting lower market share in Malaysia and Indonesia, which was due to down-trading.
Revenue
In 2018, revenue declined 1.8% to £4,882 million, as pricing, higher volume (discussed earlier) and the positive mix effect, largely in Japan through the growth in glo, was offset by a combination of inventory movements in the prior year, down-trading in Saudi Arabia and by the foreign exchange headwinds related to the relative strength of sterling. Excluding the translational foreign exchange headwind, constant currency, adjusted revenue, on a representative basis grew 5.7%.
In 2017, revenue was up by 4.3% at £4,973 million due to the combination of volume and pricing, notably in Bangladesh, Australia and New Zealand, revenue from glo following the roll-out and subsequent growth in Japan and South Korea, and the positive impact of the devaluation in sterling on the reported results. This more than offset the impact of down-trading in Malaysia and Saudi Arabia, and the industry contraction combined with growth in illicit trade in Pakistan. Excluding the positive currency effect, on a constant exchange rate basis, adjusted revenue was marginally higher than 2016, up 0.2% to £4,776 million.
Profit from operations
In 2018, profit from operations declined 2.3% to £1,858 million, as the performance was negatively affected by foreign exchange headwinds and adjusting items related to the ongoing costs of the Group’s restructuring programme. Adjusted profit from operations on a representative constant currency basis grew 1.2% to £2,099 million driven by an improvement in Japan, where the performance of both combustibles and THP more than offset the higher marketing investment, and increases in Australia, Pakistan and Bangladesh. These were partly offset by Saudi Arabia which was negatively impacted by down-trading, described above, and South Korea.
Profit from operations was 7.2% higher in 2017 at £1,902 million, as the growth in revenue, and transactional foreign exchange tailwinds notably due to the relative movements in the US dollar and euro against the Japanese yen, were partly offset by the investment behind glo in Japan and South Korea and negative mix effects from down-trading in Malaysia and Saudi Arabia. Before adjusting items, which mainly related to the Malaysian factory closure and the amortisation of trademarks, and the impact of exchange rate movements on the reported results, adjusted profit from operations on a constant currency basis was down 0.5% at £1,962 million.
| BAT Annual Report and Form 20-F 2018 | 47 | |
Table of Contents
|
|
Overview
The principal risks that may affect the Group are set out on the following pages.
Each risk is considered in the context of the Group’s strategy, as set out in this Strategic Report on pages 8 and 9. Following a description of each risk, its potential impact and management by the Group is summarised. Clear accountability is attached to each risk through the risk owner.
The Group has identified risks and is actively monitoring and taking action to manage the risks. This section focuses on those risks that the Directors believe to be the most important after assessment of the likelihood and potential impact on the business. Not all of these risks are within the control of the Group and other risks besides those listed may affect the Group’s performance. Some risks may be unknown at present. Other risks, currently regarded as less material, could become material in the future.
The risks listed in this section and the activities being undertaken to manage them should be considered in the context of the Group’s internal control framework. This is described in the section on risk management and internal control in the corporate governance statement on pages 68 to 70. This section should also be read in the context of the cautionary statement on page 296.
A summary of all the risk factors (including the principal risks) which are monitored by the Board through the Group’s risk register is set out in the Additional disclosures section on pages 270 to 284.
|
Time frame
|
||||||
| Short term |
|
|||||
| Medium term |
|
|
||||
| Long term |
|
|
|
|||
|
|
||
|
Strategic impact |
||
|
Growth |
|
|
| Productivity |
|
|
| Winning organisation |
|
|
| Sustainability |
|
|
|
|
||
| 48 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
Risks
|
Competition from illicit trade
|
||
|
Increased competition from illicit trade – either local duty evaded, smuggled illicit white cigarettes or counterfeits.
|
||
|
The enactment of regulation that significantly impairs the Group’s ability to communicate, differentiate, market or launch its products.
|
||
|
|
Please refer to pages 285 to 288 for details of tobacco and nicotine regulatory regimes under which the Group’s businesses operate.
|
| BAT Annual Report and Form 20-F 2018 | 49 | |
Table of Contents
|
Business Environment
|
Principal Group risks continued
Risks continued
|
Litigation
|
||||
|
Product liability, regulatory or other significant cases may be lost or compromised resulting in a material loss or other consequence.
|
||
|
|
Please refer to note 28 in the Notes on the Accounts for details of contingent liabilities applicable to the Group. |
|
Geopolitical tensions
|
||||
|
Geopolitical tensions, civil unrest, terrorism and organised crime have the potential to disrupt the Group’s business in multiple markets.
|
||
|
Disputed taxes, interest and penalties
|
||
|
The Group may face significant financial penalties, including the payment of interest in the event of an unfavourable ruling by a tax authority in a disputed area.
|
||
| 50 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Significant increases or structural changes in tobacco-related taxes
|
|
The Group is exposed to unexpected and/or significant increases or structural changes in tobacco-related taxes in key markets. |
||
|
Foreign exchange rate exposures
|
||
|
The Group faces translational and transactional foreign exchange (FX) rate exposure for earnings/cash flows from its global business. |
||
|
Injury, illness or death in the work place
|
|
The risk of injury, death or ill health to employees and those who work with the business is a fundamental concern of the Group and can have a significant effect on its operations. |
||
| BAT Annual Report and Form 20-F 2018 | 51 | |
Table of Contents
|
Business Environment
|
Principal Group risks continued
Risks continued
|
Solvency and liquidity
|
|
Liquidity (access to cash and sources of finance) is essential to maintaining the Group as a going concern in the short term (liquidity) and medium term (solvency). |
||
|
Inability to develop, commercialise and roll-out Potentially Reduced-Risk Products
|
||
|
Risk of not capitalising on the opportunities in developing and commercialising successful and consumer-appealing innovations. |
||
|
The Strategic Report was approved by the Board of Directors on 27 February 2019 and signed on its behalf by Paul McCrory, Company Secretary. |
||
| 52 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
| Directors’ Report |
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
|||||||||||||||||||||
| on Governance | ||||||||||||||||||||||||||
|
Richard Burrows Chairman
|
Index to key elements | ||||
| Directors’ Report | ||||||
|
|
||||||
| Chairman’s introduction | 53 | |||||
|
|
||||||
| Board of Directors | 54 | |||||
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|
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| Management Board | 56 | |||||
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|
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| Leadership and effectiveness | 57 | |||||
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| Board activities in 2018 | 58 | |||||
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|
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| Board effectiveness | 60 | |||||
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|
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| Audit Committee | 64 | |||||
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|
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| Nominations Committee | 71 | |||||
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|
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| Remuneration Report | ||||||
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|
||||||
| Annual Statement on Remuneration | 73 | |||||
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|
||||||
|
|
90 | |||||
Dear Shareholder
During 2018, our Board focused on the evolution of our business, with an emphasis on driving our potentially reduced-risk product portfolio and overseeing the integration of our US business into the Group.
Effective succession planning is another essential component underpinning our long-term sustainable success. In 2018, our Nominations Committee led a thorough and extensive selection process leading up to its recommendation to appoint Jack Bowles as successor to our Chief Executive, Nicandro Durante. We will report on the selection process leading up to the appointment of Tadeu Marroco as the successor to our Finance Director, Ben Stevens, in our Annual Report and Form 20-F for 2019.
The Nominations Committee continues to keep the composition and diversity of our Board and Management Board under regular review and, in January, we welcomed new Management Board members as part of changes introduced to accelerate execution of the Group’s strategy. Board succession planning and development of a diverse senior management succession pipeline will continue to be priorities for the Nominations Committee in 2019. We give a full report on the activities of our Nominations Committee on pages 71 to 72.
It is equally important that the Board as a whole has the capability to lead our transforming tobacco strategy. Board performance is evaluated in detail on an annual basis. I have led this year’s internal evaluation of the Board, which found that the Board continues to be effective and efficient. You will find details of this year’s evaluation and key outcomes on pages 61 to 62.
To assess the evolution of our potentially reduced-risk product portfolio, the Board visited our Global R&D Centre in Southampton to review the technologies and innovation driving our transforming tobacco strategy, and the world-class science supporting it, with scientists, product developers and other dedicated R&D teams. In support of our strategy, the Board approved refreshed International Marketing Principles in 2018 that apply across our product portfolio worldwide and demonstrate our continued commitment to marketing our products responsibly and in full compliance with evolving regulations in all markets we operate in.
We are focused on ensuring that integrity remains paramount in the conduct of our business across the Group. I would like to emphasise that the Board does not tolerate failure to comply with either our legal obligations or our internally mandated high standards of behaviour. As previously reported, through external legal advisers we are rigorously investigating allegations of misconduct and we continue to cooperate with the UK Serious Fraud Office’s investigation and with other relevant authorities. A sub-Committee of the Board continues to have oversight of these matters.
We continue to enhance our global business conduct framework and, during 2018, our ‘Delivery with Integrity’ programme included extensive training for employees worldwide on the potential bribery and corruption risks associated with our operations and the launch of a refreshed anti-bribery and corruption procedure. The Board also approved a revised Group Data Privacy Policy applicable across the Group, supporting compliance with data protection obligations introduced by the EU GDPR. You can read more about our ‘Delivery with Integrity’ programme on page 31.
Following the acquisition of RAI, we are subject to US compliance obligations under NYSE rules and US securities laws as a ‘foreign private issuer’. During 2018, our Audit Committee has played a critical role in monitoring the Group’s preparations to ensure full compliance with SOx, including oversight of our management assessment of the effectiveness of our internal controls over financial reporting (ICFR), and support the attestation of compliance by our Chief Executive and Finance Director. We explain our SOx compliance programme on page 69.
In the UK, 2018 saw some of the most extensive reform of the corporate governance landscape since the UK Corporate Governance Code was first published in 1992. We welcome the introduction of the revised Code, its broader view of corporate governance and its emphasis on relationships with shareholders and wider stakeholders in delivering long-term sustainable success. The Board has carefully considered both the letter and the spirit of the revised Code and we will report to shareholders on our application of the revised Code in our Annual Report and Form 20-F for 2019.
In revising our Directors’ Remuneration Policy, presented for your consideration in the Remuneration Report ahead of our AGM in April 2019, our Remuneration Committee took into account extensive shareholder feedback and the revised Code requirements to sharpen our policy’s alignment with shareholder interests and to ensure it continues to promote the Company’s long-term sustainable success. I would like to thank our shareholders who have already contributed to the development of our revised Remuneration Policy and their engagement on broader aspects of our corporate governance. My fellow Board members and I look forward to meeting further with shareholders in the lead up to, and at, our AGM in April 2019.
On behalf of the Board, I confirm that we believe that this combined Annual Report and Form 20-F presents a fair, balanced and understandable assessment of the Company’s position, its performance and prospects, as well as its business model and strategy.
Richard Burrows
Chairman
| BAT Annual Report and Form 20-F 2018 | 53 | |
Table of Contents
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Directors’ Report
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Board of Directors as at 27 February 2019
Nationality: Irish
Position: Chairman since November 2009; Non-Executive Director since September 2009; Chairman of the Nominations Committee.
Other appointments: Senior Independent Director and Chairman of the Remuneration Committee of Rentokil Initial plc; Supervisory Board member and Chairman of the Remuneration Committee at Carlsberg A/S.
Skills and experience: Richard brings considerable consumer goods and international business experience to the Board, having been Chief Executive of Irish Distillers and Co-Chief Executive of Pernod Ricard. Prior to joining the Board, Richard was Governor of the Bank of Ireland. Richard is a Fellow of the Institute of Chartered Accountants of Ireland.
Nationality: British
Position: Senior Independent Director since October 2016; Non-Executive Director since 2010; member of the Audit and Nominations Committees.
Other appointments: Non-Executive Director and Chair of the Audit and Compliance Committee of International Consolidated Airlines Group S.A.; Chairman and Chair of the Nominations, Audit and Compliance and Risk and Remuneration Committees of F&C Asset Management plc.
Skills and experience: Kieran brings a wealth of financial and international experience to the Board. He was Chairman and Senior Partner of PricewaterhouseCoopers from 2000 to his retirement in 2008, having started as a graduate trainee in 1971, and is a former Chairman of Nomura International PLC. Kieran is a Chartered accountant.
Nationality: Brazilian/Italian
Position: Chief Executive since 2011; Executive Director since 2008. Nicandro will retire from the Board of Directors on 1 April 2019.
Other appointments: Senior Independent Director of Reckitt Benckiser Group plc.
Skills and experience: Nicandro has extensive leadership skills developed in various senior international roles within the Group. He joined Souza Cruz in Brazil in 1981, rising to become President of that company. Nicandro joined the Management Board in 2006 as Regional Director for the Africa and Middle East region. He joined the Board in 2008 as Chief Operating Officer, before being appointed as Chief Executive in 2011.
Nationality: French
Position: Chief Executive Designate since 1 November 2018; Executive Director since 1 January 2019. Jack will succeed Nicandro Durante as Chief Executive on 1 April 2019.
Skills and experience: Jack brings significant experience in management and leadership developed across his previous roles. He joined the Group in 2004 and was appointed as Chairman of British American Tobacco France in 2005, before becoming Managing Director of British American Tobacco Malaysia in 2007. He joined the Management Board as Regional Director for Western Europe in 2009, becoming Regional Director for the Americas in 2011, then Regional Director for Asia-Pacific in 2013. Jack became Chief Operating Officer in 2017 and Chief Executive Designate in November 2018, before being appointed to the Board in January 2019.
Nationality: British
Position: Finance Director since 2008. Ben will retire from the Board of Directors on 5 August 2019.
Other appointments: Non-Executive Director of ISS A/S.
Skills and experience: Ben joined the Group in 1990 and has broad international experience spanning both senior finance and general management roles. He was Head of Merger Integration following the merger with Rothmans and Chairman and Managing Director of both Pakistan Tobacco Company and British American Tobacco Russia. Ben was appointed to the Management Board in 2001 as Development Director and became Director, Europe, in 2004. He joined the Board in 2008 as Finance Director.
Nationality: British
Position: Non-Executive Director since 2015; member of the Nominations and Remuneration Committees.
Other appointments: Special Advisor, Chime Group; Non-Executive Director and Chair of the Corporate Responsibility Committee of Dairy Crest Group plc; Non-Executive Director and Chair of the Nominations & Remuneration Committee of Accsys Technologies PLC.
Skills and experience: Sue brings considerable expertise in marketing, branding and consumer issues to the Board. Sue is a former Chairwoman of both the Marketing Society and the Marketing Group of Great Britain. Prior to joining the Chime Group in 2003, where she was Director, Strategic and Business Development until 2015, Sue’s career in corporate communications included roles with the BBC and Vauxhall Motors.
Nationality: German
Position: Non-Executive Director since 2016; member of the Nominations and Remuneration Committees.
Other appointments: Vice Chairwoman of the Supervisory Board and co-chairwoman of the Presiding and Nomination Committee of ProSiebenSat.1 Media SE; Supervisory Board member and Chairman of the Audit Committee of Heineken N.V.; Supervisory Board member of Siemens Healthineers AG and Uniper SE.
Skills and experience: Marion brings significant financial expertise and operational experience gained at an international level having spent her working life managing businesses across Europe, the Americas and Asia. Her extensive career includes Chief Financial Officer positions at Celesio, Q-Cells and ThyssenKrupp Elevator Technology.
Nationality: Canadian
Position: Non-Executive Director since July 2017; member of the Audit and Nominations Committees.
Other appointments: Independent Consultant providing executive leadership advisory services to corporate clients.
Skills and experience: Luc brings extensive financial and strategic experience, including in the US tobacco sector as an independent director of RAI from 2008 until the acquisition in 2017. Luc was President and Chief Executive Officer of Canadian National Railway Company, from July 2016 until March 2018, having served as Executive Vice President and Chief Financial Officer since 2009. He was Executive Vice President of Power Corporation of Canada from 2005 to 2009. Luc was Chief Executive Officer of Imperial Tobacco Canada, a subsidiary of the Company, from 2003 to 2005 and Executive Vice President and Chief Financial Officer from 1998 to 2003.
| 54 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
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Strategic Report
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Governance
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Financial Statements
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Other Information
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Introduction & Board
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Audit Committee
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Nominations Committee
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Remuneration Committee
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Responsibility of Directors
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Nationality: American
Position: Non-Executive Director since July 2017; Chairman of the Audit Committee since 14 January 2019; member of the Nominations Committee.
Other appointments: Non-Executive Director of Vesuvius plc; Director and Chair of the Governance Committee of AES Corporation.
Skills and experience: Holly has extensive operational and financial management experience and served as an independent director on the Board of RAI from 2008 until the acquisition in 2017. Holly was a Senior Advisor to Corsair Capital LLC until April 2018, where she had previously served as Managing Partner and Co-Head of Infrastructure from 2015 until her retirement in 2017. From 2010 to 2015, she served as Co-Head of Citi Infrastructure Investors. Prior to 2010, she held financial and executive management roles with American Electric Power Company, Inc. and Consolidated Natural Gas Company. |
Nationality: British
Position: Non-Executive Director since 2014; member of the Nominations and Remuneration Committees.
Other appointments: Co-Founder and CEO of A&K Consulting Co Ltd, advising entrepreneurs and their start-up businesses in China; Visiting Professor at Henley Business School; Member of the Governing Body of the London Business School; Non- Executive Director of the Alibaba Hong Kong Entrepreneur Fund, Crossborder Innovative Ventures International Limited and a Non-Executive Director and Advisory Board member of Homaer Financial.
Skills and experience: Savio brings significant business leadership experience of Greater China and Asia to the Board. During his extensive career he has worked broadly in technology for General Electric, BTR plc and Alibaba Group, China’s largest internet business, where he was both Chief Operating Officer and, later, a Non-Executive Director. |
Notes:
| 1. |
Number of meetings in 2018: The Board held 10 meetings in 2018, four of which were ad hoc and convened at short notice, three to discuss succession planning for the Board and the Management Board and one to discuss product regulation proposed in the US. Part of the October Board meeting was held off-site at the Group’s R&D facilities in Southampton, UK, to review the Group’s strategy and product portfolio. |
| 2. |
(a) Sue Farr did not attend the ad hoc Board meeting in October and one of the two ad hoc Board meetings in November due to prior commitments; (b) Luc Jobin did not attend one of the two ad hoc Board meetings in November due to prior commitments; (c) Savio Kwan did not attend one of the two ad hoc Board meetings in November due to prior commitments; (d) Lionel Nowell, III did not attend the February and July Board meetings and the 2018 AGM due to prior commitments; and (e) Kieran Poynter did not attend the ad hoc Board meeting in October due to prior commitments. |
| 3. |
Number of meetings in 2019: Six Board meetings are scheduled for 2019. |
| 4. |
Composition: (a) the Board of Directors is shown as at the date of this Annual Report and Form 20-F; (b) Ann Godbehere and Pedro Malan retired as Non-Executive Directors at the conclusion of the AGM on 25 April 2018; and (c) Lionel Nowell, III retired as a Non-Executive Director with effect from 12 December 2018. |
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Nationality: Greek/British
Position: Non-Executive Director since 2015; Chairman of the Remuneration Committee since October 2016; member of the Nominations Committee.
Other appointments: Senior Advisor at The Boston Consulting Group; Advisory Board member of JBS USA; Non-Executive Director of Logitech International S.A.
Skills and experience: Dimitri has extensive general management and international sales and brand building expertise. He was Vice Chairman and Adviser to the Chairman and CEO of Procter & Gamble (P&G), where he started his career in 1977. During his time at P&G, Dimitri led on significant breakthrough innovations and continued to focus on this, speed-to-market and scale across all of P&G’s businesses while Vice Chairman of all the Global Business Units. |
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Audit Committee |
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Nominations Committee |
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Remuneration Committee |
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Committee Chairman |
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Executive Director |
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Non-Executive Director |
| BAT Annual Report and Form 20-F 2018 | 55 | |
Table of Contents
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Directors’ Report
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Management Board as at 27 February 2019
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Nationality: American |
Nationality: Italian/Brazillian |
Nationality: Italian/Argentinian |
Nationality: British |
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Jerry was appointed Director, Legal & External Affairs and General Counsel in May 2015, having joined the Management Board as Group Corporate & Regulatory Affairs Director in January 2015. |
Marina joined the Management Board as Director, Digital and Information on 1 January 2019.
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Luciano joined the Management Board as Regional Director, Americas and Sub-Saharan Africa on 1 January 2019. | Alan joined the Management Board as Group Operations Director in March 2013. | |||||||||||||||||
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Nationality: Italian/American |
Nationality: Korean |
Nationality: Dutch |
Nationality: Brazilian |
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Giovanni joined the Management Board as Group Human Resources Director in June 2011. He will step down from the Management Board at the end of March 2019.
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Hae In joined the Management Board as Director, Talent and Culture Designate on 1 January 2019. She will become Director, Talent and Culture on 1 April 2019, succeeding Giovanni Giordano. | Paul joined the Management Board as Director, New Categories on 1 January 2019. | Tadeu was appointed Director, Group Transformation on 1 January 2019. In addition to this role, Tadeu has been appointed as Deputy Finance Director with effect from 1 March 2019. He will succeed Ben Stevens as Finance Director on 5 August 2019 and will be appointed to the Board as an Executive Director on the same date. | |||||||||||||||||
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Nationality: New Zealand |
Nationality: British |
Nationality: Brazilian |
Nationality: Australian/British |
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Guy joined the Management Board as Regional Director, Asia-Pacific and Middle East on 1 January 2019. |
David was appointed Director, Research and Science on 1 January 2019, having joined the Management Board as Group Scientific Director in 2012. | Ricardo was appointed President and CEO of Reynolds American Inc. on 1 January 2018, having joined the Management Board as Regional Director for the Americas in 2013. | Naresh was appointed Director, Business Development in December 2016. He joined the Management Board in 2012 and has held various roles. Naresh will step down from the Management Board at the end of March 2019. | |||||||||||||||||
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Nationality: Belgian |
Nationality: British |
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Johan was appointed Regional Director, Europe and North Africa on 1 January 2019. He joined the Management Board in 2014 and has held various roles. |
Kingsley was appointed Chief Marketing Officer on 1 January 2019. He joined the Management Board in 2012 and has held various roles. | |||||||||||||||||||
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For full biographies of the Management Board see pages 255 and 256 | |||||||||||||||||||||
| 56 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
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Strategic Report
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Governance
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Financial Statements
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Other Information
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Introduction & Board
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Audit Committee
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Nominations Committee
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Remuneration Committee
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Responsibility of Directors
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Governance framework
The Board
The Board is collectively responsible to shareholders of the Company for its performance and for the Group’s strategic direction, its values and its governance. The Board provides the leadership necessary for the Group to meet its performance objectives within a robust framework of internal controls.
Board responsibilities:
|
– |
Group strategy. | – | Group budget. | |||
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– – |
Significant corporate activities. Group policies. |
– |
Risk management and
internal control. |
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– |
Corporate governance. | – | Annual Report & 20-F approval. | |||
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– |
Board and Management Board | – | Periodic financial reporting. | |||
| appointments and succession. | – | Dividend policy. |
Board Committees
The Board has three principal Board Committees to which it has delegated certain responsibilities. The roles, memberships and activities of these Committees are described in their individual reports in this section.
Each Committee has its own terms of reference, available at www.bat.com/governance. These terms of reference are all reviewed and updated regularly, most recently to reflect revisions to internal governance and reporting processes to align with the UK Corporate Governance Code 2018.
Board programme
The Board has a comprehensive annual programme of meetings to monitor and review the Group’s strategy across all the elements of the Group’s business model. The key activities of the Board in 2018, discussed under the Group’s four strategy pillars of Growth, Productivity, Sustainability and Winning Organisation, are detailed on pages 58 and 59. The Board’s strategic priorities for 2018 are identified within the key performance indicators set out in our Strategic Report on pages 10 and 11.
The Board devotes considerable attention to Group Corporate Governance, including internal control and compliance issues. It receives verbal updates from the Chairman of each Committee following each Committee meeting. Copies of the minutes of all Committees are circulated to all members of the Board.
Collective decision-making
The Chairman seeks a consensus at Board meetings but, if necessary, decisions are taken by majority. If any Director has concerns on any issues that cannot be resolved, such concerns are noted in the Board minutes. No such concerns arose in 2018.
Management Board
The Management Board, chaired by the Chief Executive, is responsible for overseeing the implementation of the Group’s strategy and policies set by the Board, and for creating the framework for the day-to-day operation of the Group’s operating subsidiaries. Its members comprise the Executive Directors and 14 senior Group executives whose names and roles are described on page 56.
To accelerate execution of the Group’s strategy, the following appointments to the Management Board were made with effect from 1 January 2019:
| – |
Kingsley Wheaton, previously Regional Director, Americas and Sub-Saharan Africa, was appointed as Chief Marketing Officer replacing Andrew Gray; |
| – |
Tadeu Marroco, previously Regional Director, Europe and North Africa, was appointed as Director, Group Transformation and additionally, with effect from 1 March 2019, as Deputy Finance Director, to then succeed Ben Stevens as Finance Director with effect from 5 August 2019; |
| – |
Marina Bellini, previously Chief Information Officer, was appointed as Director, Digital and Information; |
| – |
Hae In Kim, previously Group Head of Talent and Organisational Effectiveness, was appointed as Director, Talent and Culture Designate and will replace Giovanni Giordano, currently Director, Group Human Resources, from 1 April 2019; |
| – |
Luciano Comin, previously Regional Head of Marketing, Americas and Sub-Saharan Africa, was appointed Regional Director, Americas and Sub-Saharan Africa; |
| – |
Johan Vandermeulen, previously Regional Director, Asia-Pacific and Middle East, was appointed as Regional Director, Europe and North Africa; |
| – |
Guy Meldrum, previously Area Director, Australasia Area, was appointed as Regional Director, Asia-Pacific and Middle East; and |
| – |
Paul Lageweg, previously Regional Marketing Manager, Asia-Pacific and Middle East, was appointed as Director, New Categories. |
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Audit Committee
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Nominations Committee
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Remuneration Committee
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page 64 |
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page 71 |
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page 73 |
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Leadership roles and responsibilities
| Leadership | ||
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Chairman |
Chief Executive |
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– Leadership of the Board.
– Ensures Board effectiveness.
– Sets the Board agenda.
– Interfaces with shareholders.
– Ensures effective shareholder engagement. |
– Overall responsibility for Group performance.
– Leadership of the Group.
– Enables planning and execution of objectives and strategies.
– Stewardship of Group assets. |
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| Oversight | ||
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Non-Executive Directors (NEDs) |
Senior Independent Director (SID) |
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– Oversee Group strategy.
– Review management proposals.
– Monitor Group performance.
– Bring an external perspective and effective challenge to management. |
– Leads the review of the Chairman’s performance.
– Presides at Board meetings in the Chairman’s absence.
– Intermediary for other Directors.
– Available to meet with major shareholders. |
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| Management Board | ||
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– Develops Group strategy for the Group’s product portfolio for approval by the Board.
– Monitors Group operating performance. |
– Ensures Group, regional and functional strategies and resources are effective and aligned.
– Manages the central functions.
– Oversees the management and development of Group talent. |
| BAT Annual Report and Form 20-F 2018 | 57 | |
Table of Contents
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Directors’ Report
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Growth remains our key strategic focus. Continued investment in, and development of, our strategic focus areas is central to the Board’s annual agenda. |
The Board pays close attention to the Group’s operational efficiency and our programmes are aimed at delivering a globally integrated enterprise with cost and capital effectiveness.
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| Activities in 2018 |
Activities in 2018 |
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| Reviewing: | Reviewing: | |||
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– the Group’s transforming tobacco strategy, its implementation in international business regions and in the US, and oversight of resource allocation activities to support strategy execution;
– the Group’s financial performance and current outlook throughout the year, and the Group’s half-year and year-end results;
– Group and regional operating performance against the Group’s key performance metrics and the key challenges faced and opportunities for growth in each region;
– the Group’s product portfolio performance in the context of the broader competitor landscape, and strategic focus areas for the Group;
– the Group’s PRRP portfolio and new product launches;
– the Company’s share price performance, factors impacting share price performance and investor perspectives;
– the continued significant impact of foreign exchange rates on the Group’s financial performance, including measures taken by management to mitigate foreign exchange risks; and
– the quarterly financial performance of the associates of the Group. |
– operating performance on a Group, regional and key market level across the product portfolio, including PRRPs;
– the Group’s cash flow performance, including monitoring the progress to realise opportunities and optimise the balance sheet, to ensure the Group is able to invest for the future whilst reducing the carrying value of debt;
– transactional arrangements to implement the offer to bond holders to exchange US$17.25 billion of bonds for SEC registered bonds and approving associated transaction documentation;
– the Group’s compliance with its financing principles, including in relation to Group liquidity, capital allocation, adjusted net debt/ adjusted EBITDA, the Group’s revolving credit facilities, planned refinancing and other treasury activities for the year ahead;
– progress in delivering expected synergies of over US$400 million by the end of 2020 from the integration of RAI Companies;
– SOx compliance governance structures and controls and updates on implementation of the Group’s SOx compliance programme;
– Group supply chain strategy and optimisation programmes; and
– business transformation programmes to implement operational efficiencies. |
Growth
Productivity
Strategy review highlights: Growth
Global product portfolios: The Board conducted a ‘deep dive’ into the Group’s product portfolios, covering PRRPs (vapour, THP and oral categories) and combustible products, the innovation pipeline and technology roadmap for those products, the Group’s investment in R&D activities supporting development of product portfolios and the regulatory and competitive landscape in which the Group operates. In relation to the US region, the Board assessed progress of the Substantial Equivalence (SE) application in relation to glo and the Modified Risk Tobacco Product Application (MRTPA) and Premarket Tobacco Product Application (PMTA) filings in relation to Camel snus products, and considered engagement activities undertaken with the FDA in respect of those applications.
Throughout the year, the Board also reviewed the performance of the Group’s product portfolios, their contribution to Group revenues, risks faced and opportunities for growth, geographic expansion in PRRP categories and progress of national product launches.
Strategy review highlights: Productivity
Supply chain review: The Board gained thorough insights into the Group’s supply chain organisation, across leaf, procurement, manufacturing and supply networks, with a particular focus on the Americas and Sub-Saharan Africa region. The Board considered actions taken to build a future-fit product portfolio for the region, strategies for combating illicit trade and business continuity measures to safeguard against potential supply chain disruption, including civil unrest and natural disasters.
Group THP and vapour supply chain optimisation: The Board reviewed the Group’s THP and vapour supply chain strategy, product components, key suppliers and sourcing footprint, and assessed the progress of actions to drive cost optimisation and enhance supply chain capabilities, resilience and geographic reach to support the Group’s transforming tobacco strategy.
| 58 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
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Strategic Report
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Governance
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Financial Statements
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Other Information
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Introduction & Board
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Audit Committee |
Nominations Committee |
Remuneration Committee |
Responsibility of Directors
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Sustainability
Winning organisation
Strategy review highlights: Sustainability
International Marketing Principles: The Board approved refreshed International Marketing Principles applicable across all Group product portfolios, designed to underpin the Group’s transforming tobacco strategy and to coherently articulate the Group’s commitment to marketing all our products responsibly and in full compliance with product and other regulations in all markets in which we operate. The Board was also updated on the robust measures maintained across the Group to prevent youth access to vapour and other products.
Group Supplier Code of Conduct: The Board reviewed changes to the Group Supplier Code of Conduct, to integrate the requirements of RAI Companies and to specify additional supply chain controls in relation to conflict minerals, and approved the adoption of the revised Supplier Code of Conduct across the Group.
Strategy review highlights: Winning organisation
Workforce engagement: The Board approved a refreshed approach to Group workforce engagement, implemented from January 2019, to ensure the Group maintains channels delivering meaningful and regular dialogue with our workforce. Given the geographical spread, scale and diversity of our workforce, the Group uses a range of engagement mechanisms to enable this, supplemented by regular Board reporting and feedback to the workforce, discussed further on page 26. The Board will report on these arrangements and their effectiveness in the Company’s Annual Report and Form 20-F 2019.
Developing talent as a competitive advantage: The Board completed a comprehensive review of the Group’s talent and diversity strategy, and initiatives supporting its objectives, including the launch of Parents@BAT, guaranteeing minimum paid leave and flexible work benefits for every new parent employed across all markets.
| BAT Annual Report and Form 20-F 2018 | 59 | |
Table of Contents
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Directors’ Report
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Balance of Non-Executive Directors
and Executive Directors
Length of tenure of
Non-Executive Directors
Gender split of Directors
Ethnicity split of Directors
* applying the Parker Report guidance.
Nationality of Directors
Note: The information in the above charts is at 31 December 2018.
Balance and diversity
Our Non-Executive Directors come from broad industry and professional backgrounds, with varied experience and expertise aligned to the needs of our business. Short biographies of the Directors are set out in this section on pages 54 and 55.
The Hampton-Alexander Review set recommendations aimed at increasing the number of women in leadership positions in FTSE 350 companies, including a target of 33% representation of women on FTSE 350 Boards by 2020. From 1 April 2019, women will represent 30.0% of our Board and 14.3% of our Management Board.
The Board appreciates the benefits of diversity in all of its forms, within its own membership and at all levels across the Group. Our Strategic Report discusses our Group diversity initiatives and provides details of the representation of women in our total workforce and in our senior manager population on pages 24 to 26.
Board Diversity Policy
We believe that great talent and an engaging culture are key to our success, and diversity is a critical component of both.
‘Strength from Diversity’ is one of our Group’s long-standing four Guiding Principles. This principle is reflected in our Group Employment Principles discussed further on pages 25 and 26, and is taken into consideration in determining the composition of our Board and Management Board.
We think of diversity in its widest sense, as those attributes that make each of us unique. These include our race, ethnicity, cultural background, geographical origin, gender, age, disability, sexual orientation, religion, skills, experience, education, professional background, perspectives and thinking styles.
The Nominations Committee is responsible for regularly reviewing the composition of the Board and Management Board to ensure both boards have an appropriate balance of skills, expertise and knowledge, and ensuring that all appointments are made on merit against objective criteria and with due regard for the benefits of diversity. These principles were rigorously applied by the Nominations Committee in identifying and recommending Jack Bowles for appointment to the Board.
Our Board Diversity Policy sets out the Board’s commitment to the following objectives:
| – |
considering all aspects of diversity when reviewing the composition of, and succession planning for, the Board and Management Board; |
| – |
considering a wide pool of candidates of both genders for appointment to the Board; |
| – |
maintaining at least 30% representation of women on our Board, with the ambition of progressing towards further gender balance; |
| – |
giving preference, where appropriate, to engagement of executive search firms that are accredited under the Standard and Enhanced Codes of Conduct for Executive Search Firms, which include gender diversity; and |
| – |
oversight of the development of a pipeline of diverse, high-performing potential Executive Directors, Management Board members and other senior managers, through the activities of the Nominations Committee. |
Please refer to page 72 for details of progress in 2018 against these objectives.
Independence
The Board considers all Non-Executive Directors to be independent, as they are free from any business or other relationships that could interfere materially with, or appear to affect, their judgement.
In respect of Luc Jobin and Holly Keller Koeppel, who were originally appointed to the Board following the acquisition of RAI and pursuant to the Agreement and Plan of Merger with RAI, the Board determined each of them to be independent Directors, having taken into account their respective periods of service on the board of RAI as independent, non-executive directors.
The Board has also considered the independence requirements outlined in the NYSE’s listing standards and has determined that these are met by the Chairman and all the Non-Executive Directors.
Conflicts of interest
The Board has formal procedures for managing conflicts of interest. Directors are required to give advance notice of any conflict issues to the Company Secretary. These are considered either at the next Board meeting or, if the timing requires it, at a meeting of the Board’s Conflicts Committee. Each year, the Board also considers afresh all previously authorised situational conflicts. Directors are excluded from the quorum and vote in respect of any matters in which they have an interest.
During 2018, the Board convened a Conflicts Committee at which the interests of Dr Marion Helmes were noted. There were two appointments considered, her appointment to the Board of Heineken N.V., where no reasonable likelihood of conflict was identified, and her appointment to the Board of Siemens Healthineers AG, where a situational conflict was authorised by the Conflicts Committee.
| 60 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
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Strategic Report
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Governance
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Financial Statements
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Other Information
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Introduction & Board
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Audit Committee |
Nominations Committee |
Remuneration Committee |
Responsibility of Directors |
A further Conflicts Committee was convened to consider Lionel Nowell, III’s appointment to the Board of Ecolab Inc. where a potential conflict was identified and authorised by the Conflicts Committee.
The Board, in accordance with the Company’s procedures, confirmed the Conflicts Committee’s decisions in these above matters.
Where a situational conflict was authorised, that Director is regarded as having an interest in any transaction or agreement between the Company and that entity, without the requirement to give further notice.
In December 2018, the Board noted that in respect of Dimitri Panayotopoulos’ appointment as a member of the Advisory Board of JBS USA Food Company, whose parent company, JBS S.A. was previously a supplier to the Group, it was established that since September 2017 both JBS S.A. and JBS USA Food Company were no longer suppliers to the Group and that a situational conflict no longer exists.
The Board further noted that Richard Burrows will step down as Senior Independent Director and Non-Executive Director of Rentokil Initial PLC on 8 May 2019, when a situational conflict will no longer exist. Mr Burrows also stepped down from the Board of Craven House Capital PLC on 17 October 2018.
Information and professional development
Board induction
On joining the Board, all Directors receive a full induction tailored to their individual requirements.
Jack Bowles completed our Executive Director induction programme in preparation for his appointment to the Board on 1 January 2019. Mr Bowles’ induction focused on the Company’s corporate governance structures, Board processes, responsibilities as Chief Executive and Directors’ duties more generally, shareholder and wider stakeholder engagement programmes and perspectives, and the UK and US regulatory frameworks applicable to listed issuers.
Training and professional development
Non-Executive Directors receive a full programme of briefings on an annual basis across all areas of the Company’s business from the Executive Directors, members of the Management Board, the Company Secretary and other senior executives.
Non-Executive Directors regularly attend meetings of the Group’s Regional Audit and Corporate and Social Responsibility Committees and Corporate Audit Committee to gain an enhanced understanding of the Group’s regions and central functions and the risks faced by the business at market, regional and functional levels.
The Chairman meets with each Non-Executive Director individually towards the end of each year, to discuss their individual training and development plans.
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Training and development highlights:
Group product portfolio
The Board gained extensive insight into the Group’s product innovation pipeline and the science supporting it, presented by scientists, product developers and other R&D teams at our Global R&D Centre in Southampton.
UK Corporate Governance
The Board received a series of briefings on the UK Corporate Governance Code 2018 and new UK reporting regulations from the Company Secretary and the Company’s external legal advisers and discussed the revised Code and the spirit in which it should be implemented. These activities informed Board decisions on the practical steps to be taken across the Group to align our corporate governance with the new requirements from 1 January 2019.
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Non-Executive Director meetings
When required, the Non-Executive Directors, led by the Chairman, meet prior to or following Board meetings. Regular meetings led by the Chairman are scheduled in the Board calendar without the Executive Directors present. |
The Executive and the Non-Executive Directors also meet annually, led by the Senior Independent Director and without the Chairman present, to discuss the Chairman’s performance.
Board evaluation
Evaluation process
The performance and effectiveness of the Board, its Committees, the Executive and Non-Executive Directors and the Chairman were evaluated internally in 2018, facilitated by the Company Secretary, using a series of detailed questionnaires. An external evaluation was undertaken in 2016, facilitated by Independent Audit Limited.
The Chairman is responsible for the overall evaluation process and each Committee Chair is responsible for the evaluation of the performance and effectiveness of their Committee.
All Directors participated in the evaluation process, assessing the Board, the Committees of which they were a member or regularly attended in 2018, and each of the Directors individually. Directors were requested to rank the Board, their Committees and each other against several outcomes across a range of different areas and to provide commentary to support their assessments.
Anonymised reports specifying the findings of the evaluations were prepared by the Company Secretary for the Board and each Committee. The Board or respective Committee (as applicable) then reviewed and discussed their report and identified action areas for 2019 taking into account the evaluation findings.
The Chairman received reports from the Company Secretary on the performance and effectiveness of each of the Executive and Non-Executive Directors in 2018 and individual feedback was provided by the Chairman to each of the Directors. The Senior Independent Director received a report from the Company Secretary on the Chairman’s performance and effectiveness in 2018 and led a discussion reviewing the Chairman’s effectiveness with the other Directors (without the Chairman present). The Senior Independent Director then provided individual feedback to the Chairman.
| BAT Annual Report and Form 20-F 2018 | 61 | |
Table of Contents
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Directors’ Report
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Board effectiveness continued
Evaluation outcomes
The findings of the annual Board evaluation show that the Board and each of its Committees continues to function effectively. The Directors work very well together and they each contribute effectively to the Board and their designated Committees.
Key strengths of the Board include its broad range of expertise and diversity of skill sets, its strong understanding of the Group’s business and the competitor landscape, and its scrutiny of business strategy and performance. Board members receive high-quality information enabling effective decision making and are well supported by the Company Secretary. The Board’s oversight of the integration of the US business into the Group, its leadership of the evolution of the NGP category and its pro-active management of succession planning for the Chief Executive were highlighted as examples of the Board’s effectiveness.
Frequent opportunities for the Board to engage with senior management and conduct ‘deep dives’ into key aspects of Group strategy continue to be highly valued by the Non-Executive Directors. Board feedback welcomed the extensive insights gained from meeting with scientists, product developers and other R&D teams at the Group’s Global R&D Centre in Southampton and recognised the high quality of operational performance information provided to the Board. The Board identified that these strategic sessions should remain a focus in 2019 through R&D Centre and market visits.
The Board retains an effective balance of skills and experience, and diversity of gender, nationalities and backgrounds, to enable it to perform effectively. The Executive Directors remain highly regarded, including for their valuable expertise and the in-depth industry knowledge they bring to the Board. The Chairman continues to ensure that Board meetings are conducted effectively with sufficient time allocated, particularly for significant or emerging matters.
As part of the annual Board evaluation, the Board assessed progress against the areas of focus identified for 2018 reported in the Company’s 2017 Annual Report and Form 20-F.
The Remuneration Committee has led a focused review of the Directors’ Remuneration Policy over the year to develop a revised policy that remains aligned with shareholder interests. The Remuneration Committee Chairman continues to lead a programme of engagement with shareholders to understand their views on the Company’s policy proposals in advance of the Company’s 2019 AGM.
Sufficient time has been allocated to ongoing risk monitoring and oversight of compliance issues, supported by continued enhancement of the Group’s global business conduct framework described further at pages 30 to 31.
The Nominations Committee has reviewed the size and composition of the Board and the membership of Board Committees in view of the retirements of Ann Godbehere, Dr Pedro Malan and Lionel Nowell, III. As part of this review, the Board accepted the recommendations of the Nominations Committee to appoint Holly Keller Koeppel as the Chairman of the Audit Committee, to appoint Luc Jobin to the Audit Committee and to appoint Dr Marion Helmes to the Remuneration Committee with effect from 14 January 2019 (Dr Helmes and Mr Jobin having stepped down from the Audit and Remuneration Committees, respectively from that date). Board succession planning will continue to be a priority for the Nominations Committee in 2019.
Other areas of focus for 2019, identified through the annual Board evaluation, include enhanced Board review of the Group’s culture and its alignment with the Group’s purpose, values and strategy, continued rigour in the oversight of the development of a diverse senior management succession pipeline and the allocation of additional time for the Nominations Committee to review and monitor the progress of the Group’s diversity strategies.
Shareholder engagement
Dialogue with our shareholders
The Board is committed to open and transparent dialogue with shareholders. The Senior Independent Director and other Non-Executive Directors are available to meet with major shareholders on request. The AGM is an opportunity for further shareholder engagement and for the Chairman to explain the Company’s progress and, with other members of the Board, to answer any questions.
All Directors attend the AGM, unless illness or pressing commitments prevent them. All Directors, except for Lionel Nowell, III, attended the AGM in 2018.
Details of our 2019 AGM are set out on page 321.
Update on 2018 AGM voting results
All resolutions were passed at the Company’s AGM held on 25 April 2018 with the requisite majority of votes. However, in respect of three resolutions, the re-election of Dr Marion Helmes as Director, authority to allot shares and the Directors’ Remuneration Report, we acknowledge that a significant minority of our shareholders did not support these resolutions.
Dr Marion Helmes has since stepped down from the Supervisory Board of Bilfinger SE with effect from 15 May 2018 and has also retired as a Non-Executive Director of NXP Semiconductors N.V. with effect from 22 June 2018. Following these retirements, and with her appointment to the Supervisory Board of Heineken N.V. from 19 April 2018, Dr Helmes’ portfolio of listed company non-executive directorships (and equivalent) total five appointments (including her position at British American Tobacco). The Board continues to listen to the views of our shareholders and Directors are required to obtain Board approval prior to undertaking additional external appointments.
Compliance statement
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Throughout the year ended 31 December 2018, we applied the Main Principles of the April 2016 version of the UK Corporate Governance Code as it applies to the year ended 31 December 2018. The Company was compliant with all provisions.
The Board considers that this Annual Report and Form 20-F, and notably this section, provides the information shareholders need to evaluate how we have complied with our current obligations under the Code. For ease of reference, we prepare a separate voluntary annual compliance report by reference to each provision of the Code, available at www.bat.com/governance.
From 1 January 2019, we have applied the Principles of the July 2018 version of the UK Corporate Governance Code and we will report on our application of those Principles in the Company’s Annual Report and Form 20-F for 2019. |
We comply with the Disclosure Guidance and Transparency Rules requirements for corporate governance statements by virtue of the information included in this section, together with the information contained in the Other Information section.
As a result of the listing of the Company’s American Depositary Shares (ADSs) on the NYSE, the Company is required to meet certain NYSE requirements relating to corporate governance matters. Certain exceptions to these requirements apply to the Company as a foreign private issuer. For a discussion of the significant differences between the NYSE requirements and the Company’s practices, please see page 293. |
| 62 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
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Strategic Report
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Governance
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Financial Statements
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Other Information
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Introduction & Board
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Audit Committee
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Nominations Committee
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Remuneration Committee
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Responsibility of Directors
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In respect of authority to allot shares, it is standard market practice for many FTSE listed companies to retain this type of authority and the authority sought by the Company at its 2018 AGM is in accordance with the Investment Association’s share capital management guidelines. However, we are aware that some institutional investors, particularly in South Africa, have policies against supporting this type of resolution. We will continue to listen to the views of our shareholders in order to better understand the position of those for which this resolution presents concerns, and will keep best practice under review.
Please refer to page 108 for an update in respect of the resolution regarding the 2017 Directors’ Remuneration Report.
Annual investor relations programme
A full programme of engagement with shareholders, potential investors and analysts, in the UK and overseas, is undertaken each year by the Head of Investor Relations, usually accompanied by one or more of the Executive Directors. The Chairman also met with shareholders over the year and, following his appointment as CEO Designate, Jack Bowles has also attended shareholder meetings.
Every two years, combined investor meetings are held over two days with the Management Board in attendance. Our next investor event will be held in March 2019 in London.
In 2018, as part of the annual investor relations programme, meetings were held with institutional shareholders owning the majority of the Group’s shares, primarily in the UK, US and South Africa. Over the past year, over 380 investor engagement activities were completed, mainly comprising face to face meetings, telephone conferences and group meetings. Regular investor presentations were also given and these together with the results presentations are published on www.bat.com. All results presentations are also available to shareholders by webcast.
In addition, there is a microsite on www.bat.com for debt investors, with comprehensive bond holder information on credit ratings, debt facilities, outstanding bonds and maturity profiles.
During 2018, the Remuneration Committee Chairman led an extensive programme of shareholder engagement in relation to proposed revisions to the Directors’ Remuneration Policy, supported by the Chairman, the Executive Directors and members of senior management. Engagement with shareholders on the revised policy has continued in the lead up to the Company’s 2019 AGM. Please refer to the Remuneration Report for details of this engagement programme and the Company’s regard for shareholder interests in developing the revised policy.
Board reporting on shareholder views
During 2018, the Head of Investor Relations regularly updated the Board on key issues raised by institutional shareholders and provided commentary on share price performance. Key issues raised by shareholders and considered by the Board during 2018 included the growth of PRRPs, the US market, FDA regulation and Group debt.
The Chairman and the Executive Directors regularly update the Board on their dialogue with shareholders. The Board discusses key issues raised and takes shareholder feedback into account in developing the Group’s strategy.
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For disclosures required by paragraph 7.2.6 of the Disclosure Guidance and Transparency Rules and the Companies Act 2006 see the Other Information section. |
| BAT Annual Report and Form 20-F 2018 | 63 | |
Table of Contents
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Directors’ Report
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Kieran Poynter Chairman of the Audit Committee to 14 January 2019 |
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Holly Keller Koeppel Current Chairman of the Audit Committee |
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Audit Committee current members |
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Holly Keller Koeppel (Chairman from 14 January 2019) |
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Luc Jobin (from 14 January 2019) |
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Kieran Poynter (Chairman to 14 January 2019) |
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Notes: |
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1. |
Holly Keller Koeppel, Luc Jobin and Kieran Poynter each have recent and relevant financial experience. Holly Keller Koeppel, Luc Jobin and Kieran Poynter are each designated as an audit committee financial expert in accordance with applicable US federal securities laws and NYSE listing standards. The members of the Committee as a whole have competence relevant to the sectors in which the Group operates. | |
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2. |
Number of meetings in 2018: (a) the Committee held five meetings in 2018; and (b) Lionel Nowell, III did not attend the meetings held in April and July due to prior commitments. | |
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3. |
Membership: (a) all members of the Committee are independent Non-Executive Directors in accordance with the UK Corporate Governance Code 2016 Provision C.3.1., applicable US federal securities laws and NYSE listing standards; (b) Dr Pedro Malan ceased to be a member of the Committee upon his retirement as a Non-Executive Director on 25 April 2018; (c) Lionel Nowell, III ceased to be a member of the Committee upon his retirement as a Non-Executive Director on 12 December 2018; and (d) Dr Marion Helmes ceased to be a member of the Committee with effect from 14 January 2019. | |
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4. |
The Finance Director attends all meetings of the Committee but is not a member. Other Directors may attend by invitation. The Director of Legal & External Affairs, the Group Head of Internal Audit and the external auditors also attend meetings on a regular basis. | |
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5. |
The Committee meets alone with the external auditors and, separately, with the Group Head of Internal Audit at the end of every Committee meeting. The Committee also meets periodically with management.
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For the Committee’s terms of reference see | |
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www.bat.com/governance
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Role
The Audit Committee monitors and reviews the:
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integrity of the Group’s financial statements and any formal announcements relating to the Company’s performance, considering any significant financial reporting issues, significant judgments and estimates reflected in them, before their submission to the Board; |
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consistency of the Group’s accounting policies; |
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effectiveness of, and makes recommendations to the Board on, the Group’s accounting, internal accounting and other financial controls, auditing matters and business risk management systems; |
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effectiveness of the Company’s internal audit function; and |
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independence, performance, effectiveness and objectivity of the Company’s external auditors, making recommendations as to their reappointment (or for a tender of audit services where appropriate), and approving their terms of engagement and the level of audit, audit-related and non-audit fees. |
Audit Committee terms of reference
Revised Audit Committee terms of reference have been adopted by the Board to reflect revisions to internal governance and reporting processes to align with the requirements of the UK Corporate Governance Code 2018. The revised Audit Committee terms of reference incorporate:
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– the Committee’s role in supporting the Board to carry out a robust assessment of the Company’s emerging risks;
– the Committee’s role in supporting the Board to routinely review the Group’s whistleblowing channels, the reports arising from their operation, and the arrangements in place for proportionate and independent investigation and follow up, as appropriate; and
– confirmation of the Committee’s responsibility to conduct the tender process for appointment of external auditors from time to time, as considered necessary or as required by applicable regulations.
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| 64 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
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Strategic Report
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Governance
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Financial Statements
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Other Information
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Introduction & Board
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Audit Committee
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Nominations Committee
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Remuneration Committee
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Responsibility of Directors
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Key activities in 2018
Regular work programme – reviewing:
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the Group’s 2017 results, 2018 half-year results, the application of accounting standards, and the external auditors’ reports where results are audited; |
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the Group’s external auditors’ year-end audit, including the key audit matters, materiality assessments and the Group’s control environment, and confirming the independence of the Group’s external auditors; |
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the Basis of Preparation and Accounting Judgements; |
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adjusting items, applicable accounting treatment and the use of alternative performance measures; |
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the annual assessment of goodwill impairment; |
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the accounting applicable to retirement benefits liabilities and assets; |
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the Group’s liquidity position, current facilities and financing needs through 2018; |
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the steps taken to validate the Group’s ‘going concern’ assessment at half-year and year-end and agreeing on the process and steps taken to determine the Group’s viability statement at year-end; |
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the internal processes followed for the preparation of the Annual Report and Form 20-F 2018 and confirming that the processes appropriately facilitated the preparation of an Annual Report and Form 20-F that is ‘fair, balanced and understandable’; |
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the Group’s Risk Register, including prioritisation and categorisation of, and mitigating factors in respect of, Group risks; |
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regular reports from the Group Head of Internal Audit on internal audits of markets, processes and operations, management responses to internal audit findings and action plans put in place to address any issues raised; |
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the 2019 internal audit plan and progress against the 2018 plan; |
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the Group’s sustainability performance, including the Group’s youth smoking prevention activities and the Group’s corporate social investment in the focus areas of empowerment, civic life and sustainable agriculture and environment initiatives in countries and communities in which the Group operates; |
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periodic reports from the Group’s Corporate Audit Committee and Regional Audit and Corporate Social Responsibility Committees; |
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annual and interim reports on the Group’s Business Conduct & Compliance programme, whistleblowing and compliance with the Group Standards of Business Conduct (SoBC); |
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the annual report from the Group Head of Security on security risks, losses and fraud arising during the preceding year; |
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half-year and year-end reports on political contributions; and |
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the Committee’s effectiveness in 2018, following the annual evaluation of the Committee discussed further at page 61. |
Further specific matters considered by the Committee in relation to the financial statements:
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in relation to the offer to bond holders to exchange debt (previously issued under Rule 144A format) for SEC registered bonds discussed at page 40, the revision of the 2017 financial statements to reflect the Group’s regional structures and retrospective implementation of IFRS 15 (Revenue from Contracts with Customers), as required by applicable US securities regulations; |
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revisions to the Group’s accounting policies to reflect the application of IFRS 9 (relating to financial instruments) with effect from 1 January 2018, the retrospective application of IFRS 15 (Revenue from Contracts with Customers) and management’s impact assessment of the application of IFRS 9 and 15, discussed further at note 1 in the Notes on the Accounts; and |
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methodology for the Group’s application of IFRS 16 (Leases) with effect from 1 January 2019 and revisions to the Group’s accounting policies to reflect the application of IFRS 16, discussed further at note 1 in the Notes on the Accounts. |
Significant accounting judgements considered by the Committee in relation to the 2018 financial statements:
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the Group’s significant tax exposures: the Committee reviewed periodic updates on corporate tax matters and considered reports from the Group Head of Tax on the current status of the Franked Income Investment Group Litigation Order (FII GLO) and the status of issues in various markets. These included significant tax disputes in Brazil, South Africa and the Netherlands. The Committee confirmed management’s assessments and extended disclosures in respect of these tax exposures (see note 28 in the Notes on the Accounts); |
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contingent liabilities, provisions and deposits in connection with ongoing litigation: the Committee confirmed that quarterly deposits made as security for costs in relation to the Quebec class-actions by the Group’s subsidiary Imperial Tobacco Canada would continue to be treated as an asset to be recovered upon a successful appeal of the original judgment (see note 14 in the Notes on the Accounts) and approved the continued recognition of a contingent liability pending the final outcome of the class-actions (see note 28 in the Notes on the Accounts). The Committee reassessed the provision in respect of the Fox River clean-up costs and related legal expenses subsequent to a funding agreement in relation to the sharing of the costs. The Committee confirmed that the provision would be retained at the prior year level (see note 3 in the Notes on the Accounts), although inherent uncertainties remain (see note 28 in the Notes on the Accounts). The Committee reviewed the position in respect of the Kalamazoo River claim and agreed with management’s assessment that no provision should be recognised on the basis set out at note 28 in the Notes on the Accounts; |
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foreign exchange: as the Group has operations in certain territories with severe currency restrictions where foreign currency is not readily available, the Committee assessed management’s approach to applicable accounting treatment and was satisfied that the methodologies used to determine relevant exchange rates for accounting purposes were appropriate; |
| BAT Annual Report and Form 20-F 2018 | 65 | |
Table of Contents
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Directors’s Report
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Audit Committee continued
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RAI group companies: the Committee reviewed and approved the final purchase price allocation in relation to the acquisition in 2017 of the remaining shares in RAI not already owned and subsequently the 2018 assessment of the carrying value of the intangibles, including goodwill. The Committee also considered and concurred with management’s approach to accounting for the Master Settlement Agreement, the Engle class-action and progeny cases and claims brought by RAI dissenting shareholders seeking determination of ‘fair value’ for their shares following acquisition of the remaining shares in RAI (see note 28 in the Notes on the Accounts); and |
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proposed FDA regulations: the Committee considered the potential impact of the FDA’s announcement proposing to regulate or prohibit menthol in cigarettes in the US and agreed with management’s judgement that, in accordance with IFRS, this did not constitute an impairment trigger on the basis that (amongst other factors) any proposed regulation of menthol in cigarettes would need to be introduced through the established US comprehensive rule-making process, the timetable and outcome for which was uncertain, and it was unclear how any such potential US regulation might affect the manufacture and marketing of Group combustible brands containing menthol, indicating a lack of evidence that any impairment had occurred and that the amount of any potential impairment could not be reasonably estimated at this time. The Committee requested that management continue to monitor developments in relation to the FDA’s proposals and required that potential impact be kept under review. |
Other specific matters considered by the Committee:
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review of the Company’s status as a Foreign Private Issuer for the purposes of US securities laws; |
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revisions to the Audit Committee terms of reference to reflect internal governance changes implementing the UK Corporate Governance Code 2018; |
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evaluation of the progress on the Group’s ‘Delivery with Integrity’ compliance programme (discussed further on page 31) and monitoring SoBC incident reporting and the effectiveness of ‘Speak Up’ channels; |
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review of the outcomes from assessments of key countries of concern to the Group from a human rights perspective, including local compliance with the Group’s Supplier Code of Conduct and other applicable Group policies in those countries; and |
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oversight of the assessment of UK Group company payment practices and the procedures established to ensure that applicable companies report on payment practices in compliance with UK regulations. |
Risk topics considered by the Committee included:
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oversight of the programme established to ensure ongoing SOx compliance (discussed further at page 69); |
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the status of Group subsidiary Imperial Tobacco Canada’s appeal of the class-action judgment in Quebec Province (see note 28 in the Notes on the Accounts); |
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revisions to the Group’s risk appetite framework as it relates to the Group’s strategic objectives and regular review of emerging risks to the Group prior to Board assessment; |
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the report on the effectiveness of the Company’s risk management system; |
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risks associated with increased exposure to interest rate changes on net finance costs, arising from existing and future refinanced debt; |
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Group anti-bribery and corruption controls, with emphasis on the controls established in markets assessed to be exposed to higher bribery and corruption risks; |
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impact of the EU General Data Protection Regulation (GDPR), review of the Group-wide programme established to support GDPR compliance from 1 May 2018 and oversight of programme implementation; |
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increased threat of cyber-attack to the Group’s operations and the evolving nature of those threats, and the Group’s implementation of enhanced administrative, technical and physical defence capabilities to protect its information systems and data through a cyber security roadmap integrated across the Group, including business continuity plans, security policies and procedures, network and systems monitoring, employee training and third-party risk assessments; and |
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periodic reassessment of the risks faced by the Group as a consequence of the UK’s decision to exit the EU (Brexit), including potential risks relating to increased costs of capital, transactional and translational foreign exchange rate exposures, supply chain continuity, taxation and changes in customs duty, and talent acquisition and retention. |
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For further information please refer to the Principal Group risks on pages 48 to 52 and the Group risk factors on pages 270 to 284. | |
Audit Committee effectiveness
An annual evaluation of the Committee’s effectiveness was undertaken as part of the wider internal Board evaluation conducted in 2018. The evaluation found that the Board considered the Committee to operate effectively and that its working relationship with the Board continues to be sound. The process by which the Committee’s effectiveness was evaluated is discussed at page 61.
External auditors
KPMG LLP (KPMG) were appointed as the Company’s auditors with effect from 23 March 2015, following a formal tender process carried out in 2015. The Committee considers the relationship with the auditors to be working well and remains satisfied with their effectiveness.
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UK Competition and Markets Authority Audit Order The Company has complied with the Statutory Audit Services Order issued by the UK Competition and Markets Authority for the financial year ended 31 December 2018.
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Group Auditor Independence Policy (AIP)
The Group has an established AIP, reflecting the requirements of applicable laws, to safeguard the independence and objectivity of the Group’s external auditors and to specify the approval processes for the engagement of the Group’s external auditors to provide audit, audit-related and other non-audit services.
The key principle of the AIP is that the Group’s external auditors may only be engaged to provide services in cases where the provision of those services does not impair the independence and objectivity of the Group’s external auditors. The Committee recognises that using the external auditors to provide services can be beneficial given their detailed knowledge of our business. However, the AIP does not permit the Committee to delegate its responsibilities to the external auditors and the external auditors are only permitted to provide audit, audit-related and non-audit services in accordance with the AIP.
The AIP does not permit the external auditors to maintain a financial, employment or business relationship with any Group company, or provide services to any Group company, which:
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creates a mutual or conflicting interest with any Group company; |
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places the external auditors in the position of auditing their own work; |
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results in the external auditors acting as a manager or employee of any Group company; or |
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places the external auditor in the position of advocate for any Group company. |
| 66 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
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Strategic Report
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Governance
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Financial Statements
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Other Information
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Introduction & Board
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Audit Committee
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Nominations Committee
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Remuneration Committee
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Responsibility of Directors
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Audit services are approved in advance by the Committee on the basis of an annual engagement letter and the scope of audit services is agreed by the Committee with the external auditors.
Subject to the restrictions specified in the AIP, the external auditors may also provide certain non-audit services with the prior approval of the Committee. The requirement for the Committee’s pre-approval of non-audit services may be waived only if the aggregate amount of all non-audit services provided is less than 5% of the total amount paid to the external auditors during the reporting year, where those services were not recognised to be non-audit services at the time of engagement, and provided those services are promptly brought to the attention of the Committee and their provision is approved prior to completion of the audit in the relevant reporting year.
The provision of permitted non-audit services must be put to tender if expected spend exceeds limits specified in the AIP, unless a waiver of this requirement is agreed by the Finance Director and notified to the Committee.
The AIP:
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requires Committee pre-approval for all audit, audit-related and other non-audit services, except in respect of non-audit services falling within the exceptions described above; |
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prohibits the provision of certain types of services by the external auditors, including those with contingent fee arrangements, expert services unrelated to audit and other services prohibited by US securities laws and the Public Company Accounting Oversight Board; |
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prohibits the Chief Executive, Finance Director, Group Financial Controller and Group Chief Accountant from having been employed by the external auditors in any capacity in connection with the Group audit for two years before initiation of an audit; |
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specifies requirements in respect of audit partner rotation, including for both the lead and the concurring external audit partners to rotate off the Group audit engagement at least every five years, and not to recommence provision of audit or audit-related services to the Group for a further five years; and |
| – |
provides authority for the Committee to oversee any allegations of improper influence, coercion, manipulation or purposeful misleading in connection with any external audit, and to review any issues arising in the course of engagement with the external auditors. |
External audit fees
The Committee reviews a schedule identifying the total fees for all audit and audit-related services, tax services and other non-audit services expected to be undertaken by the external auditors in the following year. Tax services and other non-audit services in excess of the tender thresholds referred to above must be itemised. Updated schedules are also submitted to the Committee at mid-year and year-end, so that it has full visibility of the Group spend on services provided by the Group’s external auditors.
A breakdown of audit, audit-related, tax and other non-audit fees paid to KPMG firms and associates in 2018 is provided in note 3(c) in the Notes on the Accounts and is summarised as follows:
Services provided by KPMG firms and associates 2018
|
2018
|
2017
|
|||||||
|
Audit services
|
|
15.1
|
|
|
17.6
|
|
||
|
Audit of defined benefit schemes
|
|
0.4
|
|
|
–
|
|
||
|
Audit-related assurance services
|
|
9.4
|
|
|
8.0
|
|
||
|
Total audit and audit-related services
|
|
24.9
|
|
|
25.6
|
|
||
|
Other assurance services
|
|
0.3
|
|
|
4.1
|
|
||
|
Tax advisory services
|
|
–
|
|
|
–
|
|
||
|
Tax compliance
|
|
–
|
|
|
0.2
|
|
||
|
Other non-audit services
|
|
–
|
|
|
–
|
|
||
|
Total non-audit services
|
|
0.3
|
|
|
4.3
|
|
||
Notes: In 2018, non-audit fees paid to KPMG amounted to 1.2% of the audit and audit-related assurance fees paid to them (2017: 16.8%). All audit and non-audit services provided by the external auditors in 2018 were pre-approved by the Committee. The other assurance services of £4.1 million in 2017 includes costs in relation to the Group’s acquisition of RAI and associated regulatory filings.
External auditor effectiveness
The Committee, on behalf of the Board, is responsible for the relationship with the external auditors. The Committee carries out an annual assessment of the Group’s external auditors, covering qualification, expertise and resources, and objectivity and independence, as well as the effectiveness of the audit process. This assessment takes into account the Committee’s interactions with, and observations of, the external auditors and gives regard to factors including:
| – |
experience and expertise of the external auditors in their direct communication with, and support to, the Committee; |
| – |
their mindset and professional scepticism; |
| – |
their effectiveness in completing the agreed external audit plan; |
| – |
their approach to handling significant audit and accounting judgements; |
| – |
content, quality and robustness of the external auditors’ reports; and |
| – |
their provision of non-audit services, as noted above. |
The Committee’s assessment is also informed by an external audit satisfaction survey completed by members of the Group’s senior management. No material issues were identified during the external auditor assessment in 2018. The Committee is satisfied with the qualification, expertise and resources of its external auditors and that the objectivity and independence of its external auditors are not in any way impaired by the non-audit services which they provide. The Committee has recommended to the Board the proposed reappointment of KPMG at the 2019 AGM.
The Committee Chairman, Finance Director, Director of Legal & External Affairs, Group Head of Internal Audit and the Company Secretary all meet with the external auditors regularly throughout the year to discuss relevant issues as well as the progress of the external audit. Any significant issues are included on the Committee’s agenda.
FRC Audit Quality Review
The UK Financial Reporting Council (FRC) Audit Quality Review (AQR) team selected the audit of the Group’s financial statements for the year ended 31 December 2017 for review, as part of their annual inspection of audit firms. The AQR covered the audit work at Group level and the AQR report did not identify any significant areas for improvement. The Committee reviewed and discussed the scope of the AQR, the AQR report conclusions and the actions that will be taken in response to the AQR findings with the External Audit Engagement Partner.
| BAT Annual Report and Form 20-F 2018 | 67 | |
Table of Contents
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Directors’ Report
|
||||||||||||||
|
Audit Committee
continued
|
||||||||||||||
Competition & Markets Authority statutory audit market study
The UK Competition and Markets Authority (CMA) invited the Company to participate in its statutory audit market survey in 2018. The Committee Chairman led the Committee’s response to the CMA’s requests for information in connection with the study. The Committee Chairman also met with representatives from the CMA’s study team to discuss the UK statutory audit market and the Company’s approach to external audit tenders.
Risk management and internal control
Overview
The Company maintains its system of risk management and internal control with a view to safeguarding shareholders’ investment and the Company’s assets. It is designed to identify, evaluate and manage risks that may impede the Company’s objectives. It cannot, and is not designed to, eliminate them entirely. The system therefore provides a reasonable, not absolute, assurance against material misstatement or loss. A description of the principal risks that may affect the Group’s business is provided in our Strategic Report on pages 48 to 52.
The main features of the risk management processes and system of internal control operated within the Group are described below. These have been in place throughout the year under review and remain in place to date. These do not cover associates of the Group.
Board oversight
During the year, the Board considered the nature and extent of the principal risks that the Group is willing to take to achieve its strategic objectives (its ‘risk appetite’) and for maintaining sound risk management and internal control systems. It keeps its risk appetite under review to ensure that it is appropriate and consistent with internal policies and the Group’s strategic objectives.
With the support of the Committee, the Board conducts a review of the effectiveness of the Group’s risk management and internal control systems annually. This review covers all material controls including financial, operational and compliance controls and risk management systems.
Audit and CSR Committee framework
The Group’s Regional Audit and CSR Committee framework underpins the Board’s Audit Committee. It provides a flexible channel for the structured flow of information through the Group, with committees covering each of the Group’s regions, and locally-listed Group entities and complex markets where considered appropriate in certain markets. The Regional Audit and CSR Committees are supported by Risk and Control Committees established at business unit level, and within certain Group functions where considered appropriate.
The Group’s Regional Audit and CSR Committee framework structure was amended with effect from 1 May 2018 to reflect the Group’s new international business model, and to establish a Regional Audit and CSR Committee for each of the three Group regions, in addition to the RAI Regional Audit and CSR Committee covering the Group’s US business. The Committee approved revised terms of reference for the Regional Audit and CSR Committee to implement this new international structure. The Group’s Regional Audit and CSR Committees are all chaired by a member of the Management Board and attended by one or more Non-Executive Directors.
The Corporate Audit Committee focuses on the Group’s risks and control environment that fall outside the regional committees’ remit, for example head office central functions, global programmes and projects. It comprises members of the Management Board, is chaired by a Regional Director and is also attended by one or more of the Non-Executive Directors.
External and internal auditors attend meetings of these committees and regularly have private audiences with members of the committees after meetings. Additionally, central, regional and individual market management, along with internal audit, support the Board in its role of ensuring a sound control environment.
This framework ensures that significant financial, social, environmental and reputational risks faced by the Group are appropriately managed and that any failings or weaknesses are identified so that remedial action may be taken.
Risk management
Risk registers, based on a standardised methodology, are used at Group, regional, area and individual market level to identify, assess and monitor the risks (both financial and non-financial) faced by the business at each level. Information on prevailing trends, for example whether a risk is considered to be increasing or decreasing over time, is provided in relation to each risk and all identified risks are assessed and prioritised at three levels by reference to their impact (high/medium/ low) and likelihood (probable/possible/unlikely).
Mitigation plans are required to be in place to manage the risks identified and progress against those plans is monitored. The risk registers are reviewed on a regular basis. Regional and above-market risk registers are reviewed regularly by the relevant Regional Audit and CSR Committee or the Corporate Audit Committee, as appropriate.
At Group level, specific responsibility for managing each identified risk is allocated to a member of the Management Board. The Group Risk Register is reviewed regularly by a committee of senior managers, chaired by the Finance Director. In addition, it is reviewed annually by the Board and twice yearly by the Committee. The Board and the Committee review changes in the status of identified risks, assessing the changes in impact and likelihood. The Committee also conducts ‘deep dives’ into selected risks, meeting senior managers responsible for managing and mitigating them, so that it can consider those risks in detail.
The Board noted that the Group’s principal risks remained significantly unaltered during 2018.
|
|
For more information on risks see the Principal Group risks on pages 48 to 52 and the Group risk factors on pages 270 to 284.
|
Internal control
Group companies and other business units are annually required to complete a checklist, called Control Navigator, of the key controls that they are expected to have in place. Its purpose is to enable them to self-assess their internal control environment, assist them in identifying any controls that may need strengthening and support them in implementing and monitoring action plans to address control weaknesses. The Control Navigator checklist is reviewed annually to ensure that it remains relevant to the business and covers all applicable key controls. In addition, at each year-end, Group companies and other business units are required to:
| – |
review their system of internal control, confirm whether it remains effective and report on any material weaknesses and the action being taken to address them; and |
| – |
review and confirm policies and procedures to promote compliance with the SoBC are fully embedded within the Group company or business unit and identify any material instances of non-compliance. |
| 68 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
The results of these reviews are reported to the relevant Regional Audit and CSR Committees or to the Corporate Audit Committee, and to the Committee, to ensure that appropriate remedial action has been, or will be, taken where necessary. They are also considered by the SOx Steering Committee and the Disclosure Committee in determining management’s opinion on ICFR.
Internal Audit function
The Group’s Internal Audit function is responsible for carrying out risk-based audits of Group companies, other business units, and in relation to global processes. The internal audit function of RAI Companies was integrated into the Group’s Internal Audit function and its ways of working with effect from 1 January 2018, reporting directly to the Group Head of Internal Audit.
There is a separate Business Controls Team which provides advice and guidance to the Group’s businesses on best practices in risk management and controls systems.
The Group’s Internal Audit function maintains a rolling 18-month audit plan, which is reviewed by the Committee on an annual basis. The internal audit plan is aligned to the Group’s Risk Register and prioritises principal risk areas in relation to the Group’s business. In 2018, internal audits covered various markets, Group manufacturing facilities, functional transformation programmes and specific processes, including readiness for compliance with the EU Tobacco Products Directive. The Committee considered internal audit findings and action plans established to address any issues identified.
The internal audit plan for 2019 reviewed by the Committee places increased focus on emerging risks for the Group, emphasising audits relating to THP and vapour processes, enterprise organisation programmes and global business services, whilst maintaining thorough coverage of core business activities, lines of defence and IT controls. The scope of each internal audit is assessed for SOx impact and audit of applicable SOx controls is included where relevant. Reviews of SOx controls and their effectiveness are primarily conducted by the Group’s Business Controls Team and assurance is also undertaken by the Group’s external auditors, as referred to below.
The Committee reviews the effectiveness of the Company’s Internal Audit function on an annual basis. The Committee considers the Internal Audit function to be effective and to have the necessary resources to enable it to fulfil its mandate.
Financial reporting controls
The Group has in place a series of policies, practices and controls in relation to the financial reporting and consolidation process, which are designed to address key financial reporting risks, including risks arising from changes in the business or accounting standards and to provide assurance of the completeness and accuracy of the content of the Annual Report and Form 20-F.
A key area of focus is to assess whether the Annual Report and Form 20-F and financial statements are ‘fair, balanced and understandable’ in accordance with regulatory requirements, with particular regard to:
| – |
Fair: Consistency of reporting between the financial statements and narrative reporting of Group performance and coverage of an overall picture of the Group’s performance; |
| – |
Balanced: Consistency of narrative reporting of significant accounting judgements and key matters considered by the Committee with disclosures of material judgements and uncertainties noted in the financial statements; appropriate prominence and explanation of primary and adjusted measures; and |
| – |
Understandable: Clarity and structure of the Annual Report and Form 20-F and financial statements, appropriate emphasis of key messages, and use of succinct and focused narrative with strong linkage throughout the report, to provide shareholders with the information needed to assess the Group’s business, performance, strategy and financial position. |
The Group Manual of Accounting Policies and Procedures sets out the Group accounting policies, its treatment of transactions and its internal reporting requirements. The internal reporting of financial information to prepare the Group’s half-yearly and year-end financial statements is signed off by the heads of finance responsible for the Group’s markets and business units. The heads of finance responsible for the Group’s markets and all senior managers must also confirm annually that all information relevant to the Group audit has been provided to the Directors and that reasonable steps have been taken to ensure full disclosure in response to requests for information from the external auditors.
The current and previous Committee Chairmen participated in the Annual Report and Form 20-F 2018 drafting and review processes, and engaged with the Finance Director and the Group Head of Internal Audit during the drafting process.
SOx compliance oversight
Following the registration of Company securities in 2017 under the US Securities Act of 1933, as amended (the Securities Act), the Company is subject to certain rules and regulations of US securities laws, including the US Securities Exchange Act 1934 and SOx. SOx places specific responsibility on the Chief Executive and the Finance Director to certify or disclose information applicable to the financial statements, disclosure controls and procedures (DCP) and the internal controls over financial reporting (ICFR). For 2018, this includes our Chief Executive and Finance Director giving attestation, required for the first time, in respect of ICFR effectiveness under §404 of SOx.
The Committee has oversight of processes established to ensure full and ongoing compliance with applicable US securities laws, including SOx. Two committees provided assurance during 2018 with regard to applicable SOx certifications. The Disclosure Committee reviews the Company’s financial statements for appropriate disclosure and designs and maintains DCPs and reports to, and is subject to the oversight of, the Chief Executive and the Finance Director. A sub-committee of the Disclosure Committee, the SOx Steering Committee, provides assurance that ICFR have been designed, and are being implemented, evaluated and disclosed appropriately, in accordance with applicable requirements and subject to the oversight of the Chief Executive and Finance Director. The activities of this sub-committee are directly reported to the Disclosure Committee.
The outputs from the Disclosure Committee and SOx Steering Committee were presented to and reviewed by the Committee. No material weaknesses were identified and the Committee was satisfied that, where areas for improvement were identified, processes are in place to ensure that remedial action is taken and progress is monitored.
In 2018, the Committee also reviewed the scope of the external auditors’ SOx procedures, and received reports on their progress with their independent assessment of ICFR across the Group and the Group’s SOx implementation.
| BAT Annual Report and Form 20-F 2018 | 69 | |
Table of Contents
|
Directors’ Report
|
||||||||||||||
| Audit Committee continued | ||||||||||||||
Code of Ethics for the Chief Executive and Senior Financial Officers
In addition to the SoBC, which applies to all staff of the Group including senior management and the Board, the Company has adopted a Code of Ethics applicable to the Chief Executive, the Finance Director, and other senior financial officers, as required by US securities laws and NYSE listing standards.
The Code of Ethics includes requirements in relation to confidentiality, conflicts of interest and corporate opportunities, and obligations for those senior financial officers to act with honesty and integrity in the performance of their duties and to promote full, fair, accurate, timely and understandable disclosures in all reports and other documents submitted to the US Securities and Exchange Commission, the UK Financial Conduct Authority, and any other regulatory agency. No waivers or exceptions to the Code of Ethics were granted in 2018.
Annual review
The Financial Reporting Council’s ‘Guidance on Risk Management and Internal Control and Related Business Reporting’ reflects the requirements of the UK Corporate Governance Code 2016 regarding the applicability of, and compliance with, that Code’s provisions with regard to issues of risk and internal control management and related financial and business reporting.
The processes described above, and the reports that they give rise to, enable the Board and the Committee to monitor risk and internal control management on a continuing basis throughout the year and to review its effectiveness at the year-end. The Board, with advice from the Committee, has completed its annual review of the effectiveness of that system for 2018.
The Board is satisfied that the system of risk and internal control management accords with the UK Corporate Governance Code 2016 and satisfies the requirements for internal controls over financial reporting.
Group Standards of Business Conduct
The Committee is responsible for monitoring compliance with the SoBC, which underpins the Group’s commitment to good corporate behaviour. The SoBC requires all staff to act with a high degree of business integrity, comply with applicable laws and regulations, and ensure that standards are never compromised for the sake of results. Every Group company and all staff worldwide, including senior management and the Board, are expected to adhere to the SoBC. The SoBC and the Group’s ‘Delivery with Integrity’ programme is discussed further on pages 30 to 31.
All Group companies have adopted the SoBC or local equivalent. Information on compliance with the SoBC is gathered at a regional and global level and SoBC incidents reports, and details of the channels through which incidents are reported, are provided on a regular basis to the Regional Audit and CSR Committees, Corporate Audit Committee, and to the Committee. A breakdown of incidents reported under the SoBC across the Group in 2018 is set out at page 31.
The SoBC and information on the total number of incidents reported under it in 2018 (including established breaches) is available at www.bat.com/sobc
Whistleblowing
The Group maintains whistleblowing channels which enable concerns regarding SoBC compliance matters, including concerns about possible improprieties in financial reporting, to be raised in confidence (and anonymously should an individual wish) without fear of reprisal.
The SoBC includes the Group’s whistleblowing policy, which is supplemented by local procedures throughout the Group that provide staff with further guidance on reporting matters and raising concerns, and the channels through which they can do so. The Committee is satisfied that the Group’s whistleblowing policy and procedures enable proportionate and independent investigation of matters raised, and ensure that appropriate follow-up action is taken.
|
|
Further information about the Group’s whistleblowing channels and whistleblowing reports in 2018 is provided at page 31. |
Political contributions
The Group does not make contributions to European Union (EU) political organisations or incur EU political expenditure. The total amount of political contributions made to non-EU political parties in 2018 was £3,718,540 (2017: £4,832,321) as follows:
RAI Companies reported political contributions totalling £3,718,540 (US$4,965,850) for the full year 2018 to US political organisations, non-federal-level political party committees and to campaign committees of various non-federal candidates, in accordance with their contributions programme. No corporate contributions were made to federal candidates or political party committees and all contributions were made in accordance with applicable laws.
All political contributions made by RAI Companies are assessed and approved in accordance with RAI’s policies and procedures to ensure appropriate oversight and compliance with applicable laws.
In accordance with the US Federal Election Campaign Act, RAI Companies continue to support an employee-operated Political Action Committee (PAC), a non-partisan committee registered with the US Federal Election Commission that facilitates voluntary political donations by eligible employees of RAI Companies. According to US federal finance laws, the PAC is a separate segregated fund and is controlled by a governing board of individual employee-members of the PAC. In 2018, RAI Companies incurred expenses, as authorised by US law, in providing administrative support to the PAC.
No other political contributions were reported.
| 70 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Richard Burrows Chairman of the Nominations Committee
|
|
|
Nominations Committee current members |
||
|
Richard Burrows (Chairman) |
Holly Keller Koeppel | |
|
Sue Farr |
Savio Kwan | |
|
Dr Marion Helmes |
Dimitri Panayotopoulos | |
|
Luc Jobin |
Kieran Poynter | |
|
Notes: |
||
|
1. |
Number of meetings in 2018: (a) the Committee held seven meetings, five of which were ad hoc and convened at short notice; (b) Sue Farr did not attend the ad hoc meetings in October and November due to prior commitments; (c) Luc Jobin did not attend the ad hoc meeting in November due to prior commitments; (d) Lionell Nowell, III did not attend the meeting in July, and the ad hoc meeting in April, due to prior commitments; and (e) Kieran Poynter did not attend the ad hoc meeting in October due to prior commitments. | |
|
2. |
Membership: (a) all members of the Committee are independent Non-Executive Directors in accordance with UK Corporate Governance Code 2016 Provision B.2.1., applicable US federal securities laws and NYSE listing standards; (b) Ann Godbehere and Dr Pedro Malan ceased to be members of the Committee upon their retirement as Non-Executive Directors on 25 April 2018; and (c) Lionel Nowell, III ceased to be a member of the Committee upon his retirement as a Non-Executive Director on 12 December 2018. | |
|
3. |
Other attendees: the Chief Executive, Chief Executive Designate, Group Human Resources Director, Talent and Culture Director Designate and Group Head of Talent & Organisation Effectiveness regularly attend meetings by invitation but are not members.
|
|
|
|
For the Committee’s terms of reference see | |
| www.bat.com/governance |
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
Role
The Nominations Committee is responsible for:
| – |
reviewing the structure, size and composition of the Board and Management Board on a regular basis to ensure both have an appropriate balance of skills, expertise, knowledge and (for the Board) independence; |
| – |
reviewing the succession plans for appointments to the Board, the Management Board and as Company Secretary, to maintain an appropriate balance of skills and experience and to ensure progressive refreshing of both the Board and the Management Board; |
| – |
making recommendations to the Board on suitable candidates for appointments to the Board, the Management Board and as Company Secretary, and ensuring that the procedure for those appointments is rigorous, transparent, objective and merit-based, and has regard for diversity; |
| – |
assessing the time needed to fulfil the roles of Chairman, Senior Independent Director and Non-Executive Director, and ensuring Non-Executive Directors have sufficient time to fulfil their duties; and |
| – |
implementing the Board Diversity Policy and monitoring progress towards the achievement of its objectives, highlighted on page 72. |
|
Nominations Committee terms of reference |
||||||
|
Revised Nominations Committee terms of reference have been adopted by the Board to reflect revisions to internal governance and reporting processes to align with the requirements of the UK Corporate Governance Code 2018.
The revised Nominations Committee terms of reference incorporate the Committee’s role in overseeing the development of a pipeline of diverse, high-performing potential Executive Directors, Management Board members and other senior managers.
|
||||||
Key activities in 2018:
| – |
Leading an extensive selection process to identify a successor to the Chief Executive and recommending to the Board the appointment of Jack Bowles as Chief Executive Designate with effect from 1 November 2018, discussed further on page 72. |
| – |
Making recommendations to the Board in respect of Committee appointments, specifically to appoint Holly Keller Koeppel as the Chairman of the Audit Committee, Luc Jobin to the Audit Committee and Dr Marion Helmes to the Remuneration Committee with effect from 14 January 2019 (Dr Helmes and Mr Jobin having stepped down from the Audit Committee and Remuneration Committee respectively from that date). |
| – |
Making recommendations to the Board in relation to Directors’ annual appointment and re-election at the AGM, discussed further on page 72. |
| – |
Reviewing the Executive Directors’ and Management Board members’ annual performance assessments. |
| – |
Considering organisational changes to accelerate execution of Group strategy, and recommending that the Board make the Management Board appointments set out at page 57. |
| – |
Succession planning for the Board and for the Management Board, having regard to the Board Diversity Policy. |
| – |
Reviewing the Group talent strategy, talent development priorities and the programmes underpinning the Group’s commitment to investment in engaging, developing and retaining talent. |
| – |
Reviewing the Group’s Diversity & Inclusion strategy, specific diversity initiatives to further develop a diverse and gender-balanced work place, and progress made in the development of a diverse senior management succession pipeline. |
| BAT Annual Report and Form 20-F 2018 | 71 | |
Table of Contents
|
Directors’ Report
|
Nominations Committee continued
| – |
Assessing the progress of bespoke development plans for candidates for Executive Director and Management Board roles. |
| – |
Reviewing an update on outcomes of the global ‘Your Voice’ survey of employee opinion conducted across the Group in 2017. |
| – |
Assessing the Committee’s effectiveness in 2018, following the annual evaluation of the Committee discussed further at pages 61 and 62. |
Board appointments
The Committee is responsible for identifying candidates for Board positions, taking into account the Board Diversity Policy. This includes a full evaluation of candidates’ attributes to ensure the Board maintains an appropriate balance of skills, expertise and knowledge and generally involves interviews with several candidates, supported by independent, specialist external search firms to identify and shortlist appropriate candidates.
Leading the rigorous selection process to identify the successor to the Chief Executive was a key priority for the Committee during 2018. As part of the selection process, all Committee members participated in a series of interviews with internal and external shortlisted candidates, assessed the outcomes of candidates’ competency testing, and gave thorough consideration to the skills, experience and diversity of attributes of each potential candidate and their respective abilities to deliver the Group’s strategic objectives and fulfil its leadership requirements. This selection process was supported by Heidrick & Struggles, an independent executive search firm accredited under the Standard and Enhanced Code of Conduct for Executive Search Firms. Following this selection process, the Board approved the Committee’s recommendation to appoint Jack Bowles as Chief Executive Designate with effect from 1 November 2018, then as an Executive Director with effect from 1 January 2019 and as Chief Executive from 1 April 2019.
Details of the selection process informing the Committee’s recommendation to appoint Tadeu Marroco as Deputy Finance Director with effect from 1 March 2019, and then to join the Board and succeed Ben Stevens as Finance Director with effect from 5 August 2019, will be reported in the Company’s Annual Report and Form 20-F for 2019.
Terms of appointment to the Board
Details of the Directors’ terms of appointment to the Board and the Company’s policy on payments for loss of office are contained in the Directors’ Remuneration Policy, which is set out in full in the Remuneration Report 2015, contained in the Annual Report for the year ended 2015 available at www.bat.com. The terms of appointment and the Company’s policy on payments for loss of office are retained without alteration in the proposed new Directors’ Remuneration Policy at pages 86 and 87.
The Executive Directors have rolling contracts of one year. The Non-Executive Directors do not have service contracts with the Company but instead have letters of appointment for one year. Their expected time commitment is 25–30 days per year.
Board retirements
Nicandro Durante will retire from the Board with effect from 1 April 2019, on his retirement as Chief Executive. Ann Godbehere and Dr Pedro Malan retired as Non-Executive Directors of the Company with effect from the conclusion of the Annual General Meeting on 25 April 2018. Lionel Nowell, III retired as a Non-Executive Director of the Company with effect from 12 December 2018.
Board succession planning
The Board considers the length of service of the members of the Board as a whole and the need for it to refresh its membership progressively over time. Board succession planning remains a priority for the Committee in 2019.
The Chairman will have served as a Director for just over nine years at the time of the 2019 AGM. The Committee has given careful consideration to Director transitions to ensure orderly Board succession and has prioritised effective succession planning for the Chief Executive and the Finance Director which takes effect during 2019. In the forthcoming year, the Committee will be focused on succession planning for the Chairman and will have close regard to the requirements of the new Corporate Governance Code.
Annual General Meeting 2019
The Company will be submitting all eligible Directors for re-election and, in the case of Jack Bowles, election for the first time. Prior to making recommendations to the Board in respect of Directors’ submissions for election or re-election (as applicable), the Committee carried out an assessment of each Director, including their performance, contribution to the long-term success of the Company and, in respect of each of the Non-Executive Directors, their continued independence.
In respect of the reappointment of Kieran Poynter, who will have served as a Non-Executive Director for just over eight years at the time of the 2019 AGM, the Committee conducted a particularly rigorous review, taking into account his performance (including as Senior Independent Director and, until 14 January 2019, Chairman of the Audit Committee), his involvement in matters relevant to his role outside of formal Committee meetings and his attendance record. The Committee concluded that Mr Poynter continues to make effective use of his extensive experience in the fields of accounting and risk management, challenges management constructively and maintains independence of thought and approach. Accordingly, the Committee considered it appropriate to recommend to the Board that Mr Poynter be submitted for re-election at the 2019 AGM.
The Chairman’s letter accompanying the AGM Notice confirms that all Non-Executive Directors being proposed for election or re-election (as applicable) are effective and that they continue to demonstrate commitment to their roles as Non-Executive Directors.
|
Board Diversity Policy progress update |
||
|
Board objective
|
Progress in 2018
|
|
|
Considering all aspects of diversity when reviewing the composition of, and succession planning for, the Board and Management Board.
|
– The Nominations Committee has regard to diversity in its broadest sense, including gender, social and ethnic background, and cognitive and personal strengths, when undertaking these activities.
|
|
|
Considering a wider pool of candidates of both genders for appointment to the Board.
|
– Executive search firms are engaged to support Board and Management Board succession planning where applicable and are required to provide gender-balanced shortlists of candidates. Succession planning for Executive Directors and Management Board members takes into account potential internal candidates from across the Group and potential external candidates.
|
|
|
Maintaining at least 30% female Board representation, with the ambition of progressing towards further gender balance.
|
– The representation of women on the Board will be 30% as at 1 April 2019 (30% as at 31 December 2018).
|
|
|
Giving preference, where appropriate, to engagement of executive search firms accredited under the Standard and Enhanced Code of Conduct for Executive Search Firms, including on gender diversity.
|
– Only executive search firms accredited under the Standard and Enhanced Code of Conduct for Executive Search Firms were engaged to provided executive search services to support Board and Management Board succession planning in 2018.
|
|
|
Oversight of the development of a pipeline of diverse, high- performing potential Executive Directors, Management Board members and other senior managers.
|
– The representation of women on the Management Board will be 14.3% as at 1 April 2019 (nil as at 31 December 2018), indicating the success of our Diversity & Inclusion strategy in delivering steady but significant progress. Please refer to page 25 for information about our Diversity & Inclusion strategy.
|
| 72 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
|
Dimitri Panayotopoulos Chairman of the Remuneration Committee
|
Index to our Remuneration Report | ||||||
| Policy Report | 76 | |||||||
| 1. | Overview of what our Executive Directors earned in 2018 and why | 90 | ||||||
|
2. |
Executive Directors’ remuneration for the year ended 31 December 2018 | 91 | ||||||
| 3. | Executive Directors’ remuneration for the upcoming year | 97 | ||||||
|
4. |
Chairman and Non-Executive Directors’ remuneration for the year ended 31 December 2018 | 100 | ||||||
| 5. | Directors’ share interests | 101 | ||||||
|
6. |
Other disclosures | 104 | ||||||
| 7. | The Remuneration Committee and shareholder engagement | 106 | ||||||
| 8. | Summary of our Directors’ Remuneration Policy | 109 | ||||||
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The following Annual Report on Remuneration has been prepared in accordance with the relevant provisions of the Companies Act 2006 and as prescribed in The Large and Medium-sized Companies and Group (Accounts and Reports) (Amendment) Regulations 2013 (the UK Directors’ Remuneration Report Regulations). Where required and for the purpose of the audit conducted in accordance with International Standards on Auditing (ISA) data has been audited by KPMG and this is indicated appropriately.
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Dear Shareholder
Remuneration and strategy
We have completed the review of our Directors’ Remuneration Policy during 2018, taking into consideration investor and advisory body feedback arising from the 2018 AGM, recent changes in the UK corporate governance environment and an assessment of our competitive position in the marketplace. The Committee acknowledges the feedback provided by shareholders through the vote on the Directors’ Remuneration Report in 2018, which has been uppermost in our minds as we have conducted the review process.
Our focus has been to ensure that we have an effective Remuneration Policy which: (1) enables the Group to attract and retain top quality talent in the global marketplace; (2) rewards sustainable long-term performance in an appropriate and competitive manner; (3) forges closer long-term links between the Group’s senior management and its shareholders; and (4) incorporates best practice policy features while maintaining policy elements which have been well supported and remain appropriate for the Group.
Our recent experiences of working closely with our shareholders to successfully streamline, simplify and reshape our Remuneration Policy reflect these objectives and it is my role to ensure that this focus is maintained.
Shareholder engagement
The latter part of 2018 and early 2019 have been devoted to a programme of engagement with shareholders on the outcomes for 2018 and the remuneration proposals contained in the new Remuneration Policy. I would personally like to thank all those shareholders who worked with us and have helped us achieve an ongoing and transparent dialogue concerning executive remuneration.
New remuneration policy
The Committee has undertaken a focused review of the Remuneration Policy, building on the extensive work undertaken prior to 2016 that created the current policy which is strongly aligned with shareholder interests and remains fit for purpose in all its major aspects.
I believe that the proposed changes will further sharpen alignment with shareholder interests and simplify the policy while ensuring that executive compensation continues to be competitive. Key changes are as follows:
Pension: Pension contribution rates for new Executive Directors under the defined contribution plan will be reduced from 35% to 15% of annual base salary. Changes will align contributions with those available to our wider UK population and deliver a coherent pension policy throughout the organisation.
Short-Term Incentive Scheme (STI): The individual performance multiplier has been removed from the annual bonus, refocusing the STI on strategic metrics and corporate performance solely, while retaining the ability to reduce bonus in cases of poor individual performance.
Short-Term Incentive Scheme (STI): Post–cessation payments to ‘good leavers’ will no longer be paid ‘on target’ on a pro rata basis at leave date and instead will operate on a ‘wait and see’ basis, being paid pro rata, by reference to full-year results and paid at the normal time in March of the following year.
Long-Term Incentive Plan (LTIP): While there are no current changes in award quantum for the Executive Directors, the policy will move to a singular scheme maximum. Moving to a singular scheme maximum is considered an appropriate policy adjustment; it will mean an appropriate level of differentiation in award quantum is maintained between the CEO and other Executive Directors whilst providing flexibility to the Committee over the lifetime of the policy.
Long-Term Incentive Plan (LTIP): In addition, Altria will be included in the TSR comparator group for awards made from 2019. This expansion of the TSR comparator group is believed to be appropriate following the acquisition of RAI and the Group’s presence in the US market.
Dividend equivalent payments: Dividend equivalent payments under the Deferred Share Bonus Scheme (DSBS) and the LTIP will be settled in shares, rather than cash.
Post-employment shareholding: In accordance with the UK Corporate Governance Code 2018, we have developed a policy setting out post-employment shareholding requirements for Executive Directors. This policy introduces a requirement for former Executive Directors to hold shares equivalent to 100% of current shareholding requirements for two full years following the date of their departure.
These changes to policy have been introduced to further ensure long-term alignment between the interests of the Executive Directors and those of shareholders, and to support Executive Directors in building a high level of personal shareholding in the Company.
| BAT Annual Report and Form 20-F 2018 | 73 | |
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Remuneration Report
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Annual Statement on Remuneration continued
Disclosure of STI targets
A number of shareholders have requested publication of targets relating to the STI earlier than has previously been made. Since the revised reporting requirements came into effect, publication of the STI targets has been deferred for one year on the basis of the commercially sensitive nature of those targets. Notwithstanding that the Remuneration Committee continues to consider that STI targets remain commercially sensitive, the Remuneration Committee has, on balance, decided that publication of STI targets will in future be published in the remuneration report following the end of the relevant performance year. Consequently, this year’s remuneration report sets out the targets relating to both the 2017 and 2018 performance years.
Outcomes 2018
Our incentive arrangements are closely aligned to our strategy and performance metrics align with the key performance indicators stated in the Strategic Report.
The Group has delivered an outstanding operational performance in 2018, building on the long-term strategic growth agenda and exceeding the expectations established by the Committee, which had been revised upwards beyond the original targets which were established in early 2018.
This is evidenced by the Group’s performance in 2018 across key business metrics, excluding the impact of translational foreign exchange and on a representative basis, which normalises the Group’s results for acquisitions in prior periods.
In 2018, the Group has exceeded performance expectations, growing market share together with an increase in adjusted revenue and adjusted profit from operations (at constant rates of exchange) in all regions. In addition, the Group delivered a strong set of results with growth in adjusted, diluted, constant currency EPS and a strong operating cash conversion rate. RAI Companies’ results are now wholly reflected within the 2018 short-term incentive scheme and within the 2018 performance year attaching to the 2016, 2017 and 2018 LTIP awards.
These results are reflected positively in the outcomes for the Group’s STI, the International Executive Incentive Scheme (IEIS), for which the corporate result across the four measures (Adjusted profit from operations, the Group’s share of key markets, Adjusted revenue growth from the strategic portfolio and Cash generated from operations) was 100%.
The 2016 LTIP award with metrics representing Adjusted diluted EPS, relative TSR, Adjusted revenue growth and the Operating cash flow conversion ratio will vest in March 2019 at 70.5%. The vesting result is an accurate reflection of the sustained and strong underlying performance of the Company in challenging market conditions, but also reflects, through the relative TSR measure, the movement in the Group’s share price during the performance period. Consequently, the absolute value attached to the awards at the close of three year performance period is circa 50% lower than the value of the 2016 awards at grant.
Following determination of the formulaic outcome for both the 2018 STI and the 2016 LTIP performance conditions, the Remuneration Committee considered the vesting levels against the underlying performance of the Group, and whether the decrease in the Group’s share price performance should be reflected in the STI and LTIP outcomes for Directors. The Remuneration Committee considered that a further adjustment to the STI and LTIP outcomes was not appropriate, in recognition of:
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the strong underlying performance of the Group which should form a solid basis for future growth and share price performance; |
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the structure of the LTIP is already designed to ensure that the value delivered to Directors is affected by share price movements, through fixing the maximum number of shares at the time of grant; |
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share price movements are also reflected in three tranches of deferred bonus held by each of the Directors; and |
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the significant personal shareholdings of the Directors in the Group, which have experienced a material decline in value. |
The Remuneration Committee considered salary increases for Executive Directors in the context of the level of pay increases for UK employees. These ranged between 0% and 5% based on performance in the prior year and the position of an individual’s pay relative to the market, with an average increase of 2%.
With consideration of the changes in the composition of the Main Board, the Remuneration Committee decided that with effect from
1 April 2019 the Chief Executive’s salary will remain as per the terms of appointment at £1,175,000 and the Finance Director’s salary will remain unchanged at £924,000.
2019 LTIP awards
The Committee acknowledges the recent decline in the Group’s share price and the attendant concern as to new awards being out of proportion with previous awards made. Accordingly, the Committee has decided to apply a downward adjustment to the 2019 LTIP award. The 2019 award will be made on the basis of the Group’s closing share price on 25 February 2019, increased by 15%, with a resulting share price of £33.28. In the event that the Group’s share price increases beyond this level at the award date in March 2019, the higher share price shall be used as the basis of the award.
Executive Director changes
As discussed elsewhere in the Annual Report, Nicandro Durante will be stepping down as CEO with effect from 1 April 2019 and will be succeeded by Jack Bowles. Mr Durante’s leaving arrangements will be in line with our shareholder approved Remuneration Policy and as such will include no additional elements outside of our normal approach to executives who are departing by reason of retirement.
The Committee gave careful and detailed consideration to Mr Bowles’ remuneration package for 2019, taking into account all relevant factors. This included a thorough review of the external marketplace, consideration of Mr Bowles’ experience within the industry and his accumulated experience as part of the Management Board and most recently as COO together with due consideration to changes within the UK Corporate Governance environment and the views expressed by shareholders during previous engagements on policy.
| 74 | BAT Annual Report and Form 20-F 2018 | |
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Strategic Report
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Governance
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Financial Statements
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Other Information
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Introduction & Board |
Audit Committee
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Nominations Committee
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Remuneration Committee
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Responsibility of Directors
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Upon appointment Mr Bowles will receive an annual salary of £1,175,000 which will next be reviewed in April 2020. This compares to the current salary for the CEO of £1,310,000. In addition, the pension contribution rate for Mr Bowles will be revised downward to 15% of salary which will then be aligned with our wider UK population. When considering the changes in aggregate, the result is a 21% decrease in fixed pay for the CEO and a 15% decrease in total remuneration.
As set out elsewhere in this Annual Report, Ben Stevens will step down from his role as Finance Director and from the Main Board with effect from 5 August 2019. He will retire from the Group with effect from 30 September 2019. The terms and conditions of Mr Stevens’ retirement are in accordance with our current shareholder approved Remuneration Policy and as such will include no additional elements outside our normal approach to executives who are leaving by reason of retirement. As also set out in this Annual Report, Mr Stevens will be succeeded by Tadeu Marroco, currently Director, Group Transformation. The Remuneration Committee, at its February 2019 meeting, has discussed and approved the terms of appointment for Mr Marroco.
Pay and transparency
The Remuneration Committee is very aware of the continued debate on executive remuneration and corporate governance, the emphasis on long-term alignment with shareholder interests and the importance of considering executive compensation in the broader context of the Group’s employees. With the introduction of the UK Corporate Governance Code 2018 from 1 January 2019, we have ensured that, during the Remuneration Policy review process, we have applied where appropriate the principles of the new Code to the design and structure of our remuneration arrangements.
We have taken the opportunity to review our Remuneration Policy and have restructured and shortened it where possible to simplify and streamline content, which we hope readers will find helpful.
New UK reporting regulations have introduced the requirement to disclose our CEO to employee pay ratio for financial years from 1 January 2019. The Committee will be reviewing the relevant data during 2019 in readiness to report on the ratios, following calculation method A which we believe to be the most robust and comprehensive means of assessment, as part of the Directors’ Remuneration Report to be published in early 2020.
In March 2019 we will be publishing data relating to UK Gender Pay in line with statutory requirements. Upon reviewing the data prior to publication, the Committee noted that while men and women are rewarded equally for similar roles, the Group does have a ‘gender pay gap’ as defined by the UK legislation. While the Group continues to make excellent progress with senior female representation, including two recent female appointments to the Management Board, the pay gap is largely a reflection of having more men than women in senior roles and the Group has a comprehensive set of diversity initiatives in place to drive progress on this issue.
Our focus in 2019
On behalf of the Remuneration Committee, I acknowledge the scope of the tasks for the year ahead as we turn our attention to the implementation of our new policy and continue our work in relation to delivering on the pay and transparency agenda.
Dimitri Panayotopoulos
Chairman, Remuneration Committee
27 February 2019
| BAT Annual Report and Form 20-F 2018 | 75 | |
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Remuneration Report
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Annual Statement on Remuneration continued
Introduction
This policy section of the Remuneration Report (the Policy Report) sets out a proposed new Remuneration Policy for the Executive Directors and the Non-Executive Directors.
This new Remuneration Policy, which is intended to replace the current remuneration policy approved by shareholders at the 2016 AGM, is subject to a binding vote by shareholders at the AGM on 25 April 2019 and, if approved, will come into effect from 26 April 2019. The new Remuneration Policy is set out in full on the following pages with changes from the current remuneration policy identified for reference.
Principles of remuneration
The Committee’s remuneration principles are to:
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reward, as an overriding objective, the delivery of the Group’s long-term strategy in a manner which is simple, straightforward and understandable and which is aligned with shareholders’ interests; |
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structure a remuneration package that is appropriately positioned relative to the market and comprises core fixed elements and performance-based variable elements; |
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design the fixed elements of pay (comprising base salary, pension and other benefits) to recognise the skills and experience of our Executive Directors and to ensure current and future market competitiveness in attracting talent; |
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design the variable elements of pay (provided via two performance-based incentive schemes: a short-term incentive scheme delivered through a combination of a cash element and a deferral element, and a long-term incentive scheme), to be both transparent and stretching and to support, motivate and reward the successful delivery of the Group’s long-term strategy and growth for shareholders on a sustainable basis; |
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ensure that reputational, behavioural and other risks that can arise from target-based incentive plans are identified and mitigated; |
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maintain an appropriate balance between fixed pay and the opportunity to earn performance-related remuneration with immediate and deferred elements: the performance-based elements form, at maximum opportunity, between 80% and 90% of the Executive Directors’ total remuneration packages; |
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ensure, through its annual review, that the Remuneration Policy is both rigorously applied and remains aligned with the Company’s purpose, values and strategy and the need to promote the long-term success of the Company; and |
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ensure that remuneration arrangements are transparent and promote effective engagement with shareholders and the workforce. |
Summary of key changes
The background and explanation of the proposed key changes from the current remuneration policy are given in the Annual Statement from the Chairman of the Remuneration Committee starting on page 73 of this Remuneration Report. Those key changes have been further explained in relevant sections of the Policy Report as summarised below:
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Policy Element
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Change in Policy |
Page Number
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Pensions |
The rate of pension provision under the defined contribution arrangements has been reduced from 35% of base salary to 15% of base salary, to ensure alignment with the defined contribution arrangements in place for UK employees. |
78 | ||
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Short-Term Incentive Scheme (STI), annual bonus opportunity |
The previous individual performance multiplier, allowing a +20% adjustment to the outcome based on the corporate result, has been removed with effect from the 2019 performance year. |
79 | ||
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Short-Term Incentive Scheme (STI), good leaver provisions |
Post-cessation payments to ‘good leavers’ will no longer be paid pro rata and ‘on target’ at leave date and instead will operate on a ‘wait and see’ basis, being paid pro rata, by reference to full year results and paid at the normal time in March of the following year. |
86 | ||
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Long-Term Incentive Plan (LTIP), award quantum |
The limit on the levels of award to Executive Directors other than the Chief Executive, which has featured in previous remuneration policies, has been removed. It is not intended that this will lead to a change in the maximum opportunity for the current Finance Director, but is believed to be appropriate to give flexibility over the life of the Remuneration Policy, while maintaining an appropriate level of differentiation between the Chief Executive and other Executive Directors. |
81 | ||
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Long-Term Incentive Plan (LTIP), performance measures |
The TSR comparator group is expanded to include the Altria Group for awards made from 2019. |
80 | ||
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Dividend equivalent payments |
For awards made from 2019, dividend equivalent payments under the Deferred Share Bonus Scheme (DSBS) and the LTIP will be settled in shares, rather than cash. |
79, 80 | ||
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Shareholding requirements |
Post-employment shareholding requirements have been introduced for former Executive Directors to hold shares equivalent to 100% of current shareholding requirements for two full years following the date of their departure.
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81 |
| 76 | BAT Annual Report and Form 20-F 2018 | |
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Strategic Report
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Governance
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Financial Statements
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Introduction & Board |
Audit Committee
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Nominations Committee
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Remuneration Committee
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Responsibility of Directors
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Future Policy Table – Executive Directors
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Base salary
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| How the element supports the Company’s strategic objectives |
To attract and retain high calibre individuals to deliver the Group’s long-term strategy and to offer market-competitive levels of guaranteed cash to reflect an individual’s skills, experience and role within the Company.
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| Operation of the element 2019 Policy: no change in policy |
Base salary is normally paid in 12 equal monthly instalments during the year. Salaries are normally reviewed annually in February (with salary changes effective from April) or subject to an ad hoc review on a significant change of responsibilities.
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Salaries are reviewed taking into account factors including individual performance as well as appropriate market data including general UK pay trends and a company size and complexity model based on a Pay Comparator Group including UK companies, the constituents of which for 2019 are as follows:
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| Altria Group | Anheuser-Busch InBev | AstraZeneca | Bayer | |||||||||
| BP | Coca-Cola | Colgate-Palmolive | Danone | |||||||||
| Diageo | Estée Lauder | GlaxoSmithKline | Heineken | |||||||||
| Imperial Brands | Japan Tobacco | Johnson & Johnson | Kellogg | |||||||||
| Kraft Heinz | L’Oréal | LVMH | Mondelēz International | |||||||||
| Nestlé | PepsiCo | Pfizer | Philip Morris International | |||||||||
| Procter & Gamble | Reckitt Benckiser | Royal Dutch Shell | Unilever | |||||||||
| Vodafone | ||||||||||||
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The Committee will continue to exercise its judgement to vary the constituents of the Pay Comparator Group over the life of this Remuneration Policy. |
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Only base salary is pensionable.
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| Maximum potential value 2019 Policy: no change in policy |
Annual increases for Executive Directors’ base salaries in the normal course will generally be in the range of the increases in the base pay of other UK-based employees in the Group and will not exceed 10% per annum during the policy period.
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The salary of a recently appointed Executive Director as he or she progresses in a role may exceed the top of the range of the salary increases for UK-based employees where the Committee considers it appropriate to reflect the accrual of experience. A significant change in responsibilities or material change in role may be reflected in an above average increase (which may exceed 10%) in salary.
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Benefits
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| How the element supports the Company’s strategic objectives |
To provide market-competitive benefits consistent with the role which:
– attract and retain high calibre individuals to deliver the Group’s long-term strategy; and |
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– recognise that such talent is global in source and that the availability of certain benefits (e.g. relocation, repatriation, taxation compliance advice) will from time to time be necessary to avoid such factors being an inhibitor to accepting the role.
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| Operation of the element 2019 Policy: no change in policy |
The Company currently offers the following contractual benefits to Executive Directors: a car or car allowance ; the use of a car and driver for personal and business use ; employment tax advice (including in instances where multi-jurisdictional tax authorities are involved); tax equalisation payments (where appropriate); private medical insurance , including general practitioner ‘walk-in’ medical services ; personal life and accident insurance ; and housing and education allowances or similar arrangements as appropriate to family circumstances (anticipated to be provided for Executive Directors who relocate internationally).
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Other benefits may include the Executive Directors ‘and their partners’ attendance at hospitality or similar functions, and the provision of services and benefits which may be treated as benefits for tax purposes, such as the provision of home security and the reimbursement of expenses incurred in connection with their duties.
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Other benefits not identified above may be offered if, in the Committee’s view, these are necessary in order to remain aligned with market practice.
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With the exception of the car or car allowance, in line with the UK market and the practice followed for all the Group’s other UK employees, it is also practice to pay the tax that may be due on benefits.
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The Company provides Directors and Officers liability insurance (D&O) and an indemnity to Directors to cover costs and liabilities incurred in the execution of their duties.
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| BAT Annual Report and Form 20-F 2018 | 77 | |
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Remuneration Report
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Annual Statement on Remuneration continued
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Maximum potential value 2019 Policy: no change in policy |
The maximum potential values are based on market practice for individuals of this level of seniority, with any tax on benefits paid by the Company in addition. | |
| The maximum annual value (subject to periodic inflation-related increases where applicable) that can be offered for the following benefits is: | ||
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– car allowance: £20,000; |
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– use of a car and company driver for personal and business use: cost is dependent on the miles driven in any year; |
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– the cost of private medical insurance is dependent on an individual’s circumstances and is provided on a family basis; |
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– GP ‘walk-in’ medical services located close to the Group’s headquarters in London: £5,000; |
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– personal life and accident insurance designed to pay out at a multiple of four and five times base salary, respectively; |
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– employment tax advice as required, but not exceeding £30,000 and tax equalisation payments as agreed by the Committee from time to time; and |
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– housing and education allowances or other similar arrangements, as appropriate to the individual’s family circumstances. |
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Pensions
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How the element supports the Company’s strategic objectives |
To provide competitive post-retirement benefit arrangements which recognise both the individual’s length of tenure with the Group and the external environment in the context of attracting and retaining senior high calibre individuals to deliver the Group’s long-term strategy.
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Operation of the element 2019 Policy: The rate of pension provision under the defined contribution arrangements is to be reduced from 35% of base salary to 15% of base salary, to ensure alignment with the defined contribution arrangements in place for UK employees. This change will apply to the newly-appointed Chief Executive.
This Remuneration Policy continues to be subject to Executive Directors being permitted to participate in legacy defined benefit arrangements.
This change will apply from 1 May 2019, being the start of the first payroll month after this Remuneration Policy will come into effect.
Please refer to the Statement of the Chairman of the Remuneration Committee on page 73 for further detail. |
Defined contribution benefits
Subject to participation in legacy arrangements, and with effect from 1 May 2019, Executive Directors are eligible to receive a pension benefit equivalent to 15% of base salary, which the Committee may determine to provide as a contribution into the defined contribution section of the British American Tobacco UK Pension Fund (the Pension Fund) (or a similar defined contribution arrangement from time to time) or as a gross cash sum paid in lieu thereof.
The level of contribution in the defined contribution section of the Pension Fund is restricted to take into account the annual allowance, and the individual may elect to accumulate any balance in the unfunded unapproved retirement benefits scheme (UURBS) or receive the balance as a gross cash sum.
Legacy arrangements
Executive Directors may continue to participate in the defined benefit section of the Pension Fund where they were doing so before the section closed to new members. This is the case for the Finance Director and could also apply to future Executive Directors where they have legacy participation in the defined benefit section prior to appointment to the Board. In addition, the legacy pension provision of internal appointees may differ marginally from that outlined in this Remuneration Policy and such arrangements would ordinarily continue to apply.
Where an individual is entitled to benefits calculated on a base salary that exceeds a scheme-specific salary cap, these are accrued in the UURBS.
Operation
The pension arrangements operate in accordance with the rules of the applicable scheme, including in respect of the benefits payable in the event of death or on early retirement. Details of the Executive Directors’ accrued pension benefits are provided in the Annual Report on Remuneration on page 95. |
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Maximum potential value |
With effect from 1 May 2019 the maximum annual contribution in the defined contribution section of the Pension Fund is 15% of base salary. Excess benefits (whether accrued in the UURBS or paid as a cash sum) are subject to this same limit.
The pension accrual rate in respect of legacy participation in the defined benefit section of the Pension Fund will not exceed the maximum one-fortieth of salary per annum.
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| 78 | BAT Annual Report and Form 20-F 2018 | |
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Strategic Report
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Governance
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Financial Statements
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Other Information
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Introduction & Board |
Audit Committee
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Nominations Committee
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Remuneration Committee
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Responsibility of Directors
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| BAT Annual Report and Form 20-F 2018 | 79 | |
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Remuneration Report
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Annual Statement on Remuneration continued
| 80 | BAT Annual Report and Form 20-F 2018 | |
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Strategic Report
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Governance
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Financial Statements
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Other Information
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Introduction & Board |
Audit Committee
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Nominations Committee
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Remuneration Committee
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Responsibility of Directors
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Maximum potential value and payment at threshold |
The maximum annual award of shares permitted under the rules of the LTIP, as approved by shareholders, is 500% of salary for Executive Directors. If the threshold performance level is attained in respect of all five measures, 15% of the award will vest. | |
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2019 Policy: the limit on the levels of award to Executive Directors other than the Chief Executive, which was featured in previous remuneration policies, has been removed. It is not intended that this will lead to a change in the maximum opportunity for the current Finance Director, but is believed to be appropriate to give flexibility over the life of the Remuneration Policy, while maintaining an appropriate level of differentiation between the Chief Executive and other Executive Directors. |
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All-employee share schemes
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How the element supports the Company’s strategic objectives |
Executive Directors are eligible to participate in the Company’s all-employee share schemes which are designed to incentivise employees by giving them an opportunity to build shareholdings in the Company. | |
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Operation of the element 2019 Policy: no change in policy |
The Company currently operates two all-employee share schemes: the Sharesave Scheme , an HM Revenue & Customs (HMRC) tax-advantaged savings-related share option scheme, and the Share Incentive Plan (SIP) – an HMRC tax-advantaged plan operated by the Company to allow eligible employees to purchase shares in the Company (the Partnership Plan) and to make an annual award of free shares of a level based on performance in the previous financial year (the Share Reward Scheme). | |
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Maximum potential value 2019 Policy: no change in policy |
Executive Directors are subject to the same limits on participation as other employees, as defined by the applicable statutory provisions. Currently, these limits are monthly savings under the Sharesave Scheme of £500 per month, and annual share purchases under the Partnership Plan of £1,800 and annual share awards under the Share Reward Scheme of £3,600. | |
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Shareholding requirements
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How the element supports the Company’s strategic objectives |
To strengthen the alignment between the interests of the Executive Directors and those of the shareholders by requiring Executive Directors to build up a high level of personal shareholding in the Company.
To ensure long-term alignment between the interests of the Executive Directors and those of shareholders through the operation of post-employment shareholding requirements. |
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Operation of the element and performance metrics used 2019 Policy: post-employment shareholding requirements are to be introduced with effect from the approval of this Remuneration Policy, to achieve a longer-term alignment with the Group’s strategy and shareholders’ interests. |
Executive Directors are required to hold shares in the Company:
– during service as a Director, equal to the value of the same multiple of salary at which LTIP awards are made to that Director (and therefore of 500% for the CEO); and
– after ceasing service as a Director during the period until the second anniversary of cessation of employment with the Group, of a value equal to 100% of the shareholding requirement that applied whilst a Director. In order to monitor and enforce the above provisions, former Executive Directors are required to hold their shares in a nominee account in respect of which a sale restriction applies to shares held to comply with the requirements.
Those Executive Directors who do not, at any point, meet the shareholding requirements, may generally sell a maximum of up to 50% of any shares vesting (after tax) under the Company’s share plans until the threshold for the shareholding requirements has been met. The estimated notional net-of-tax number of shares held subject to unvested awards under the DSBS element, and LTIP Awards during the LTIP Extended Vesting Period, will count towards the respective shareholding requirements.
A waiver of compliance with the shareholding requirements is permitted at the discretion of the Committee in circumstances which the Committee considers to be exceptional.
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Additional notes to the Future Policy Table:
| 1. |
The Committee reserves the right to make any remuneration payments where the terms were agreed prior to an individual being appointed an Executive Director of the Company or prior to the approval and implementation of the Remuneration Policy (including, for the avoidance of doubt, pursuant to the current Remuneration Policy). This includes the achievement of the applicable performance conditions for Executive Directors who are eligible to receive payment from any award made prior to the approval and implementation of the Remuneration Policy. |
| 2. |
The Company recognises the opportunities and benefits that accrue to the Company and its Executive Directors who undertake non-executive roles. Consequently, an Executive Director may, with the permission of the Board, undertake a single external appointment and the Executive Director may retain the fees from such appointment. |
| 3. |
Malus and clawback: Bonus amounts paid under the IEIS are subject to clawback provisions, and awards made under the DSBS and the LTIP are subject to malus and clawback provisions. In summary, these provisions may be applied if, within specified periods of payment/grant; (1) there has been a material misrepresentation in relation to the performance of any Group company, relevant business unit and/or the participant; or (2) an erroneous calculation was made in assessing the extent to which an award vested or bonus was paid, which in either case resulted in the value of the award or payment being more than it should have been. These provisions may also be applied where a participant is found to have committed, at any time prior to payment of a bonus or the vesting of an award, an act or omission which justified dismissal for misconduct. Where the Committee determines that these provisions are to be applied, the participant may be required to repay up to the excess value which was paid or vested. This repayment may also be effected by the number of shares subject to the award being reduced and/or by a reduction in other cash or share-based awards held by the participant. |
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| Annual Statement on Remuneration continued | ||||||||||||||
Illustrations of the application of the Remuneration Policy
The levels of remuneration to be received by Jack Bowles and Ben Stevens as Executive Directors for the first complete year in which the Remuneration Policy will apply are shown as the hypothetical values of their remuneration packages under different performance scenarios in the charts below.
Remuneration outcomes for varying levels of performance
The following assumptions have been applied in the table above.
|
Maximum award opportunities (% of salary)
|
Chief Executive
|
Finance Director
|
||||
| STI (IEIS) | 250% | 190% | ||||
| LTI (LTIP) | 500% | 350% (current award level maintained for Ben Stevens) | ||||
| Minimum | Fixed salary, pension and benefits only: | No bonus payout; no vesting under LTIP | ||||
| Expectation | Fixed salary, pension and benefits, plus: | 50% of the maximum IEIS award; threshold vesting under the LTIP | ||||
| Maximum (1) | Fixed salary, pension and benefits, plus: | 100% payout of the IEIS; 100% vesting under the LTIP | ||||
| Maximum (2) | Fixed salary, pension and benefits, plus: | 100% payout of the IEIS; 100% vesting under the LTIP; 50% share price appreciation during the relevant performance period of LTIP | ||||
Notes:
| 1. |
Benefits value for 2019: (1) comprises an estimated value of the car allowance, medical insurance, life assurance, tax advice and home security benefits, and associated tax costs, based where applicable on the values of the corresponding benefits in 2018, and for the Chief Executive taking into account an estimate of home security costs and an assumed value of tax advice based for these purposes on the policy maximum; (2) excludes any expenses incurred in connection with individual and/or accompanied attendance at certain business functions and/or corporate events; (3) excludes the cost of the car and driver provision as the cost of this benefit fluctuates annually depending on business need; and (4) in respect of all employee share plan participation, includes an assumed value of participation in the Share Reward Scheme based for these purposes on the plan maximum and excludes the value of any participation in the Sharesave Scheme or the Partnership Share Scheme. |
| 2. |
Pension value for 2019: for the Chief Executive is based on the contribution rate of 15% of base salary that will apply under this Remuneration Policy with effect from 1 May 2019 and for the Finance Director represents an estimated value of his legacy arrangements based on the corresponding value in 2018. |
| 3. |
No illustration is provided for Nicandro Durante, as he will cease to be an Executive Director from 1 April 2019, which is prior to the date on which this Remuneration Policy will (if approved by shareholders) come into force. |
| 82 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
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Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
|
Other policy provisions in relation to Directors’ pay
|
||
|
Flexibility, judgement and discretion
|
||
| As the Remuneration Policy needs to be capable of operating over a three-year period, the Committee has built in a degree of flexibility to enable the practical implementation of the Remuneration Policy over that prospective lifetime, including as set out in the Future Policy Table above. The key discretions and areas of flexibility and judgement are summarised as follows: | ||
|
Salary |
To determine salary levels, including any annual salary increases. | |
| To review and change the pay comparator group to ensure that it remains appropriate. | ||
|
Benefits |
To determine benefit provision. | |
|
Pensions |
To determine the form and level of pension provision within the parameters set out in the policy. | |
|
STI (cash and deferred shares) and LTIP |
To annually determine the targets for each STI performance measure, and to annually amend the performance measures and/or vary their weighting. | |
| To annually determine the targets for each LTIP performance measure, including to review and change the LTIP TSR comparator group. | ||
| To amend the LTIP performance measures and/or vary their weighting, although the Committee will generally only seek to make amendments following consultation with shareholders. | ||
| In respect of STI and LTIP: | ||
|
– to adjust, whether positively or negatively, the level of payment/vesting in circumstances where the Committee considers it is appropriate to do so to reflect the overall performance of the Company. |
||
|
– to alter performance conditions if events happen which cause the Committee to determine that the performance condition is no longer a fair measure of the Company’s performance, provided that the revised target is, in the opinion of the Committee, not materially less challenging than was intended in setting the original condition. |
||
|
– to exercise the available discretions in connection with any termination of employment or a change of control or similar event. |
||
|
– to determine whether awards under the LTIP are delivered as options or under any other form permitted under the LTIP rules as approved by shareholders and, in respect of operational matters not otherwise covered by the Policy, to operate the IEIS, DSBS and LTIP in accordance with their terms. |
||
|
Other |
To determine (within the parameters set out in the Policy) appropriate contractual and remuneration arrangements in connection with the recruitment of a new Executive Director, and to determine, for an initial period only, to agree a contract of longer than a one-year rolling duration. | |
| Within the parameters set out in the Policy, to determine appropriate arrangements in connection with any termination of employment. | ||
| Within the parameters set out in the Policy, to agree a waiver of shareholding guidelines, whether during or after service. | ||
|
To operate malus and clawback provisions.
|
||
| BAT Annual Report and Form 20-F 2018 | 83 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
| Annual Statement on Remuneration continued | ||||||||||||||
| 84 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board |
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
Service contracts – Executive Directors
The following table describes the provisions of the service contract of Jack Bowles. It is currently anticipated that service contracts for newly-appointed Executive Directors will not contain terms differing materially from these provisions (provided that other arrangements may be entered into in connection with the recruitment of Executive Directors, as described in the ‘Approach to remuneration of Directors on recruitment’ section on page 84).
|
Notice period
Employed on a permanent contract, terminable by either party on one-year’s notice. |
– A period of notice to be given by either the Executive Director or the Company of 12 months. |
|||||
|
– The Company may require the Executive Director to be on garden leave during all or any part of the period of notice (whether given by the Executive Director or the Company). |
||||||
|
Contractual terms
The contract includes obligations which could give rise to, or impact upon, remuneration and/or payments for loss of office.
The provisions of the Company’s incentive arrangements applicable on a termination of employment are set out separately below. |
The primary obligations under the contract which may give rise to remuneration or payments for loss of office are as follows:
– to provide salary payment, contributions to applicable pension arrangements and benefits (whether in cash or in kind) as specified in the contract, and to reimburse reasonable expenses incurred by the Executive Director in performing his duties;
– to give the Executive Director eligibility to participate in annual and/or long-term incentive arrangements;
|
|||||
|
– to provide a company car and driver for personal and/or business use, and a car allowance; |
||||||
|
– to provide 25 working days’ (plus public holidays) paid holiday per annum. On termination of employment the Company may at its discretion require the Executive Director to take all accrued holiday during any period of notice or pay him a sum in lieu; |
||||||
|
– to provide sick pay at the Executive Director’s normal salary rate for up to 12 weeks during any rolling 12-month period, and thereafter at the Company’s discretion, subject to the Company’s Sick Pay Policy; |
||||||
|
– to give the Executive Director eligibility to participate in a private medical expenses scheme and a personal accident scheme, and to provide life assurance benefits, subject to the terms and conditions of such schemes from time to time in force; |
||||||
|
– to terminate the contract only on the expiry of 12 months’ written notice or to make a payment in lieu of notice in respect of all, or the unexpired part, of the 12 months’ notice calculated based on: (1) salary at then current base pay; and (2) the cost to the Company of providing private medical expenses insurance and personal accident insurance (or the Company may, at its option, continue those benefits for the unexpired period of the notice). In determining the value of a payment in lieu of notice the Company shall not be required to reward failure on the part of the Executive Director and shall have regard to corporate governance standards at the termination date. The Company may, at its reasonable discretion, make the payment in lieu of notice in phased monthly or quarterly instalments and may determine that it should be reduced in accordance with the duty on the part of the Executive Director to mitigate his loss; and |
||||||
|
– to continue to pay the Executive Director’s salary and contractual benefits during any garden leave period. |
||||||
| In addition to the contractual rights to a payment on loss of office, the Executive Director may have statutory and/or common law rights to certain additional payments depending on the circumstances of the termination. | ||||||
|
Legacy arrangements |
The contractual terms of the Finance Director, entered into prior to this Remuneration Policy coming into force, include the following provisions which are in addition to or differ from those described above: |
|||||
|
– the contractual entitlement to sick pay applies at the Executive Directors’ normal salary for a period of up to two months, and then half his normal salary for a period of up to one month, and thereafter at the Company’s discretion; |
||||||
|
– any payment in lieu of notice is calculated based on: (1) salary at then current base pay; (2) car allowance; and (3) the cost to the Company of providing private medical expenses insurance, life assurance and personal accident insurance (or the Company may, at its option, continue any of those benefits for the unexpired period of the notice). Any payment in lieu of notice is payable in full on termination of employment; and |
||||||
|
– for any time spent on garden leave, the assessment of the Executive Director’s performance under his relevant bonus scheme shall be at ‘target’ level.
|
||||||
|
Inspection of service contracts
Copies may be inspected at the Company’s registered office; these contracts are amended annually following the salary review.
|
The dates of the latest service contracts are shown below:
|
|||||
| Executive Director | Execution date of current service contract | |||||
| Jack Bowles | 11 December 2018 (appointment as an Executive Director commenced 1 January 2019) | |||||
| Ben Stevens |
26 March 2008 (as amended by side letter dated 23 July 2010)
|
|||||
| BAT Annual Report and Form 20-F 2018 | 85 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
| Annual Statement on Remuneration continued | ||||||||||||||
|
The Committee retains discretion in deciding ‘good leaver’ status other than in cases of automatic ‘good leavers’ as set out in the applicable provisions of the DSBS and LTIP rules. The discretionary powers are intended to provide flexibility as Executive Directors may leave employment for a broad variety of reasons which may not necessarily fall within the prescribed category of ‘good leaver’. The Committee exercises its discretion by reference to guidelines which set out its agreed relevant factors to assist in the determination of a leaver’s status. |
Guidelines |
|||||||
|
Factors which may indicate that discretion may be exercised to treat as a ‘good leaver’
Resignation intending to cease work altogether.
Resignation intending to take up a different occupation, such as a portfolio career. Delayed resignation from the Company to accommodate the Company’s plans or the demands of his or her current workload.
Departure at the request of and/or with the agreement of the Company. |
Factors which may indicate that discretion may not be exercised
Resignation from the Company to work for a competitor or to undertake a role otherwise acting in conflict with the interests of the Company.
Resignation from the Company notwithstanding the Company’s plans and role demands.
Termination or resignation in any circumstance involving factors such as misconduct or poor performance. |
|||||||
|
In exercising its discretion, the Committee will also take into account the individual’s overall performance as well as their contribution to the Company during their total period of employment.
|
||||||||
| 86 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board |
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
|
Other |
Payment of legal fees incurred by an individual in connection with reviewing a settlement agreement on termination of employment.
Reimbursement of reasonable relocation costs of up to £200,000 where an Executive Director (and, where relevant, his or her family) had originally relocated to take up the appointment; this may include the shipment of personal goods and winding-up his or her affairs in the UK and the incidental costs incurred in doing so.
In certain circumstances, the Committee may approve new contractual arrangements with departing Executive Directors, potentially including (but not limited to) settlement, confidentiality, restrictive covenants and/or consultancy arrangements. These arrangements would only be entered into where the Committee believes that it is in the best interests of the Company and its shareholders to do so.
|
| BAT Annual Report and Form 20-F 2018 | 87 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
| Annual Statement on Remuneration continued | ||||||||||||||
Statement of consideration of employment conditions elsewhere in the Company remuneration provisions applicable to the wider Group
Remuneration provisions applicable to the wider Group
The Group’s remuneration policies and practices are founded on a high degree of alignment and consistency across the organisation. Accordingly, remuneration for members of the Management Board and senior management is determined taking into account the remuneration principles that apply to the Executive Directors, and similar principles also form the basis of the remuneration arrangements for the wider workforce.
A globally consistent pay comparator group, derived from the peer group used by the Remuneration Committee for executive pay benchmarking, is utilised across all levels of the organisation for pay benchmarking purposes, with an appropriate level of flexibility provided to the other employing entities.
The approach to annual salary reviews is consistent across the Group, with consideration given to the scope of the role, level of individual experience, responsibility, individual performance and pay levels in the selected peer group.
All middle-to-senior managers are eligible to participate in a short-term incentive plan with the same metrics as Executive Directors. Other employees in corporate functions are eligible to participate in annual bonus plans, which mirror the Executive Directors’ performance objectives. Functional incentive schemes are offered to the Group’s employees in non-corporate positions such as sales force or manufacturing roles. Opportunities and metrics which apply to those schemes may vary by organisational level with functional performance indicators incorporated where appropriate.
Senior managers are eligible to participate in the long-term incentive programme (LTIP), with opportunities varying across levels with the most senior managers having a bigger portion of their pay delivered under the LTIP.
In the UK, all employees are encouraged to become shareholders by participating in all-employee share plans on the same terms as Executive Directors. Similar all-employee share schemes have been adopted for other jurisdictions with the goal of encouraging broader long-term employee ownership.
The key difference between Executive Directors’ remuneration and the wider employee population is the increased emphasis on long-term performance in respect of Executive Directors, with a greater percentage of their total remuneration being performance-related. This includes an additional two-year holding period on vested LTIPs, and post-employment shareholding requirements which do not apply to other employees. Under the LTIP, Executive Directors and Management Board members are subject to ’wait and see’ provisions requiring the full three-year performance measure to be assessed before vesting is determined.
Retirement benefits, typically in the form of a pension, are provided based on local market practice. Pension contribution rates for Executive Directors under the defined contribution scheme will be aligned with those available to the wider UK employee population. Other benefits provided to the wider employee population reflect local market practice and legislative requirements.
Process in setting Executive Directors’ remuneration
The Committee considers the budgeted salary increases for the UK-based employee population, the guidance given to managers on the range of salary increases and other remuneration arrangements and employment conditions for all UK-based employees when determining the remuneration for Executive Directors.
It is expected that future salary increases for Executive Directors will be in line with the range set out in the salary review guidelines for the general UK employee population, except in exceptional circumstances, such as where a recently-appointed Executive Director’s salary is increased to reflect his or her growth in the role over time or where significant additional responsibilities are added to the role.
As a key principle, management provides the Remuneration Committee with visibility of the potential impact of proposed changes to the Executive Directors’ Remuneration Policy on the wider employee population.
Workforce engagement
The Group has a range of well-established workforce engagement channels worldwide to ensure the Board, through updates provided by management, understands the views of the Group’s workforce across all jurisdictions in which the Group operates. Group engagement channels include works councils, meetings with the European Employee Council, town hall sessions, global, functional and regional webcasts, and CEO webcasts. Additionally, the Board undertakes a Group market or site visit on an annual basis, including meeting with local employees, and the Executive Directors regularly visit markets and local sites across the Group. A global employee opinion survey is conducted across the Group every two years. Questions on the Group’s pay arrangements are included in the survey and the outcomes are reviewed by the Remuneration Committee and the Board and then reported back across the Group. Regional and local Board Compensation Committees (covering our business units and global functions) are provided with the outcomes of remuneration policies and practices for the wider employee population and have visibility of key issues that may have an impact on competitiveness of remuneration elements.
From 1 January 2019, the Group has adopted an enhanced approach to workforce engagement worldwide, to ensure meaningful and regular dialogue is maintained between the Board and our workforce given its geographical spread, scale and diversity. In addition to the range of engagement channels above, which are implemented at market, business unit, functional and/or regional level as appropriate for the composition of the local workforce populations, the Group has implemented new reporting channels to enable regular reporting to the Board on workforce views on key topics at all levels across the Group, including pay and related policies. Board feedback and associated action planning, as appropriate, is cascaded back to the workforce and the Board is kept updated on progress against identified actions during the year.
The Remuneration Committee is regularly updated on the pay principles and practices in operation across the Group, in order to take these into account in setting the policy for Directors’ pay. Although employees are not specifically consulted on the policy for Directors’ pay as set out above, there continues to be an ongoing dialogue with employees, through a variety of channels, about the Company’s pay practices.
| 88 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
|
Chairman and Non-Executive Directors
|
||
|
Fees 2019 Policy: no change in policy |
The Chairman receives a single all-inclusive fee. Other Non-Executive Directors receive a base fee and may also receive additional fees in respect of committee membership and/or chairmanship.
|
|
|
The Committee considers annually the fee payable to the Chairman and to the other Non- Executive Directors. This process may take into account factors including the breadth and demands of the relevant role as well as comparison with fees paid by the same comparator group of companies used for setting the base salary of Executive Directors. The annual review does not necessarily result in a change to the fees.
|
||
|
It is anticipated that any future aggregate increase in fees for the Chairman and other Non- Executive Directors will generally be in the range of the increases in the base pay of UK-based employees in the Group and will not exceed 10% per annum during the policy period. 1
|
||
|
The Chairman and other Non-Executive Directors do not participate in any discussion on their own respective remuneration.
|
||
|
Benefits, travel and related expenses
2019 Policy: no change in policy |
Non-Executive Directors may be reimbursed for the cost of travel, accommodation and related expenses incurred in connection with their duties and are eligible to use general practitioner ‘walk-in’ services. The Non-Executive Directors and their partners may attend hospitality or similar functions.
|
|
|
Benefits for the Chairman may also include: the use of a Company driver; private medical insurance and personal accident insurance benefits; the provision of home and personal security; and assistance in relation to personal tax matters.
|
||
|
If necessary, the Company will pay for independent professional advice in connection with the performance of duties as Non-Executive Directors.
|
||
|
The Company provides D&O insurance and an indemnity to the Non-Executive Directors to cover costs and liabilities incurred in the execution of their duties.
|
||
|
In instances where any benefits, reimbursements or expenses are classified by HMRC as a benefit to the Non-Executive Directors, it is also the practice of the Company to pay any tax due on any such benefits.
|
||
|
Other
2019 Policy: no change in policy |
There are no formal requirements or guidelines to hold shares in the Company. No Non- Executive Director is eligible to participate in the British American Tobacco share schemes, bonus schemes or incentive plans and no Non-Executive Director may be a member of any Group pension plan.
|
|
Note:
| 1. |
Aggregate fees limit: the total annual fees of the Chairman and other Non-Executive Directors are limited to the overall aggregate annual limit authorised by shareholders with reference to the Company’s Articles of Association (currently £2,500,000). |
Terms of Appointment for the Chairman and other Non-Executive Directors
Non-Executive Directors, including the Chairman, are appointed as officeholders, not employees. In any given year, the period of appointment runs from the close of the Company’s last AGM to the close of the Company’s next AGM.
The Chairman may terminate his or her appointment on one month’s written notice, and the Company may give a compensation payment in lieu of all or part of such notice. The Chairman may be removed by the Company prior to the expiry of his or her term of appointment by three months’ written notice or a compensation payment in lieu of all or part of such notice.
A Non-Executive Director may terminate his or her appointment at any time in accordance with the Company’s Articles of Association. Alternatively, a Non-Executive Director’s appointment will terminate if: (1) the Board requests that he or she not offer himself or herself for re-election at the next AGM; (2) the Non-Executive Director is not re-elected at the next AGM; (3) the Non-Executive Director is required to vacate office for any reason pursuant to any of the provisions of the Company’s Articles of Association; or (4) the Non-Executive Director is removed as Director or otherwise required to vacate office under any applicable law.
| BAT Annual Report and Form 20-F 2018 | 89 | |
Table of Contents
|
Remuneration Report
|
1 Overview of what our Executive Directors earned in 2018 and why
What our Executive Directors earned in 2018
|
Single figure
for Executive |
Salary | Taxable benefits | Short-term incentives | Long-term incentives | Pension | Other emoluments | Total | |||||||||||||||||||||||||||||||||||||||||||||||||
| Directors | £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |||||||||||||||||||||||||||||||||||||||||||||||||
| 2018 | 2017 | 2018 | 2017 | 2018 | 2017 | 2018 | 2017 1 | 2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||||||||||||||||||||
|
Nicandro |
1,295 | 1,235 | 295 | 218 | 3,275 | 3,039 | 3,510 | 5,411 | 430 | 307 | 32 | 34 | 8,837 | 10,244 | ||||||||||||||||||||||||||||||||||||||||||
|
Durante |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
Ben Stevens |
916 | 887 | 132 | 167 | 1,756 | 1,650 | 1,790 | 2,957 | 491 | 305 | 18 | 16 | 5,103 | 5,982 | ||||||||||||||||||||||||||||||||||||||||||
|
Total |
2,211 | 2,122 | 427 | 385 | 5,031 | 4,689 | 5,300 | 8,368 | 921 | 612 | 50 | 50 | 13,940 | 16,226 | ||||||||||||||||||||||||||||||||||||||||||
Note:
| 1. |
Long-term incentives shown for 2017: in accordance with the UK Directors’ Remuneration Report Regulations, estimates for the values of the vesting 2015 LTIP awards were given in the Annual Report on Remuneration 2017; these amounts have been re-presented to show the actual market value on the date of vesting in 2018. |
Further information in respect of this remuneration can be found in Section 2 on page 91.
How this aligns to performance
Non-GAAP measures
Adjusted profit from operations (APFO), adjusted cash generated from operations (Adjusted CGFO), adjusted diluted EPS, adjusted revenue and operating cash flow conversion ratio are non-GAAP measures used by the Remuneration Committee to assess performance. Please refer to pages 258 to 266 for definitions of these measures and a reconciliation of these measures to the most directly comparable IFRS measure where applicable.
For the purposes of the Remuneration Report in relation to STI and LTIP performance measures, APFO, Adjusted CGFO, Adjusted revenue and Adjusted operating cash flow conversion ratio for 2018 are measured on a representative basis to include the impact of acquisitions in 2017 as though they were acquired for the whole of that period.
| 90 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
2 Executive Directors’ remuneration for the year ended 31 December 2018
Total remuneration for the year ended 31 December 2018
|
Nicandro Durante |
Ben Stevens |
For further
information |
||||||||||||||||||||
| 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||
| £’000 | £’000 | £’000 | £’000 | |||||||||||||||||||
|
Salary |
1,295 | 1,235 | 916 | 887 | ||||||||||||||||||
|
Taxable benefits 1 |
||||||||||||||||||||||
|
– car allowance |
16 | 16 | 14 | 14 | ||||||||||||||||||
|
– health insurance |
7 | 6 | 10 | 9 | ||||||||||||||||||
|
– tax advice |
62 | 6 | – | – | ||||||||||||||||||
|
– use of Company driver |
83 | 64 | 100 | 80 | ||||||||||||||||||
|
– home and personal security |
121 | 115 | 6 | 44 | ||||||||||||||||||
|
– other expenses related to individual and/or accompanied attendance at Company functions/events |
6 | 11 | 2 | 20 | ||||||||||||||||||
|
Total taxable benefits |
295 | 218 | 132 | 167 | ||||||||||||||||||
|
Short-term incentives |
||||||||||||||||||||||
|
STI vesting percentage (% of maximum) |
100% | 97.2% | 100% | 97.2% | ||||||||||||||||||
|
STI: cash – Group performance element |
1,637.5 | 1,266 | 877.8 | 687.5 | ||||||||||||||||||
|
STI: cash – Individual performance adjustment factor |
– | 507 | – | 275 | ||||||||||||||||||
|
STI: DSBS – Group performance deferred element |
1,637.5 | 1,266 | 877.8 | 687.5 | ||||||||||||||||||
|
Total short-term incentives |
3,275 | 3,039 | 1,756 | 1,650 | Page 92 | |||||||||||||||||
|
Long-term incentives |
||||||||||||||||||||||
|
LTIP vesting percentage (% of maximum) |
70.5% | 96.1% | 70.5% | 96.1% | ||||||||||||||||||
|
LTIP value to vest |
3,001 | 2 | 4,833 | 3 | 1,531 | 2 | 2,641 | 3 | ||||||||||||||
|
Dividend equivalent |
509 | 578 | 4 | 259 | 316 | 4 | ||||||||||||||||
|
Total long-term incentives |
3,510 | 5,411 | 1,790 | 2,957 | Page 94 | |||||||||||||||||
|
Total pension-related benefits |
430 | 307 | 491 | 305 | Page 95 | |||||||||||||||||
|
Other emoluments |
||||||||||||||||||||||
|
Life insurance |
29 | 26 | 15 | 12 | ||||||||||||||||||
|
Share Reward Scheme (value of ordinary shares awarded) |
3 | 4 | 3 | 4 | ||||||||||||||||||
|
Sharesave Scheme (face value of discount on options granted) |
– | 4 | 5 | – | – | |||||||||||||||||
|
Total other emoluments |
32 | 34 | 18 | 16 | ||||||||||||||||||
|
Total remuneration |
8,837 | 10,244 | 5,103 | 5,982 | ||||||||||||||||||
Notes:
| 1. |
Taxable benefits: the figures shown are gross amounts as in line with the UK market; it is the normal practice of the Company to pay the tax which may be due on any benefits, with the exception of the car or car allowance. Ben Stevens’ home and personal security benefit in 2017 included costs associated with installation of a new home security system. Nicandro Durante’s tax advice cost in 2018 is net £28,371; the number presented above is inclusive of applicable VAT and income tax. |
| 2. |
LTIP award shown for 2018: the 2016 LTIP award is due to vest on 12 May 2021 based on performance to 31 December 2018. The value shown is based on the average share price for the three-month period ended 31 December 2018 of 3,029.52p. |
| 3. |
LTIP award shown for 2017: the values disclosed in the Annual Report on Remuneration for the year ended 31 December 2017 were estimated values as the award had not vested by the date of that report; these amounts have been re-presented based on the actual market value on the date of vesting of 27 March 2018 of 3,946p. |
| 4. |
LTIP dividend equivalent payments: the dividend equivalent payment that will attach to the LTIP award that is included in the Single Figure Table is reported. The values for the year ended 31 December 2017 have been restated on this basis. |
| 5. |
Sharesave Scheme: the value disclosed for the year ended 31 December 2017 represents the difference between the closing share price on the working day prior to the start of the invitation period (24 February 2017) of 5,070p and the option price of 4,056p. |
| BAT Annual Report and Form 20-F 2018 | 91 | |
Table of Contents
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Remuneration Report
|
||||||||||||||
| Annual Report on Remuneration continued | ||||||||||||||
Short-term incentives for the year ended 31 December 2018
Timing of disclosures
In previous years, publication of the STI targets has been deferred for one year on the basis of the commercially sensitive nature of those targets. Notwithstanding that the Remuneration Committee continues to consider that STI targets remain commercially sensitive, the Remuneration Committee has, on balance, decided that publication of STI targets will in future be published in the remuneration report following the end of the relevant performance year. Consequently, this year’s remuneration report sets out the targets relating to both the 2017 and 2018 performance years.
Disclosure of the specific targets for the STI in the year ended 31 December 2017, and the outcomes against those targets, are included on page 104.
| 92 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
Consideration of individual performance adjustment factor
In addition to the Company-based STI corporate performance measures, the Remuneration Committee has also reviewed each Executive Director’s personal performance against a weighted set of operational and strategic measures. These were agreed as their specific individual objectives at the beginning of the year and depend on the priorities for each Director’s area of responsibility in the context of the delivery of Group strategy. Personal performance rated as ‘Outstanding’ can result in an adjustment factor of up to 20% to the corporate STI result but is subject to the applicable maximum award limit. Personal performance rated as ‘Requires Improvement’ results in any corporate STI result being reduced by 50%. No individual performance adjustment factor is applicable for the 2018 STI results.
STI outcome for year ended 31 December 2018
|
Available STI award as
% of base salary |
Group % result |
Individual
performance adjustment factor % |
STI award achieved
% of base salary |
STI award achieved
£’000 (Value shown in Single Figure Table) |
||||||||||||||||
|
Nicandro Durante |
250% | 100% | n/a% | 250% | 3,275 | |||||||||||||||
|
Ben Stevens |
190% | 100% | n/a% | 190% | 1,756 | |||||||||||||||
50% of the award in respect of the Group result will be paid in cash and 50% as an award under the DSBS.
Note:
| 1. |
DSBS: awards made under the DSBS are in the form of free ordinary shares in the Company that normally vest after three years and no further performance conditions apply in that period. In certain circumstances, such as resigning before the end of the three-year period, participants may forfeit all of the shares. Malus-only provisions apply for DSBS awards made from 2014 and clawback provisions operate from 2016 STI cash awards. |
| BAT Annual Report and Form 20-F 2018 | 93 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
|
Annual Report on Remuneration
continued
|
||||||||||||||
Long-term incentives (LTIP) for the year ended 31 December 2018
LTIP performance measures, weightings and results for the year ended 31 December 2018
|
LTIP: performance measure
|
Description of measure and target for
2016 LTIP
|
Result achieved
|
Vesting percentage
|
|||||
|
Relative TSR 1 Relative to a peer group of |
2016–2018 LTIP target |
Ranked 19 out of 23 |
0% (out of maximum of 20%) |
|||||
|
|
||||||||
| international FMCG companies | Threshold | At median, 3% vests | ||||||
|
|
||||||||
| Weighting: 20% | Maximum | At upper quartile, 20% vests | ||||||
| EPS growth at current exchange rates | 12.5% CAGR |
20% (out of maximum of 20%) |
||||||
|
Compound annual growth in adjusted diluted EPS measured at current rates of exchange |
2016–2018 LTIP target | |||||||
|
|
||||||||
| Threshold | At CAGR of 5%, 3% vests | |||||||
|
|
||||||||
| Maximum | At CAGR of 10%, 20% vests | |||||||
| Weighting: 20% | ||||||||
| EPS growth at constant exchange rates | 10.7% CAGR |
20% (out of maximum of 20%) |
||||||
|
Compound annual growth in adjusted diluted EPS measured at constant rates of exchange |
2016–2018 LTIP target | |||||||
|
|
||||||||
| Threshold | At CAGR of 5%, 3% vests | |||||||
|
|
||||||||
| Maximum | At CAGR of 10%, 20% vests | |||||||
| Weighting: 20% | ||||||||
| Adjusted revenue growth 2 | 3.9% CAGR |
10.5% (out of maximum of 20%) |
||||||
| Compound annual growth measured at constant rates of exchange | 2016–2018 LTIP target | |||||||
|
|
||||||||
| Threshold | At CAGR of 3%, 3% vests | |||||||
|
|
||||||||
| Maximum | At CAGR of 5%, 20% vests | |||||||
| Weighting: 20% | ||||||||
| Adjusted Operating cash flow conversion ratio | 100.8% ratio |
20% (out of maximum of 20%) |
||||||
| Ratio over the performance period at current exchange rates | 2016–2018 LTIP target | |||||||
|
|
||||||||
| Threshold | Ratio of 85%, 3% vests | |||||||
|
|
||||||||
| Maximum | Ratio of 95%, 20% vests | |||||||
| Weighting: 20% | ||||||||
| Total vesting level | 70.5% vesting | |||||||
Note:
| 1. |
Relative TSR: the constituents of the FMCG peer group are listed on page 80. |
| 2. |
The underpin for adjusted revenue growth measure: the adjusted revenue growth measure can only vest provided the corresponding three-year CAGR of APFO exceeds the CAGR of the threshold performance level for APFO as approved annually in the STI and approved by the Board. The underpin was exceeded with reference to the APFO STI outcomes for 2016, 2017 and 2018. |
Impact of the RAI acquisition on 2016 LTIP awards
Following the acquisition of the remaining shares of RAI which the Group did not already own on 25 July 2017, the Committee has taken time to consider how the impact of this major acquisition should be treated for the purposes of the 2017 performance year within the 2016 LTIP award. As a result of this review, the following treatments have been applied in respect of the RAI acquisition:
| – |
relative TSR and EPS growth – no further adjustments were needed as the incremental costs and benefits associated with the acquisition are already factored into performance; and |
| – |
adjusted revenue growth and underpin – the 2017 performance year was measured based on organic BAT performance (excluding the impact of RAI and other 2017 acquisitions) to allow for a like-for-like comparison. The 2018 performance year was measured on a representative basis; please refer to page 259 for further details. |
The Remuneration Committee believe this is the correct, fair and appropriate way to treat the acquisition of RAI.
LTIP outcome for year ended 31 December 2018
|
Number of ordinary shares
award |
Vesting % achieved
(based on 2016–2018 performance period) |
Number of ordinary
to vest |
Value of ordinary
shares to vest 1 £’000 |
Dividend equivalent
£’000 |
Total value to vest
£’000
|
|||||||||||||||||
|
Nicandro Durante |
140,529 | 70.5% | 99,072 | 3,001 | 509 | 3,510 | ||||||||||||||||
|
Ben Stevens |
71,669 | 70.5% | 50,526 | 1,531 | 259 | 1,790 | ||||||||||||||||
These LTIP awards are due to vest on 12 May 2021, and will become exercisable on that same date.
Notes:
| 1. |
The value of ordinary shares to vest shown above is based on the average share price for the three-month period ended 31 December 2018 of 3,029.52p. |
| 2. |
The dividend equivalent amount shown above that will become payable on vesting is the value of the dividend equivalents accrued on the proportion of the award that is due to vest. |
| 94 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
Executive Directors’ pension entitlements and accruals for the year ended 31 December 2018
Nicandro Durante
| Pension values |
Accrued pension
at year-end 31 Dec 2018 £’000 |
Additional value
of pension on early retirement |
||||||
|
UURBS (UK) |
168 | – | ||||||
|
Total |
168 | – | ||||||
Nicandro Durante’s UURBS pension entitlements are derived as follows:
| – |
effective from 1 March 2006 (being the date of his appointment as a member of the Management Board), an accrual of 0.65% for each year of service on a basic £ sterling salary comparable to that of a General Manager of Souza Cruz S.A. At retirement the pension will be based on a 12 month average and will be provided through the UURBS; and |
| – |
with effect from 1 January 2011 (being the date of his appointment as Chief Executive Designate), Nicandro Durante commenced an accrual of 2.5% for each year of service on a basic salary in excess of that stated above. At retirement the pension is based on a 12 month average and will be provided through the UURBS. |
Total accrued pension is the amount of pension that would be paid annually on retirement based on service to the end of the year.
The pension-related benefits disclosed in the single figures for Executive Directors’ remuneration represent Nicandro Durante’s net accrual for the period, being the differential between his total pension entitlements as at 31 December 2017 (adjusted for inflation) and as at 31 December 2018, multiplied by 20 in accordance with the UK Directors’ Remuneration Report Regulations.
Nicandro Durante receives a pension in payment from the Fundação Albino Souza Cruz (FASC) from Souza Cruz S.A., a Brazilian registered wholly-owned subsidiary of the Group. This pension benefit has been in payment since April 2012 and currently amounts to approximately £445,905 per annum (after adjusting for currency exchange) S.A. reflecting his 31 years’ service at Souza Cruz.
Ben Stevens
| Pension values |
Accrued pension
£’000 |
Additional value
of pension on early retirement |
||||||
|
British American Tobacco UK Pension Fund |
101 | – | ||||||
|
UURBS (UK) |
345 | – | ||||||
|
Total |
446 | – | ||||||
Ben Stevens joined the UK Pension Fund after 1989, before the closure of its non-contributory defined benefit section to new members in April 2005. As a result, prior to 6 April 2006, he was subject to the HMRC cap on pensionable earnings (notionally £160,800 for the tax year 2018/19). In addition, he has an unfunded pension promise from the Company in respect of earnings above the cap on an equivalent basis to the benefits provided by the UK Pension Fund. This is provided through the UURBS. Further to the changes to the applicable tax regulations, Ben Stevens has reached his lifetime allowance of £1.8 million and therefore has ceased accrual in the Pension Fund with all future benefits being provided through membership of the UURBS. During the year, there has been no change to the overall pension entitlement of Ben Stevens.
Total accrued pension is the amount of pension that would be paid annually on retirement based on service to the end of the year.
The pension-related benefits disclosed in the single figures for Executive Directors’ remuneration represent Ben Stevens’ net accrual for the period, being the differential between his total pension entitlements as at 31 December 2017 (adjusted for inflation) and as at 31 December 2018, multiplied by 20 in accordance with the UK Directors’ Remuneration Report Regulations.
These commitments are included in note 12 in the Notes on the Accounts. UK Pension Fund members are entitled to receive increases in their pensions once in payment, in line with price inflation (as measured by the Retail Prices Index) and up to 6% per annum.
Notes:
| 1. |
UK Pension Fund: this is non-contributory. Voluntary contributions paid by an Executive Director and resulting benefits are not shown. No excess retirement benefits have been paid to or are receivable by an Executive Director or past Executive Director. |
| 2. |
Revised pension arrangements apply from 2019 for new Executive Directors as detailed further in the revised remuneration policy at page 78. |
| BAT Annual Report and Form 20-F 2018 | 95 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
| Annual Report on Remuneration continued | ||||||||||||||
Other information relating to Chief Executives’ remuneration for the year ended 31 December 2018
Chief Executives’ pay – comparative figures 2009 to 2018
| Year | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | ||||||||||||||||||||||||||||||
| Chief Executives’ ‘single figure’ of total remuneration (£’000) | ||||||||||||||||||||||||||||||||||||||||
|
Paul Adams 1 (to 28 February 2011) |
7,713 | 8,858 | 5,961 | n/a | n/a | n/a | n/a | n/a | n/a | n/a | ||||||||||||||||||||||||||||||
|
Nicandro Durante 2 (from 1 March 2011) |
n/a | n/a | 5,589 | 6,340 | 6,674 | 3,617 | 4,543 | 8,313 | 10,244 | 3 | 8,837 | |||||||||||||||||||||||||||||
| Annual bonus (STI) paid against maximum opportunity (%) | ||||||||||||||||||||||||||||||||||||||||
|
Paul Adams 1 (to 28 February 2011) |
67.7 | 87.0 | 100 | n/a | n/a | n/a | n/a | n/a | n/a | n/a | ||||||||||||||||||||||||||||||
|
Nicandro Durante 2 (from 1 March 2011) |
n/a | n/a | 100 | 85.0 | 81.3 | 73.2 | 100 | 100 | 97.2 | 100 | ||||||||||||||||||||||||||||||
| Long-term incentive (LTIP) paid against maximum opportunity (%) | ||||||||||||||||||||||||||||||||||||||||
|
Paul Adams 1 (to 28 February 2011) |
100 | 100 | 100 | n/a | n/a | n/a | n/a | n/a | n/a | n/a | ||||||||||||||||||||||||||||||
|
Nicandro Durante 2 (from 1 March 2011) |
n/a | n/a | 100 | 87.1 | 49.2 | 0.0 | 8.7 | 46.0 | 96.1 | 70.5 | ||||||||||||||||||||||||||||||
Notes:
| 1. |
Paul Adams: (a) historic data is taken from the Remuneration Reports for the relevant years and is recast (as appropriate) on the basis of the ‘single figure’ calculation as prescribed in the UK Directors’ Remuneration Report Regulations; and (b) he retired as Chief Executive on 28 February 2011 which affected his STI and LTIP as follows in accordance with the rules of those schemes: (i) his STI for the year ended 31 December 2010 was paid as a 100% cash bonus instead of 50% in cash and 50% in deferred ordinary shares; (ii) the outstanding LTIP awards of ordinary shares vested immediately on his retirement either in full (2008 award) or on a time-apportioned basis (2009 award and 2010 award); and (iii) the LTIP dividend equivalent payments for the LTIP awards which vested at his retirement were also paid in full and/or on a pro-rated time and performance basis. |
| 2. |
Nicandro Durante: (a) historic data is taken from the Remuneration Reports for the relevant years and is recast (as appropriate) on the basis of the ‘single figure’ calculation as prescribed in the UK Directors’ Remuneration Report Regulations; and (b) he became Chief Executive on 1 March 2011 and his ‘single figure’ remuneration for the year ended 31 December 2011 has accordingly been time-apportioned. |
| 3. |
Long-term incentives 2017: in accordance with the UK Directors’ Remuneration Report Regulations, estimates for the values of the vesting 2015 LTIP awards were given in the Annual Report on Remuneration 2017. These amounts have been re-presented to show the actual market value on the date of vesting in 2018. |
Total shareholder return (TSR) performance: 1 1 January 2009 to 31 December 2018
Note:
| 1. |
Performance and pay chart: this shows the performance of a hypothetical investment of £100 in ordinary shares (as measured by the TSR for the Company) against a broad equity market index (the FTSE 100 Index) over a period of ten financial years starting from 1 January 2009 through to 31 December 2018 based on 30-trading-day average values. A local currency basis is used for the purposes of the TSR calculation making it consistent with the approach to TSR measurement for the LTIP. |
| 96 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
Percentage change in the Chief Executive’s remuneration
The following table shows the percentage change in the Chief Executive’s remuneration measured against a comparator group comprising the UK employee population on UK employment contracts (2018: 2,097 individuals; 2017: 2,202 individuals). 1 This comparator group is considered to be the most appropriate group as Executive Directors are employed on UK contracts. Using a more widely-drawn group encompassing the worldwide nature of the Group’s business would also present practical difficulties in collation and a less relevant comparator, given the significant variations in employee pay across the Group, the differing economic conditions and wide variations in gross domestic product per capita.
| Base salary | Taxable benefits | Short-term incentives | ||||||||||||||||||||||||||||||||||||||||||
| Percentage | Percentage | Percentage | ||||||||||||||||||||||||||||||||||||||||||
| 2018 | 2017 | change | 2018 | 2017 | change | 2018 | 2017 | change | ||||||||||||||||||||||||||||||||||||
| £’000 | £’000 | % | £’000 | £’000 | % | £’000 | £’000 | % | ||||||||||||||||||||||||||||||||||||
|
Nicandro Durante |
1,295 | 1,235 | 4.9 | 295 | 218 | 35.3 | 3,275 | 3,039 | 7.8 | |||||||||||||||||||||||||||||||||||
|
(Chief Executive) |
||||||||||||||||||||||||||||||||||||||||||||
|
UK-based employees |
75 | 70 | 5.9 | 4 | 4 | 3.7 | 25 | 23 | 7.5 | |||||||||||||||||||||||||||||||||||
Notes: UK-based employees:
| 1. |
The 5.9% increase to average base salary and the increase in short-term incentive awards for UK-based employees is due to an increase in the proportion of more senior staff within the population. UK-based employees were awarded performance-based pay increases in 2018 in the range 0% to 8% with an average of around 3%. |
| 2. |
The data for the UK-based employees comparator group is made up as follows as at 31 December 2018: (1) the weighted average base salaries; (2) the average taxable benefits per grade; and (3) an estimated weighted average target bonus based on that population as at that date. |
3 Executive Directors’ remuneration for the upcoming year
Base salary for 2019
The Remuneration Committee has determined the following salaries for the Executive Directors.
| Base salary | Base salary | |||||||||||
| from | Percentage | from | ||||||||||
| 1 Apr 2019 | change | 1 Apr 2018 | ||||||||||
| Executive Directors – salaries | £ | % | £ | |||||||||
|
Nicandro Durante |
n/a | n/a | 1,310,000 | |||||||||
|
Ben Stevens 1 |
924,000 | n/a | 924,000 | |||||||||
|
Jack Bowles 2 |
1,175,000 | n/a | n/a | |||||||||
The Remuneration Committee considered salary increases for Executive Directors in the context of the level of pay increases for UK employees. These ranged between 0% and 5% based on performance in the prior year, with an average increase of 2%.
Notes:
| 1. |
The Remuneration Committee determined that Ben Stevens’ salary will remain unchanged at £924,000. |
| 2. |
Jack Bowles’ salary will next be reviewed in April 2020. |
Benefits and pension
No changes have been made to the provision of benefits for 2019. Should the Policy be approved, Jack Bowles and other newly-appointed Executive Directors will participate in the Group’s Defined Contribution Pension Plan, equivalent to 15% of base salary.
| BAT Annual Report and Form 20-F 2018 | 97 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
| Annual Report on Remuneration continued | ||||||||||||||
Short-term incentives for 2019 onwards
STI metrics and weightings will remain unchanged from 2018.
| 2019 STI metrics & weightings | ||||
|
Group share of key markets |
10 | % | ||
|
Adjusted revenue growth from the Strategic Portfolio 1 |
30 | % | ||
|
APFO |
30 | % | ||
|
Adjusted CGFO |
30 | % | ||
| Total | 100 | % | ||
Note:
| 1. |
The Strategic Portfolio is comprised of the following core strategic categories – both cigarette brands and PRRP brands – in our portfolio, please refer to page 260 for further details: |
|
Strategic Portfolio Definition for STI from 2018 Cigarette brands: |
PRRP brands: |
|
| 1. GDBs: Dunhill, Kent, Lucky Strike, Pall Mall, Rothmans | 1. Vapour Brands | |
| 2. RAI Companies Strategic Brands: Camel, Natural American Spirit, Newport | 2. THP Brands | |
| 3. Traditional Oral Brands | ||
|
4. Modern Oral Brands
|
||
Further detail is included in the description of the STI measures for the year ended 31 December 2018 on page 92.
| 98 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
Long-term incentives for 2019 onwards
The TSR comparator group has been expanded to include the Altria Group from the 2019 awards onwards. The performance measures and weightings for the LTIP award to be granted in 2019 will remain unchanged from those for 2018 awards. The measures and targets for 2019 LTIP awards are set out below.
|
LTIP measures and performance ranges
|
% of award
|
% of award
|
||||||||||||||
|
Relative TSR |
20 | 3 | ||||||||||||||
|
Median performance vs. FMCG peer group to upper quartile. |
||||||||||||||||
|
The current constituents of the FMCG peer group as at the date of this report are: |
||||||||||||||||
|
Altria Group |
Colgate-Palmolive | Japan Tobacco |
Mondelēz
International |
Procter & Gamble | ||||||||||||
|
Anheuser-Busch InBev |
Danone | Johnson & Johnson | Nestlé | Reckitt Benckiser | ||||||||||||
|
Campbell Soup |
Diageo | Kellogg | PepsiCo | Unilever | ||||||||||||
|
Carlsberg |
Heineken | Kimberly-Clark | Pernod Ricard | |||||||||||||
|
Coca-Cola |
Imperial Brands | LVMH |
Philip Morris
International |
|||||||||||||
| EPS growth at current exchange rates | 20 | 3 | ||||||||||||||
|
5%–10% compound annual growth in adjusted diluted EPS over the performance period |
||||||||||||||||
| EPS growth at constant exchange rates | 20 | 3 | ||||||||||||||
|
5%–10% compound annual growth in adjusted diluted EPS over the performance period |
||||||||||||||||
| Adjusted revenue growth | 20 | 3 | ||||||||||||||
|
3%–5% compound annual growth over the performance period |
||||||||||||||||
| Adjusted Operating cash flow conversion ratio | 20 | 3 | ||||||||||||||
|
Ratio of 85%–95% over the performance period at current exchange rates |
||||||||||||||||
| Total | 100 | 15 | ||||||||||||||
As explained in the Annual Statement from the Chairman of the Remuneration Committee on page 74, the Committee has decided to apply a downward adjustment to the 2019 LTIP award. The 2019 award will be made on the basis of the Group’s closing share price on 25 February 2019, increased by 15%, with a resulting share price of £33.28. In the event that the Group’s share price increases beyond this level at the award date in March 2019, the higher share price shall be used as the basis of the award.
| BAT Annual Report and Form 20-F 2018 | 99 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
| Annual Report on Remuneration continued | ||||||||||||||
4 Chairman and Non-Executive Directors’ remuneration for the year ended 31 December 2018
The following table shows a single figure of remuneration for the Chairman and Non-Executive Directors in respect of qualifying services for the year ended 31 December 2018 together with comparative figures for 2017.
| Chair/Committee | ||||||||||||||||||||||||||||||||||||||
| Base fee 5 | membership fees 5 | Taxable benefits 1 | Total remuneration | |||||||||||||||||||||||||||||||||||
|
£’000
|
£’000
|
£’000
|
£’000
|
|||||||||||||||||||||||||||||||||||
|
2018
|
2017
|
2018
|
2017
|
2018
|
2017
|
2018
|
2017
|
|||||||||||||||||||||||||||||||
|
Chairman |
||||||||||||||||||||||||||||||||||||||
|
Richard Burrows |
680 | 660 | – | – | 116 | 129 | 796 | 789 | ||||||||||||||||||||||||||||||
|
Non-Executive Directors |
||||||||||||||||||||||||||||||||||||||
| Sue Farr | 93 | 93 | 24 | 19 | 2 | 1 | 119 | 113 | ||||||||||||||||||||||||||||||
| Dr Marion Helmes | 93 | 93 | 24 | 19 | 12 | 12 | 129 | 124 | ||||||||||||||||||||||||||||||
| Luc Jobin 2 (from 25 July 2017) | 93 | 40 | 24 | 6 | 41 | 18 | 158 | 64 | ||||||||||||||||||||||||||||||
| Holly Keller Koeppel 3 (from 25 July 2017) | 93 | 40 | 24 | 6 | 94 | 20 | 211 | 66 | ||||||||||||||||||||||||||||||
| Savio Kwan | 93 | 93 | 24 | 19 | 42 | 51 | 159 | 163 | ||||||||||||||||||||||||||||||
| Dimitri Panayotopoulos | 93 | 93 | 50 | 44 | 17 | 24 | 160 | 161 | ||||||||||||||||||||||||||||||
| Kieran Poynter | 93 | 93 | 86 | 79 | – | 14 | 179 | 186 | ||||||||||||||||||||||||||||||
|
Retired Non-Executive Directors |
||||||||||||||||||||||||||||||||||||||
| Ann Godbehere (to 25 April 2018) | 30 | 93 | 7 | 19 | 1 | 1 | 38 | 113 | ||||||||||||||||||||||||||||||
| Dr Pedro Malan (to 25 April 2018) | 30 | 93 | 7 | 19 | 15 | 49 | 52 | 161 | ||||||||||||||||||||||||||||||
| Gerry Murphy (to 26 April 2017) | – | 31 | – | 4 | – | – | – | 35 | ||||||||||||||||||||||||||||||
| Lionel Nowell, III 3 (from 25 July 2017 to 12 December 2018) | 88 | 40 | 23 | 6 | 79 | 5 | 190 | 51 | ||||||||||||||||||||||||||||||
| Total | 1,479 | 1,462 | 293 | 240 | 419 | 324 | 2,191 | 2,026 | ||||||||||||||||||||||||||||||
Notes:
| 1. |
Benefits: the Chairman’s benefits in 2018 comprised: health insurance and ‘walk-in’ medical services £15,000 (2017: £17,000); the use of a Company driver £81,000 (2017: £63,000); home and personal security in the UK and Ireland £4,000 (2017: £13,000); hotel accommodation and related expenses incurred in connection with individual and/or accompanied attendance at certain business functions and/or corporate events £3,000 (2017: £29,000); and commuting flights to London £13,000 (2017: £7,000). The benefits for the other Non-Executive Directors principally comprised travel-related expenses incurred in connection with individual and/or accompanied attendance at certain business functions and/or events and ‘walk-in’ medical services. The figures shown are grossed-up amounts (as appropriate) as, in line with the UK market, it is the normal practice of the Company to pay the tax that may be due on any benefits. |
| 2. |
Pension: Luc Jobin receives a pension in respect of prior service to Imasco Limited (acquired in 2000 by the Group) and Imperial Tobacco Canada Limited, a subsidiary of BAT. In 2018 this amount was CAD$150,228.96 (£86,849.10) (2017: CAD$150,228.96 (£89,849.86) for the full year, however Luc Jobin was a Director from 25 July 2017). |
| 3. |
Deferred Compensation Plan for Directors of RAI (DCP): as former outside directors of RAI, Holly Keller Koeppel and Lionel Nowell, III each participated in the DCP under which they could elect to defer payment of a portion of their RAI retainers and meeting attendance fees to an RAI stock account, a cash account, or a combination of both. Following the acquisition of RAI by BAT, amounts deferred to a stock account (Deferred Stock Units or DSUs) mirror the performance of, and receive dividend equivalents based on, BAT American Depository Shares (ADSs). Amounts deferred to a cash account earn quarterly interest at the prime rate as set by JPMorgan Chase Bank. The respective DSUs of Holly Keller Koeppel and Lionel Nowell, III are disclosed as a note to ‘Summary of Directors’ share interests’ below. The deferred cash account for Lionel Nowell, III showed a balance of US$125,879.62 at 12 December 2018 (31 December 2017: US$119,824). DSUs and cash deferred under the DCP will be paid in accordance with the terms of the DCP, section 409A of the US Internal Revenue Code of 1986, as amended, and the Director’s existing deferral elections. |
| 4. |
Committee memberships: are shown, together with changes during the year, in the reports of the respective committees in the Governance sections of the Directors’ Report. |
| 5. |
Non-Executive Directors’ fees structure 2018: is set out in the table below. |
|
Fees from
|
Fees
to
|
|||||||
|
Base fee |
92,700 | 92,700 | ||||||
|
Senior Independent Director – supplement |
37,100 | 36,000 | ||||||
|
Audit Committee: Chairman |
39,200 | 36,000 | ||||||
|
Audit Committee: Member |
13,500 | 11,000 | ||||||
|
Nominations Committee: Chairman |
– | – | ||||||
|
Nominations Committee: Member |
12,000 | 11,000 | ||||||
|
Remuneration Committee: Chairman |
39,200 | 36,000 | ||||||
|
Remuneration Committee: Member |
13,500 | 11,000 | ||||||
Chairman and Non-Executive Directors’ fees and remuneration for the upcoming year
As described in the Annual Report on Remuneration for the year ended 31 December 2017, the Chairman’s fee was increased from £665,000 to £685,000 from 1 April 2018. In keeping with the level of pay awards granted to UK employees based on a 2% increase in budget, the Remuneration Committee determined the Chairman’s fee will be £698,000 with effect from 1 April 2019 (+1.9%).
The fees for Non-Executive Directors are scheduled to be reviewed in April 2019 with any changes being effective from 1 May 2019.
| 100 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
Summary of Directors’ share interests
|
Outstanding scheme interests 31 Dec 2018
|
||||||||||||||||||||||||
|
Ordinary shares
held at 31 Dec 2018 |
Unvested awards subject to
performance measures and continued employment (LTIP) |
Unvested awards
subject to continued employment only (DSBS) |
Unvested
interests (Sharesave) |
Total ordinary
shares subject to outstanding scheme interests |
Total of all
interests in ordinary shares at 31 Dec 2018 |
|||||||||||||||||||
| Executive Directors | ||||||||||||||||||||||||
| Nicandro Durante 1,3 | 345,201 | 415,213 | 90,752 | 912 | 506,877 | 852,078 | ||||||||||||||||||
| Ben Stevens 2,3 | 126,032 | 210,165 | 52,928 | 1,038 | 264,131 | 390,163 | ||||||||||||||||||
| Chairman | ||||||||||||||||||||||||
| Richard Burrows | 19,000 | 19,000 | ||||||||||||||||||||||
| Non-Executive Directors | ||||||||||||||||||||||||
| Sue Farr | – | – | ||||||||||||||||||||||
| Dr Marion Helmes | 4,500 | 4,500 | ||||||||||||||||||||||
| Luc Jobin 4 | 45,236 | 45,236 | ||||||||||||||||||||||
| Holly Keller Koeppel 4,5 | 8,416 | 8,416 | ||||||||||||||||||||||
| Savio Kwan 3 | 6,616 | 6,616 | ||||||||||||||||||||||
| Dimitri Panayotopoulos | 3,300 | 3,300 | ||||||||||||||||||||||
| Kieran Poynter | 5,000 | 5,000 | ||||||||||||||||||||||
Notes:
| 1. |
Nicandro Durante: ordinary shares held include 2,316 held by the trustees of the BAT Share Incentive Plan (SIP). |
| 2. |
Ben Stevens: ordinary shares held include 669 held by the trustees of the SIP. |
| 3. |
Changes from 31 December 2018: (a) Nicandro Durante: purchases of six ordinary shares on 2 January 2019 and six ordinary shares on 6 February 2019 under the SIP; acquisition of 41 ordinary shares on 7 February 2019 as a result of reinvestment of dividend income under the SIP; acquisition of 3,250 ordinary shares on 12 February 2019 as a result of reinvestment of dividend income; and acquisition of 2,741 ordinary shares on 12 February 2019 as a result of reinvestment of dividend income by Mrs Durante. (b) Ben Stevens: purchases of six ordinary shares on 2 January 2019 and six ordinary shares on 6 February 2019 under the SIP; and acquisition of 12 ordinary shares on 7 February 2019 as a result of reinvestment of dividend income under the SIP. (c) Savio Kwan: purchase of 115 ordinary shares as a result of the reinvestment of dividend income on 14 February 2019. There were no changes in the interests of the Chairman and the other Non-Executive Directors. |
| 4. |
American Depositary Shares (ADSs): each of the interests in ordinary shares held by Luc Jobin and Holly Keller Koeppel consist of an equivalent number of BAT ADSs each of which represents one ordinary share in the Company. |
| 5. |
Deferred Stock Units (DSUs): at the date of this report Holly Keller Koeppel, being a former director of RAI and a participant in the Deferred Compensation Plan for Directors of RAI (DCP), holds DSUs which were granted prior to becoming a Director of BAT – 21,842.98 DSUs (31 December 2018: 21,456.34 DSUs). Each DSU entitles the holder to receive a cash payment upon ceasing to be a Director equal to the value of one BAT ADS. The number of DSUs will increase on each dividend date by reference to the value of dividends declared on the ADSs underlying the DSUs. Lionel Nowell, III held 38,941.32 DSUs as at 12 December 2018. |
| 6. |
Director changes during 2018: Ann Godbehere and Dr Pedro Malan retired on 25 April 2018; Lionel Nowell, III retired on 12 December 2018. Shares held at the date of retirement: (a) Ann Godbehere held 3,100 ADSs, each of which represented one ordinary share in the Company; (b) Dr Pedro Malan did not hold any shares in the Company; and (c) Lionel Nowell, III held 17,436 ADSs, each of which represented one ordinary share in the Company. |
Executive Directors’ shareholding guidelines
Executive Directors are encouraged to build up a high level of personal shareholding to ensure a continuing alignment of interests with shareholders. The shareholding guidelines require Executive Directors to hold ordinary shares equal to the value of a percentage of salary as set out in the table below.
|
Shareholding
requirements (% of base salary 31 Dec 2018) |
No. of eligible
ordinary shares held at 31 Dec 2018 |
Value of eligible
ordinary shares held at 31 Dec 2018 1 £m |
Actual
percentage (%) of base salary at 31 Dec 2018 |
|||||||||||||
|
Nicandro Durante |
500 | 433,637 | 10.8 | 827.6 | ||||||||||||
|
Ben Stevens |
350 | 178,291 | 4.5 | 482.4 | ||||||||||||
Eligibility of shares: (a) unvested ordinary shares under the DSBS, which represent deferral of earned bonus, are eligible and count towards the requirement; (b) unvested ordinary shares under the LTIP are not eligible and do not count towards the requirement during the performance period, but the estimated notional net number of ordinary shares held during the LTIP Extended Vesting Period are eligible and will count towards the requirement; and (c) ordinary shares held in trust under the all-employee share ownership plan (SIP) are not eligible and do not count towards the shareholding requirement.
Notes:
| 1. |
Value of ordinary shares shown above: this is based on the closing mid-market share price on 31 December 2018 of 2,500p. |
| 2. |
Meeting the guidelines: if an Executive Director does not, at any time, meet the requirements of the shareholding guidelines, the individual may, generally, only sell a maximum of up to 50% of any ordinary shares vesting (after tax) under the Company share plans until the threshold required under the shareholding guidelines has been met. |
| 3. |
Waiver of compliance with guidelines: this is permitted with the approval of the Remuneration Committee in circumstances where a restriction on a requested share sale could cause undue hardship. No such applications were received from the Executive Directors during 2018. |
Non-Executive Directors are not subject to any formal shareholding requirements although they are encouraged to build a small interest in ordinary shares during the term of their appointment.
| BAT Annual Report and Form 20-F 2018 | 101 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
| Annual Report on Remuneration continued | ||||||||||||||
Executive Directors’ outstanding scheme interests
|
Plan
|
At 1 Jan 2018
|
Awarded in
|
Lapsed in
|
Exercised/
|
At 31 Dec
|
Exercise price
|
End of
|
Date from which
|
||||||||||||||||||||||||||||
| Nicandro Durante | LTIP | 1 | 127,448 | 4,971 | 122,477 | – | 31 Dec 17 | 27 Mar 18 | ||||||||||||||||||||||||||||
| LTIP | 2 | 140,529 | 140,529 | 31 Dec 18 | 12 May 21 | |||||||||||||||||||||||||||||||
| LTIP | 3 | 114,181 | 114,181 | 31 Dec 19 | 27 Mar 22 | |||||||||||||||||||||||||||||||
| LTIP | 3 | 160,503 | 160,503 | 31 Dec 20 | 26 Mar 23 | |||||||||||||||||||||||||||||||
| DSBS | 19,419 | 19,419 | – | 27 Mar 18 | ||||||||||||||||||||||||||||||||
| DSBS | 29,690 | 29,690 | 29 Mar 19 | |||||||||||||||||||||||||||||||||
| DSBS | 28,545 | 28,545 | 27 Mar 20 | |||||||||||||||||||||||||||||||||
| DSBS | 32,517 | 32,517 | 26 Mar 21 | |||||||||||||||||||||||||||||||||
| Sharesave | 543 | 543 | 2,787 | 1 Oct 19 | ||||||||||||||||||||||||||||||||
| Sharesave | 369 | 369 | 4,056 | 1 May 22 | ||||||||||||||||||||||||||||||||
| Ben Stevens | LTIP | 1 | 69,641 | 2,716 | 66,925 | – | 31 Dec 17 | 27 Mar 18 | ||||||||||||||||||||||||||||
| LTIP | 2 | 71,669 | 71,669 | 31 Dec 18 | 12 May 21 | |||||||||||||||||||||||||||||||
| LTIP | 3 | 58,232 | 58,232 | 31 Dec 19 | 27 Mar 22 | |||||||||||||||||||||||||||||||
| LTIP | 3 | 80,264 | 80,264 | 31 Dec 20 | 26 Mar 23 | |||||||||||||||||||||||||||||||
| DSBS | 12,732 | 12,732 | – | 27 Mar 18 | ||||||||||||||||||||||||||||||||
| DSBS | 19,468 | 19,468 | 29 Mar 19 | |||||||||||||||||||||||||||||||||
| DSBS | 15,805 | 15,805 | 27 Mar 20 | |||||||||||||||||||||||||||||||||
| DSBS | 17,655 | 17,655 | 26 Mar 21 | |||||||||||||||||||||||||||||||||
| Sharesave | 543 | 543 | 2,787 | 1 Oct 19 | ||||||||||||||||||||||||||||||||
|
|
Sharesave
|
|
|
495
|
|
|
495
|
|
|
3,026
|
|
|
1 May 20
|
|
||||||||||||||||||||||
Notes:
| 1. |
Details of the performance condition for the LTIP awards granted in 2015 (which vested during 2018), and of achievement against that condition in the period to 31 December 2017, was set out in the Annual Report on Remuneration for the year ended 31 December 2017. |
| 2. |
Details of the performance condition attached to 2016 LTIP awards, and of achievement against that condition in the period to 31 December 2018, are set out on page 94. |
| 3. |
Details of the performance condition attached to 2017 and 2018 LTIP awards are set out on page 103. |
Further details in relation to scheme interests granted during the year ended 31 December 2018
| Plan |
Ordinary shares
awarded |
Price per
ordinary share at award 1 |
Face value of
£’000 |
Exercise price |
Proportion of
performance (%) |
Performance period |
Date from which
exercisable or shares released |
|||||||||||||||||||||||||
| Nicandro Durante | LTIP | 2 | 160,503 | 3,894p | 6,250 | n/a | 15 | 2018–2020 | 26 Mar 23 | |||||||||||||||||||||||
| DSBS | 3 | 32,517 | n/a | n/a | n/a | 26 Mar 21 | ||||||||||||||||||||||||||
| Ben Stevens | LTIP | 2 | 80,264 | 3,894p | 3,125 | n/a | 15 | 2018–2020 | 26 Mar 23 | |||||||||||||||||||||||
| DSBS | 3 | 17,655 | n/a | n/a | n/a | 26 Mar 21 | ||||||||||||||||||||||||||
Notes:
| 1. |
The price per ordinary share is the price used to determine the number of ordinary shares subject to the awards, which is calculated as the average of the closing mid-market price of an ordinary share over the three dealing days preceding the date of grant. |
| 2. |
Details of the performance condition attached to these LTIP awards are set out on page 103. |
| 3. |
These DSBS awards were granted to deliver 50% of the annual bonus earned for the year ended 31 December 2017, details of which are set out on page 104. |
| 102 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
Further details in relation to performance conditions attaching to outstanding scheme interests
|
LTIP awards granted in 2017 |
LTIP awards granted in 2018 |
|||||||||||||||||||||||||
|
1 January 2017–31 December 2019 |
1 January 2018–31 December 2020 |
|||||||||||||||||||||||||
| Weighting | Threshold | Maximum | Weighting | Threshold | Maximum | |||||||||||||||||||||
|
Relative TSR Ranking against a peer group of international FMCG companies |
20% |
|
At median,
3% of award vests |
|
|
At upper
quartile, 20% of award vests |
|
20% |
|
At median,
3% of award vests |
|
|
At upper
quartile, 20%
|
|
||||||||||||
|
EPS growth at current exchange rates Compound annual growth in adjusted diluted EPS measured at current rates of exchange |
20% |
|
At 5% CAGR,
3% of award vests |
|
|
At 10% CAGR,
20% of award vests |
|
20% |
|
At 5% CAGR,
3% of award vests |
|
|
At 10%
CAGR, 20% of award vests |
|
||||||||||||
|
EPS growth at constant exchange rates Compound annual growth in adjusted diluted EPS measured at constant rates of exchange |
20% |
|
At 5% CAGR,
3% of award vests |
|
|
At 10% CAGR,
20% of award vests |
|
20% |
|
At 5% CAGR,
3% of award vests |
|
|
At 10%
CAGR, 20% of award vests |
|
||||||||||||
|
Adjusted revenue growth Compound annual growth measured at constant rates of exchange |
20% |
|
At 3% CAGR,
3% of award vests |
|
|
At 5% CAGR,
20% of award vests |
|
20% |
|
At 3% CAGR,
3% of award vests |
|
|
At 5% CAGR,
20% of award vests |
|
||||||||||||
|
Adjusted operating cash flow conversion ratio Measured at current rates of exchange, as a percentage of APFO |
20% |
|
At 85%, 3%
of award vests |
|
|
At 95%, 20%
of award vests |
|
20% |
|
At 85%, 3%
of award vests |
|
|
At 95%, 20%
of award vests |
|
||||||||||||
For LTIP awards granted from 2016 onwards, an additional vesting period of two years applies from the third anniversary of the date of grant.
Impact of the RAI acquisition on 2017 and 2018 LTIP awards
The Committee has taken time to consider how the impact of the RAI acquisition should be treated for the purposes of the 2017 and 2018 performance years. As a result of this review, the following treatments will apply:
| – |
relative TSR and EPS growth – no further adjustments are needed as the incremental costs and benefits associated with the acquisition are already factored into performance; |
| – |
adjusted revenue growth – the 2017 performance year has been measured based on organic BAT performance versus the 2016 base year to allow for a like-for-like comparison. The contribution of RAI (and other 2017 acquisitions) has been included from 2018 onwards, with the growth against 2017 being on a representative basis; and |
| – |
operating cash flow conversion ratio – the 2017 performance year has been measured based on organic BAT performance, excluding RAI profit and cash, and any additional costs related to the acquisition. The contribution of RAI (and other 2017 acquisitions) has been included on a representative basis for the 2018 performance year. |
The Committee believes this is the correct, fair and appropriate way to treat the acquisition of RAI.
| BAT Annual Report and Form 20-F 2018 | 103 | |
Table of Contents
|
Remuneration Report
|
Annual Report on Remuneration continued
STI targets and outcome for the year ended 31 December 2017
As explained on page 92, in previous years, publication of the STI targets has been deferred for one year on the basis of the commercially sensitive nature of those targets. Notwithstanding that the Remuneration Committee continues to consider that STI targets remain commercially sensitive, the Remuneration Committee has, on balance, decided that publication of STI targets will in future be published in the remuneration report following the end of the relevant performance year. Consequently, this year’s remuneration report sets out the targets relating to both the 2017 and 2018 performance years.
|
STI: performance measure
|
Description of measure and target 2017
|
Result achieved
|
Vesting percentage
|
|||||
|
Adjusted profit from operations (APFO) (growth over prior year)
Weighting: 40%
|
APFO is the adjusted profit from operations at constant rates of exchange for the year ended 31 December 2017 and is assessed on an organic basis. | Growth over 2016 of 4% on an organic basis |
21% (out of maximum of 40%) |
|||||
| STI target 2017 | ||||||||
| Threshold | 2% growth over 2016 | |||||||
| Maximum | 5% growth over 2016 | |||||||
|
Group’s share of Key Markets (growth over prior year)
Weighting: 20% |
The Group’s retail market share in its Key Markets accounts for around 80% of the volumes of the Group’s subsidiaries. The Group’s share is calculated from data supplied by retail audit service providers and is rebased as and when the Group’s Key Markets change. When rebasing does occur, the Company will also restate history and provide fresh comparative data on the markets. | Global market share in key markets grew over 2016 by 40 bps. |
20% (out of maximum of 20%) |
|||||
| STI target 2017 | ||||||||
| Threshold | 5 bps growth over 2016 | |||||||
| Maximum | 15 bps growth over 2016 | |||||||
|
Global Drive Brands (GDB) and Key Strategic Brands (KSB) volumes (growth over prior year)
Weighting: 20% |
GDB volumes comprise the cigarette volumes of Dunhill, Kent, Lucky Strike, Pall Mall and Rothmans, and include volumes of the Fine Cut variants of those brands sold in Western Europe.
KSB volumes comprise the cigarette volumes of State Express 555 and Shuang Xi associated with the joint venture with China National Tobacco Corporation in China.
GDB and KSB volumes are assessed on an organic basis. |
GDB and KSB volumes grew over 2016 by 7.5% on an organic basis. |
20% (out of maximum of 20%) |
|||||
| STI target 2017 | ||||||||
| Threshold | 1% growth over 2016 | |||||||
| Maximum | 3% growth over 2016 | |||||||
|
Adjusted cash generated from operations (Adjusted CGFO) (as against adjusted budget)
|
Adjusted CGFO is defined as net cash generated from operating activities, before the impact of adjusting items, dividends paid to non-controlling interests and received from associates, net interest paid and net capital expenditure. Adjusted CGFO is measured at constant rates of exchange. | Adjusted CGFO exceeded 2017 budget by 11% (equivalent to 94% operating cash flow conversion 1 ) |
20% (out of maximum of 20%) |
|||||
| STI target 2017 | ||||||||
| Weighting: 20% | Threshold | Equivalent to 85% operating cash flow conversation | ||||||
| Maximum | Equivalent to 95% operating cash flow conversation | |||||||
|
Available STI award
as % of base salary |
Corporate result % |
Individual
% |
STI award achieved
% of base salary |
STI award achieved £’000
(Value shown in
|
||||||||||
|
Nicandro Durante |
250 | 81% | 20% | 243.1% | 3,039 | |||||||||
|
Ben Stevens |
190 | 81% | 20% | 184.8% | 1,650 | |||||||||
The STI awards shown above were paid as 50% in cash and 50% as an award under the DSBS granted in March 2018, the details of which are set out on page 102 above.
Note:
| 1. |
In 2017 the operating cash flow conversion ratio is affected by the exclusion of results from RAI, post acquisition. The conversion ratio is also impacted by the application of IFRS 15 as detailed on page 264 which reduces the ratio from 96% (as reported in 2017) to 94%. |
Payments to former Directors and payments for loss of office: the Company did not make: (1) any payments of money or other assets to former Directors; or (2) any payments to Directors for loss of office during the year ended 31 December 2018.
External directorships: Nicandro Durante is a non-executive director of Reckitt Benckiser Group and he retains the fees for this appointment; 2018: £122,000 (2017: £120,000). Ben Stevens is a non-executive director of ISS A/S and he retains the fees for this appointment; 2018: DKK896,250 (£106,373) (2017: DKK892,500 (£105,080)).
| 104 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee |
Responsibility of Directors
|
Relative importance of spend on pay
To illustrate the relative importance of the remuneration of the Directors in the context of the Group’s finances overall, the Remuneration Committee makes the following disclosure:
|
Item
|
2018
|
2017
|
% change
|
|||||||||
|
Remuneration of Group employees 1 |
3,005 | 2,679 | 12.2 | |||||||||
|
Remuneration of Executive Directors |
14 | 16 | -14.1 | |||||||||
|
Remuneration of Chairman and Non-Executive Directors |
2 | 2 | 8.1 | |||||||||
|
Total dividends 2 |
4,463 | 4,465 | – | |||||||||
Notes:
| 1. |
Total remuneration of Group employees: this represents the total employee benefit costs for the Group, set out on page 138 within note 3a in the Notes on the Accounts. |
| 2. |
Total dividends: this represents the total dividend declared in 2018, set out on page 247 within the Statement of Changes in Equity. |
Shareholder dilution – options and awards outstanding
|
Satisfaction of Company share plan awards in accordance with the
|
New ordinary shares issued by the Company during the year ended
31 December 2018 |
|
|
– by the issue of new ordinary shares;
– ordinary shares issued from treasury only up to a maximum of 10% of the Company’s issued share capital in a rolling 10-year period;
– within this 10% limit, the Company can only issue (as newly issued ordinary shares or from treasury) 5% of its issued share capital to satisfy awards under discretionary or executive plans; and
– the rules of the Company’s Deferred Share Bonus Scheme (DSBS) do not allow for the satisfaction of awards by the issue of new ordinary shares. |
– 137,470 ordinary shares issued by the Company in relation to the Sharesave Scheme;
– a total of 765,277 Sharesave Scheme options over ordinary shares in the Company were outstanding at 31 December 2018, representing 0.03% of the Company’s issued share capital (excluding shares held in treasury); and
– options outstanding under the Sharesave Scheme are exercisable until the end of October 2023 at option prices ranging from 2,600p to 4,056p. |
| BAT Annual Report and Form 20-F 2018 | 105 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
| Annual Report on Remuneration continued | ||||||||||||||
7 The Remuneration Committee and shareholder engagement
|
Remuneration Committee current members
|
|
Dimitri Panayotopoulos (Chairman) |
|
Sue Farr |
|
Dr Marion Helmes (from 14 January 2019) |
|
Savio Kwan |
Role
The Remuneration Committee is responsible for:
| – |
determining and proposing the Directors’ Remuneration Policy (covering salary, benefits, performance-based variable rewards and pensions) for shareholder approval; |
| – |
determining, within the terms of the approved Directors’ Remuneration Policy, the specific remuneration packages for the Chairman and the Executive Directors, on appointment, on review and, if appropriate, any compensation payment due on termination of appointment; |
| – |
the setting of targets applicable for the Company’s performance-based variable reward scheme and determining achievement against those targets, exercising discretion where appropriate and as provided by the applicable scheme rules and the Directors’ Remuneration Policy; |
| – |
setting remuneration for members of the Management Board and the Company Secretary; and |
| – |
monitoring and advising the Board on any major changes to the policy on employee benefit structures for the Group. |
Remuneration Committee terms of reference
Revised Remuneration Committee terms of reference have been adopted by the Board to reflect revisions to internal governance processes to align with the requirements of the UK Corporate Governance Code 2018. The revised Remuneration Committee terms of reference incorporate:
| – |
a requirement for any appointee as Committee Chairman to have served on a remuneration committee for at least 12 months prior to appointment; |
| – |
the Committee’s responsibility for reviewing workforce remuneration and related policies, and the alignment of incentives and rewards with culture, and to take these into account when setting the policy for Executive Director remuneration; |
| – |
the requirement for the Committee to maintain a formal policy for post-employment shareholding requirements for Executive Directors, encompassing both unvested and vested shares; and |
| – |
responsibility for the Committee to determine the remuneration package for the Company Secretary (in addition to Management Board members) on appointment, review and termination. |
Attendance at meetings in 2018
|
Name
|
Member
|
Attendance/
|
Attendance/
|
|||||||||
|
Dimitri Panayotopoulos |
2015 | 4/4 | 3/3 | |||||||||
|
Sue Farr 1(b) |
2016 | 4/4 | 1/3 | |||||||||
|
Ann Godbehere 2(b) |
2011–2018 | 1/1 | 0/0 | |||||||||
|
Luc Jobin 1(c), 2(c) |
2017–2019 | 4/4 | 2/3 | |||||||||
|
Savio Kwan |
2016 | 4/4 | 3/3 | |||||||||
Notes:
| 1. |
Number of meetings in 2018: (a) the Committee held seven meetings in 2018, three of which were ad hoc and convened at short notice; (b) Sue Farr did not attend the ad hoc meetings in October and November due to prior commitments; and (c) Luc Jobin did not attend the ad hoc meeting in November due to prior commitments. |
| 2. |
Membership: (a) all members of the Committee are independent Non-Executive Directors in accordance with the UK Corporate Governance Code 2016 Provision D.2.1. and applicable NYSE listing standards; (b) Ann Godbehere ceased to be a member of the Committee upon her retirement as a Non-Executive Director on 25 April 2018; and (c) Luc Jobin ceased to be a member of the Committee with effect from 14 January 2019. |
| 3. |
Other attendees: the Chairman, the Chief Executive, the Chief Executive Designate, the Group Human Resources Director, the Talent and Culture Director Designate, the Group Head of Reward and other senior management, including the Company Secretary, may be consulted and provide advice, guidance and assistance to the Remuneration Committee. They may also attend Committee meetings (or parts thereof) by invitation. Neither the Chairman nor any Executive Director plays any part in determining their own respective remuneration. |
| 4. |
Deloitte LLP: as the Remuneration Committee’s remuneration consultants, they may attend meetings of the Remuneration Committee. As a member of the Remuneration Consultants Group (RCG), Deloitte agrees to the RCG Code of Conduct which seeks to clarify the scope and conduct of the role of executive remuneration consultants when advising UK-listed companies. |
|
|
For the Remuneration Committee’s terms of reference see: www.bat.com/governance |
| 106 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
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Financial Statements
|
Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
Remuneration Committee advisers during 2018
|
Independent
|
Services provided to the Remuneration Committee
|
Fees
|
Other services
provided
|
|||
| Deloitte LLP |
General advice on remuneration matters including: market trends and comparator group analysis; policy review and shareholder engagement perspectives; and independent measurement of the relative TSR performance conditions.
|
2018: £136,700 2017: £86,000 |
Tax, corporate finance and consulting services to Group companies worldwide. | |||
| Herbert Smith Freehills LLP | Advice in respect of share plan regulations is provided to the Company and is available to the Remuneration Committee. | Fees relate to advice given to the Company |
General corporate legal and tax advice principally in the UK.
|
|||
| Ernst & Young LLP | Provision of personal tax advice regarding Executive Directors’ international pension planning. | Fees relate to advice given to the Company |
Tax, corporate finance and consulting services to Group companies worldwide.
|
|||
| KPMG LLP |
Specified procedures to assist in the assessment of the calculations of the STI bonus outcomes and future targets.
|
2018: £18,000 2017: £15,000
|
Audit and tax services and other non-audit services.
|
Regular work programme 2018
The Committee:
| – |
reviewed salaries for the Executive Directors from 1 April 2018 taking into account both the Pay Comparator Group positioning and the pay and employment conditions elsewhere in the Group, particularly in the UK; |
| – |
reviewed the Chairman’s fee from 1 April 2018 with specific reference to the level of pay awards granted to UK employees; |
| – |
assessed the achievement against the targets for the 2017 STI award and set the STI targets for 2018; |
| – |
assessed, and agreed to apply, an individual adjustment factor to the 2017 STI outcomes for Executive Directors; |
| – |
assessed the achievement against the performance conditions for the vesting of the LTIP 2015 award, determined the contingent level of LTIP awards for May 2018 and confirmed the associated performance conditions; |
| – |
assessed the achievement against the targets for the 2017 Share Reward Scheme and set the targets for the 2018 award; |
| – |
monitored the continued application of the Company’s shareholding guidelines for the Executive Directors; |
| – |
reviewed the Annual Statement and the Annual Report on Remuneration for the year ended 31 December 2017 prior to its approval by the Board and subsequent shareholder submission to the Company’s AGM on 25 April 2018; |
| – |
analysed the 2018 AGM results on remuneration voting and reviewed market trends in the context of that annual general meeting season together with ongoing corporate governance trends; |
| – |
reviewed the achievement against the performance measures for the six months to 30 June 2018 for the STI 2018 and the outstanding LTIP awards; and |
| – |
reviewed the Remuneration Committee’s effectiveness following the Board evaluation process. |
Directors’ Remuneration Policy
The Committee considered amendments to the current Directors’ Remuneration Policy, taking into account shareholder feedback and the requirements of the UK Corporate Governance Code 2018 and applicable regulations, and determined the revised Directors’ Remuneration Policy to be proposed for shareholder approval at the Company’s AGM on 25 April 2019.
Other incentive matters 2018
The Committee:
| – |
approved the remuneration package in respect of the appointment of Jack Bowles as an Executive Director with effect from 1 January 2019; |
| – |
reviewed the terms of appointment and associated remuneration, and terms of termination of employment, in connection with Management Board changes during the year; |
| – |
reviewed the alignment of Group workforce remuneration and related policies with the Directors’ Remuneration Policy; |
| – |
approved changes to the constituents for the STI volume share metrics, based on market changes and reporting capabilities; |
| – |
reviewed post-employment benefits arrangements across the Group; and |
| – |
noted preliminary insights on UK gender pay reporting for 2018. |
| BAT Annual Report and Form 20-F 2018 | 107 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
| Annual Report on Remuneration continued | ||||||||||||||
Voting on the Remuneration Report at the 2018 AGM and engagement with shareholders
At the 2018 AGM on 25 April, the shareholders considered and voted on the 2017 Directors’ Remuneration Report as set out on the table below. No other resolutions in respect of Directors’ remuneration and incentives were considered at the 2018 AGM. The Directors’ Remuneration Policy was approved by shareholders at the AGM on 27 April 2016. A summary of this Policy is on pages 109 to 113.
|
Approval of Directors’
Remuneration Report 2017 |
Approval of Directors’
Remuneration Report 2018 |
|||||||
|
Percentage for |
92.05 | 75.68 | ||||||
|
Votes for (including discretionary) |
1,346,502,332 | 1,326,830,858 | ||||||
|
Percentage against |
7.95 | 24.32 | ||||||
|
Votes against |
116,220,156 | 426,315,629 | ||||||
|
Total votes cast excluding votes withheld |
1,462,722,488 | 1,753,146,487 | ||||||
|
Votes withheld 1 |
13,100,905 | 30,934,018 | ||||||
|
Total votes cast including votes withheld |
1,475,823,393 | 1,784,080,505 | ||||||
Note:
| 1. |
Votes withheld: these are not included in the final proxy figures as they are not recognised as a vote in law. |
The Company acknowledges that a number of shareholders did not support the resolution regarding the 2017 Directors’ Remuneration Report. Following the Company’s 2018 AGM, the Company has undertaken an extensive programme of engagement with shareholders as part of a full review of the Company’s Directors’ Remuneration Policy to understand shareholder perspectives in depth. The Committee has carefully considered the feedback received and has taken this into account in revising the Company’s Directors’ Remuneration Policy, presented for shareholders’ consideration at pages 76 to 89.
| 108 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
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Financial Statements
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Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
8 Summary of our Directors’ Remuneration Policy
The Remuneration Policy, that sets the basis for remuneration in 2018, for the Executive Directors and the Non-Executive Directors was approved by shareholders at the AGM on 27 April 2016.
The full Directors’ Remuneration Policy is set out in the Remuneration Report 2015 contained in the Annual Report for the year ended 2015, which is available at www.bat.com.
To assist in reviewing our Annual Report on Remuneration, we have summarised the key elements of the Directors’ Remuneration Policy as it principally applies to remuneration paid during 2018.
Directors’ Remuneration Policy summary: our remuneration strategy
Our principles of remuneration – summary
The Remuneration Committee’s remuneration principles seek to reward the delivery of the Group’s strategy in a simple and straightforward manner which is aligned to shareholders’ long-term sustainable interests.
The remuneration structure comprises fixed and variable elements. These rewards are structured and designed to be both transparent and stretching while recognising the skills and experience of the Executive Directors and ensuring a market competitiveness for talent. The fixed elements comprise base salary, pension and other benefits. The variable elements are provided via two performance-based incentive schemes (a single short-term cash and share incentive annual bonus plan (STI), and a single long-term incentive plan (LTIP)).
In applying these principles, the Remuneration Committee maintains an appropriate balance between fixed pay and the opportunity to earn performance-related remuneration with the performance-based elements forming, at maximum opportunity, between 75% and 85% of the Executive Directors’ total remuneration. An annual review is conducted to ensure application and alignment of the Directors’ Remuneration Policy with the business needs to promote the long-term success of the Company.
| BAT Annual Report and Form 20-F 2018 | 109 | |
Table of Contents
|
Remuneration Report
|
||||||||||||||
| Annual Report on Remuneration continued | ||||||||||||||
Directors’ Remuneration Policy summary: elements of pay for the current Executive Directors
Base salary
Normally paid in 12 equal monthly instalments during the year and is pensionable.
Normally reviewed annually in February (with salary changes effective from April) or subject to an ad hoc review on a significant change of responsibilities.
Salaries are reviewed against appropriate market data, including general UK pay trends and a company size and complexity model based on UK companies, as well as a Pay Comparator Group.
Increases in salary will generally be in the range of the increases in the base pay of other UK-based employees in the Group.
Year-on-year increases for Executive Directors, currently in role, will not exceed 10% per annum during the policy period.
A significant change in responsibilities may be reflected in an above-average increase (which may exceed 10%) of salary.
Pensions
Pension Fund: non-contributory defined benefit section
Accrual rates differ according to individual circumstances but do not exceed 1/40th of pensionable salary for each year of pensionable service.
Retains a scheme-specific salary cap (currently £160,800 effective 1 April 2018).
Benefits in excess of the cap are accrued in the UURBS.
Pension Fund: defined contribution section
In place since April 2005.
Annual contribution up to the equivalent of 35% of base salary would be made.
Actual level of contribution paid to the Pension Fund is restricted to take account of the annual allowance and lifetime allowance.
Balance of contribution payable as a gross cash allowance or accumulated in the UURBS.
UURBS
Accrued defined benefits in the UURBS may be received on retirement either as a single lump sum or as an ongoing pension payment.
Pension accrual in the UURBS is at the same rate as in the Pension Fund (1/40th per annum).
Benefits
The Company currently offers the following range of contractual benefits to Executive Directors (on an individually specific basis) with maximum annual values (subject to periodic inflation-related increases where applicable):
| – |
car or car allowance: £20,000; |
| – |
use of a Company driver: variable maxima as the actual cost is dependent on the miles driven in any year; |
| – |
variable maxima will apply to the cost of private medical insurance which is dependent on an individual’s circumstances and is provided on a family basis; |
| – |
GP ‘walk-in’ medical services located close to the Group’s headquarters in London: £5,000; |
| – |
personal life and accident insurance designed to pay out at a multiple of four and five times base salary respectively; |
| – |
employment tax advice as required, but not exceeding £30,000 and tax equalisation payments as agreed by the Remuneration Committee from time to time; and |
| – |
relocation and shipment expenses at the beginning and end of service as an Executive Director up to £200,000 and, in addition, housing and education allowances or other similar arrangements, as appropriate to the individual’s family circumstances. |
With the exception of the car or car allowance, in line with the UK market and the practice followed for all the Group’s other UK employees, it is also practice to pay the tax that may be due on these benefits.
| Short-term incentives – STI | ||||||||
|
Chief Executive
|
Finance Director
|
|||||||
|
STI opportunity (Group outcome |
Maximum | On-target | Maximum | On-target | ||||
| delivered 50% cash; 50% | 250% | 125% | 190% | 95% | ||||
| deferred ordinary shares, individual performance adjustment factor delivered in cash) | ||||||||
| Performance adjustment and clawback and malus | Individual performance adjustment factor: up to 20% uplift possible if individual performance is assessed as outstanding (up to the maximum opportunity) and paid in cash. Up to 50% reduction possible if individual performance is assessed as poor. | |||||||
| Clawback and malus: provisions are in place. | ||||||||
| Performance measures and weightings | The Remuneration Committee sets the performance targets each year at the beginning of the performance period and is able to vary the exact measures and the weighting of them from year to year. | |||||||
| The performance measures are detailed for 2018 on page 92 and for 2019 and on page 98. | ||||||||
| 110 | BAT Annual Report and Form 20-F 2018 | |
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Governance
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Financial Statements
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Other Information
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Introduction & Board
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Audit Committee
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Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
| Long-term incentives – LTIP | ||||||||
| Chief Executive | Finance Director | |||||||
|
LTIP opportunity |
Maximum | 500% | Maximum | 350% | ||||
| Performance measures and weightings |
The Remuneration Committee may make revisions to the performance measures, their weightings, thresholds and target levels as permitted under the LTIP rules. The performance measures are detailed for the 2016 – 2018 performance period on page 94 and for the award to be granted in 2019 on page 99. |
|||||||
| Dividend equivalent payment and clawback and malus | Dividend equivalent payment: on all vesting ordinary shares. Clawback and malus: provisions are in place. | |||||||
| LTIP extended vesting period |
For awards granted in 2016 and subsequently, an additional vesting period of two years applies from the third anniversary of the date of grant. Where this applies, LTIP awards vest only to the extent that: – the performance conditions are satisfied at the end of the three-year performance period; and – an additional vesting period of two years from the third anniversary of grant is completed. |
|||||||
Other elements of remuneration for the Executive Directors
All-employee share plans
Executive Directors are eligible to participate in the Company’s all-employee share schemes:
| – |
Sharesave Scheme: a UK tax-advantaged approved scheme where eligible employees are granted savings-related share options to subscribe for ordinary shares in the Company. |
| – |
Share Incentive Plan (SIP): a UK tax-advantaged plan incorporating: (1) Partnership Scheme; and (2) Share Reward Scheme. |
External Board appointments
Each Executive Director is limited to one external appointment, with the permission of the Board. Any fees from such appointments are retained by the individual in recognition of the increased level of personal commitment required.
| BAT Annual Report and Form 20-F 2018 | 111 | |
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Remuneration Report
|
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| Annual Report on Remuneration continued | ||||||||||||||
Directors’ Remuneration Policy summary: other policy provisions in relation to Executive Directors
Service contracts
The current Executive Directors are employed on a one-year rolling contract, executed at the time of the original appointment.
The Remuneration Committee may exercise its discretion to award two- or three-year contracts in the event that the Executive Director is recruited externally or from overseas.
Contracts with an initial period of longer than one year will then reduce to a one-year rolling contract after the expiry of the initial period.
Policy on payment for loss of office
Principles
The principles on which the Remuneration Committee will approach the determination for payments on termination are as follows:
– compensation for loss of office in service contracts is limited to no more than 12 months’ salary and benefits excluding pension;
– in the event that the contract is terminated for cause (such as gross misconduct), the Company may terminate the contract with immediate effect and no compensation would be payable; and
– the service contracts of the Executive Directors are terminable on the expiry of 12 months’ notice from either the Director or the Company which means that, where an internal successor has not been identified, the Company would have sufficient time to replace the Executive Director through an orderly external recruitment process and ideally have a period of handover.
Treatment of awards under the share incentive schemes: STI/DSBS and LTIP; All-employee scheme: SRS
Executive Directors do not have contractual rights to the value inherent in any awards held under the share incentive schemes. The release of awards is dependent on ‘leaver’ status and is at the discretion of the Remuneration Committee.
The Remuneration Committee retains discretion in deciding ‘good leaver’ status other than in cases of automatic ‘good leavers’ as set out in the applicable provisions of the DSBS and LTIP rules. The discretionary powers are intended to provide flexibility as Executive Directors may leave employment for a broad variety of reasons which may not necessarily fall within the prescribed category of ‘good leaver’. The Remuneration Committee exercises its discretion by reference to guidelines which set out its agreed relevant factors to assist in the determination of a leaver’s status.
In exercising its discretion, the Remuneration Committee will also take into account the individual’s overall performance as well as their contribution to the Company during their total period of employment.
Details of how leavers are assessed as ‘good leavers’ are set out in the Remuneration Policy.
| 112 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
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Strategic Report
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Governance
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Financial Statements
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Other Information
|
|
Introduction & Board
|
Audit Committee
|
Nominations Committee
|
Remuneration Committee
|
Responsibility of Directors
|
Directors’ Remuneration Policy summary: elements of pay for the current
Chairman and Non-Executive Directors
Fees – Chairman
Considered annually by the Remuneration Committee using data from the FTSE 30 companies and taking into account the breadth of that role, coupled with its associated levels of personal commitment and expertise in the overall context of international reach and the ‘ambassadorial’ aspect of the role. The Chairman does not participate in discussions on his level of remuneration.
It is anticipated that any future aggregate increase to any of the fees for the Chairman and Non-Executive Directors will be within the salary range which governs the Company’s annual salary reviews for UK-based staff and will not exceed the equivalent of 10% per annum in aggregate.
Benefits, travel and related expenses – Chairman
Reimbursed for the cost of travel and related expenses incurred by him in respect of attendance at Board, Committee and General Meetings including the cost of return airline tickets to London from his home in Ireland in connection with his duties as Chairman.
Entitled to: the use of a Company driver; private medical insurance and personal accident insurance benefits; the provision of home and personal security; and general practitioner ‘walk-in’ medical services based a short distance from the Company’s headquarters in London.
Richard Burrows’ spouse may, from time to time, accompany him to participate in a partners’ programme occasionally organised in conjunction with overseas or UK-based Board meetings and otherwise at hospitality functions during the year.
In instances where any reimbursements or expenses are classified by HMRC as a benefit to the Chairman, it is also the practice of the Company to pay any tax due on any such benefits.
Fees – Non-Executive Directors
Non-Executive Directors receive a base fee and an appropriate Board Committee Membership Fee.
The Chairs of the Audit and Remuneration Committees receive an additional supplement and an additional supplement is also paid to the Senior Independent Director.
The quantum and structure of Non-Executive Directors’ remuneration primarily are assessed against the same Pay Comparator Group of companies used for setting the remuneration of Executive Directors. The Board may also make reference to and take account of relevant research and analysis on Non-Executive Directors’ fees in FTSE 100 companies published by remuneration consultants from time to time.
Fees for the Non-Executive Directors are reviewed annually, usually in April. The review does not always result in an increase in the Board fees or Committee fees.
The Board as a whole considers the policy and structure for the Non-Executive Directors’ fees on the recommendation of the Chairman and the Chief Executive. Non-Executive Directors do not participate in discussions on their specific levels of remuneration.
It is anticipated that any future aggregate increase to any of the fees for the Chairman and Non-Executive Directors will be within the salary range which governs the Company’s annual salary reviews for UK-based staff and will not exceed the equivalent of 10% per annum in aggregate.
Benefits, travel and related expenses – Non-Executive Directors
Non-Executive Directors are generally reimbursed for the cost of travel and related expenses incurred by them in respect of attendance at Board, Committee and General Meetings.
It is Board policy that the partners of the Non-Executive Directors may, from time to time, accompany the Directors to participate in a partners’ programme occasionally organised in conjunction with overseas or UK-based Board meetings and otherwise at hospitality functions during the year.
Non-Executive Directors are also eligible for general practitioner ‘walk-in’ medical services based a short distance from the Company’s headquarters in London; Non-Executive Directors receive no other benefits.
In instances where any reimbursements or expenses are classified by HMRC as a benefit to the Director, it is also the practice of the Company to pay any tax due on any such benefits.
The Directors’ Remuneration Report has been approved by the Board on 27 February 2019 and signed on its behalf by:
Dimitri Panayotopoulos
Chairman, Remuneration Committee
27 February 2019
| BAT Annual Report and Form 20-F 2018 | 113 | |
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Introduction & Board
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Nominations Committee
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Remuneration Committee
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| 120 | BAT Annual Report and Form 20-F 2018 | |
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Report of Independent Registered Public
Accounting Firm
to the Stockholders and Board of Directors of British American Tobacco p.l.c.
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying Group Balance Sheets of British American Tobacco and subsidiaries (the “Group”) as of December 31, 2018 and 2017, the related Group Income statement, Group Statement of Comprehensive Income, Group Statement of Changes in Equity, and Group Cash Flow Statement for each of the years in the three-year period ended December 31, 2018 and the related notes (collectively, the Group’s “consolidated financial statements”). We also have audited the Group’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Group as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board and in conformity with IFRS as adopted by the European Union. Also in our opinion, the Group maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Basis for Opinions
The Group’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s report on internal control over financial reporting. Our responsibility is to express an opinion on the Group’s consolidated financial statements and an opinion on the Group’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Group in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
We have served as the Group’s auditor since 2015.
KPMG LLP
London, United Kingdom
February 27, 2019
| BAT Annual Report and Form 20-F 2018 | 121 | |
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Financial Statements
|
Group Income Statement
| For the years ended 31 December | ||||||||||||||||||||
|
2018 £m |
2017 £m |
2016 £m |
||||||||||||||||||
| Notes | Revised | Revised | ||||||||||||||||||
| Revenue 1 | 2 | 24,492 | 19,564 | 14,130 | ||||||||||||||||
| Raw materials and consumables used | (4,664 | ) | (4,520 | ) | (3,777 | ) | ||||||||||||||
| Changes in inventories of finished goods and work in progress | 3(h) | 114 | (513 | ) | 44 | |||||||||||||||
| Employee benefit costs | 3(a),(e) | (3,005 | ) | (2,679 | ) | (2,274 | ) | |||||||||||||
| Depreciation, amortisation and impairment costs | 3(b),(e),(f),(h) | (1,038 | ) | (902 | ) | (607 | ) | |||||||||||||
| Other operating income | 3(e) | 85 | 144 | 176 | ||||||||||||||||
| Loss on reclassification from amortised cost to fair value | (3 | ) | – | – | ||||||||||||||||
| Other operating expenses | 3(c),(d),(e),(g),(h) | (6,668 | ) | (4,682 | ) | (3,037 | ) | |||||||||||||
| Profit from operations | 2 | 9,313 | 6,412 | 4,655 | ||||||||||||||||
| Net finance costs | 3(h),4 | (1,381 | ) | (1,094 | ) | (637 | ) | |||||||||||||
| Share of post-tax results of associates and joint ventures | 2, 5 | 419 | 24,209 | 2,227 | ||||||||||||||||
| Profit before taxation | 8,351 | 29,527 | 6,245 | |||||||||||||||||
| Taxation on ordinary activities | 6 | (2,141 | ) | 8,129 | (1,406 | ) | ||||||||||||||
| Profit for the year | 6,210 | 37,656 | 4,839 | |||||||||||||||||
| Attributable to: | ||||||||||||||||||||
| Owners of the parent | 6,032 | 37,485 | 4,648 | |||||||||||||||||
| Non-controlling interests | 178 | 171 | 191 | |||||||||||||||||
| 6,210 | 37,656 | 4,839 | ||||||||||||||||||
| Earnings per share | ||||||||||||||||||||
| Basic | 7 | 264.0 | p | 1,833.9 | p | 250.2 | p | |||||||||||||
| Diluted | 7 | 263.2 | p | 1,827.6 | p | 249.2 | p | |||||||||||||
| 1. |
Revenue is net of duty, excise and other taxes of £38,553 million, £37,780 million and £32,136 million for the years ended 31 December 2018, 2017 and 2016, respectively. |
The accompanying notes are an integral part of these consolidated financial statements.
The results for the twelve-month period ended 31 December 2017 and 31 December 2016 have been revised as explained in notes 1 and 31.
| 122 | BAT Annual Report and Form 20-F 2018 | |
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Governance
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Financial Statements
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Other Information
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Group Statement of Comprehensive Income
| For the years ended 31 December | ||||||||||||||||
| Notes |
2018
|
2017
£m
|
2016
£m
|
|||||||||||||
| Profit for the year | 6,210 | 37,656 | 4,839 | |||||||||||||
| Other comprehensive income/(expense) | ||||||||||||||||
| Items that may be reclassified subsequently to profit or loss: | 3,099 | (3,809 | ) | 1,760 | ||||||||||||
| Differences on exchange | 3,868 | (3,084 | ) | 1,270 | ||||||||||||
| Cash flow hedges | ||||||||||||||||
| – net fair value (losses)/gains | (58 | ) | (264 | ) | 29 | |||||||||||
| – reclassified and reported in profit for the year | 17 | 109 | 38 | |||||||||||||
| – reclassified and reported in total assets | – | (16 | ) | (12 | ) | |||||||||||
| Investments held at fair value | ||||||||||||||||
| – net fair value losses | – | (27 | ) | – | ||||||||||||
| Net investment hedges | ||||||||||||||||
| – net fair value (losses)/gains | (472 | ) | 425 | (837 | ) | |||||||||||
| – differences on exchange on borrowings | (236 | ) | (68 | ) | (124 | ) | ||||||||||
| Associates – share of OCI, net of tax | 5 | (38 | ) | (918 | ) | 1,415 | ||||||||||
| Tax on items that may be reclassified | 6(f) | 18 | 34 | (19 | ) | |||||||||||
| Items that will not be reclassified subsequently to profit or loss: | 115 | 681 | (173 | ) | ||||||||||||
| Retirement benefit schemes | ||||||||||||||||
| – net actuarial gains/(losses) | 12 | 138 | 833 | (228 | ) | |||||||||||
| – surplus recognition and minimum funding obligations | 12 | 4 | (6 | ) | (1 | ) | ||||||||||
| Associates – share of OCI, net of tax | 5 | 6 | 25 | 20 | ||||||||||||
| Tax on items that will not be reclassified | 6(f) | (33 | ) | (171 | ) | 36 | ||||||||||
| Total other comprehensive (expense)/income for the year, net of tax | 3,214 | (3,128 | ) | 1,587 | ||||||||||||
| Total comprehensive income for the year, net of tax | 9,424 | 34,528 | 6,426 | |||||||||||||
| Attributable to: | ||||||||||||||||
| Owners of the parent | 9,239 | 34,361 | 6,180 | |||||||||||||
| Non-controlling interests | 185 | 167 | 246 | |||||||||||||
| 9,424 | 34,528 | 6,426 | ||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
The results for the twelve-month period ended 31 December 2017 have been revised as explained in notes 1 and 31.
| BAT Annual Report and Form 20-F 2018 | 123 | |
Table of Contents
|
Financial Statements
|
Group Statement of Changes in Equity
|
Attributable to owners of the parent |
||||||||||||||||||||||||||||||||
| Notes |
Share
capital £m |
Share
|
Other
reserves £m |
Retained
earnings £m |
Total
attributable to owners of parent £m |
Non-
controlling interests £m |
Total
equity £m |
|||||||||||||||||||||||||
|
Balance at 31 December 2017 |
614 | 26,602 | (3,392 | ) | 36,935 | 60,759 | 222 | 60,981 | ||||||||||||||||||||||||
|
Accounting policy change (IFRS 9 see note 31) |
– | – | (9 | ) | (29 | ) | (38 | ) | – | (38 | ) | |||||||||||||||||||||
|
Revised balance at 1 January 2018 |
614 | 26,602 | (3,401 | ) | 36,906 | 60,721 | 222 | 60,943 | ||||||||||||||||||||||||
|
Total comprehensive income for the year comprising: |
– | – | 3,090 | 6,149 | 9,239 | 185 | 9,424 | |||||||||||||||||||||||||
|
Profit for the year |
– | – | – | 6,032 | 6,032 | 178 | 6,210 | |||||||||||||||||||||||||
|
Other comprehensive income for the year |
– | – | 3,090 | 117 | 3,207 | 7 | 3,214 | |||||||||||||||||||||||||
|
Cash flow hedges reclassified and reported in total assets |
– | – | (22 | ) | – | (22 | ) | – | (22 | ) | ||||||||||||||||||||||
|
Other changes in equity |
||||||||||||||||||||||||||||||||
|
Employee share options |
||||||||||||||||||||||||||||||||
|
– value of employee services |
25 | – | – | – | 121 | 121 | – | 121 | ||||||||||||||||||||||||
|
– proceeds from shares issued |
– | 4 | – | – | 4 | – | 4 | |||||||||||||||||||||||||
|
Dividends and other appropriations |
||||||||||||||||||||||||||||||||
|
– ordinary shares |
8 | – | – | – | (4,463 | ) | (4,463 | ) | – | (4,463 | ) | |||||||||||||||||||||
|
– to non-controlling interests |
– | – | – | – | – | (163 | ) | (163 | ) | |||||||||||||||||||||||
|
Purchase of own shares |
||||||||||||||||||||||||||||||||
|
– held in employee share ownership trusts |
– | – | – | (139 | ) | (139 | ) | – | (139 | ) | ||||||||||||||||||||||
|
Non-controlling interests – acquisitions |
24(c) | – | – | – | (11 | ) | (11 | ) | – | (11 | ) | |||||||||||||||||||||
|
Other movements |
– | – | – | (6 | ) | (6 | ) | – | (6 | ) | ||||||||||||||||||||||
| Balance at 31 December 2018 | 614 | 26,606 | (333 | ) | 38,557 | 65,444 | 244 | 65,688 | ||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
|
Attributable to owners of the parent |
||||||||||||||||||||||||||||||||
| Revised | Notes |
Share
capital £m |
Share
|
Other
reserves £m |
Retained
earnings £m |
Total
attributable to owners of parent £m |
Non-
controlling interests £m |
Total
equity £m |
||||||||||||||||||||||||
|
Balance at 1 January 2017 |
507 | 3,931 | 413 | 3,331 | 8,182 | 224 | 8,406 | |||||||||||||||||||||||||
|
Total comprehensive income for the year comprising: |
– | – | (3,805 | ) | 38,166 | 34,361 | 167 | 34,528 | ||||||||||||||||||||||||
|
Profit for the year |
– | – | – | 37,485 | 37,485 | 171 | 37,656 | |||||||||||||||||||||||||
|
Other comprehensive income for the year |
– | – | (3,805 | ) | 681 | (3,124 | ) | (4 | ) | (3,128 | ) | |||||||||||||||||||||
|
Other changes in equity |
||||||||||||||||||||||||||||||||
|
Employee share options |
||||||||||||||||||||||||||||||||
|
– value of employee services |
25 | – | – | – | 105 | 105 | – | 105 | ||||||||||||||||||||||||
|
– proceeds from shares issued |
– | 5 | – | – | 5 | – | 5 | |||||||||||||||||||||||||
|
Dividends and other appropriations |
||||||||||||||||||||||||||||||||
|
– ordinary shares |
– | – | – | (4,465 | ) | (4,465 | ) | – | (4,465 | ) | ||||||||||||||||||||||
|
– to non-controlling interests |
– | – | – | – | – | (169 | ) | (169 | ) | |||||||||||||||||||||||
|
Purchase of own shares |
||||||||||||||||||||||||||||||||
|
– held in employee share ownership trusts |
– | – | – | (205 | ) | (205 | ) | – | (205 | ) | ||||||||||||||||||||||
|
Shares issued – RAI acquisition |
24(a) | 107 | 22,666 | – | – | 22,773 | – | 22,773 | ||||||||||||||||||||||||
|
Other movements |
– | – | – | 3 | 3 | – | 3 | |||||||||||||||||||||||||
|
Balance at 31 December 2017 |
614 | 26,602 | (3,392 | ) | 36,935 | 60,759 | 222 | 60,981 | ||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
The results for the twelve-month period ended 31 December 2017 have been revised as explained in notes 1 and 31.
| 124 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
|
Attributable to owners of the parent |
||||||||||||||||||||||||||||||||
| Notes |
Share
capital £m |
Share
|
Other
reserves £m |
Retained
earnings £m |
Total
attributable to owners of parent £m |
Non-
controlling interests £m |
Total
equity £m |
|||||||||||||||||||||||||
|
Balance at 1 January 2016 |
507 | 3,927 | (1,294 | ) | 1,754 | 4,894 | 138 | 5,032 | ||||||||||||||||||||||||
|
Total comprehensive income for the year comprising: |
– | – | 1,707 | 4,473 | 6,180 | 246 | 6,426 | |||||||||||||||||||||||||
|
Profit for the year |
– | – | – | 4,648 | 4,648 | 191 | 4,839 | |||||||||||||||||||||||||
|
Other comprehensive income for the year |
– | – | 1,707 | (175 | ) | 1,532 | 55 | 1,587 | ||||||||||||||||||||||||
|
Other changes in equity |
||||||||||||||||||||||||||||||||
|
Employee share options |
||||||||||||||||||||||||||||||||
|
– value of employee services |
25 | – | – | – | 71 | 71 | – | 71 | ||||||||||||||||||||||||
|
– proceeds from shares issued |
– | 4 | – | – | 4 | – | 4 | |||||||||||||||||||||||||
|
Dividends and other appropriations |
||||||||||||||||||||||||||||||||
|
– ordinary shares |
– | – | – | (2,910 | ) | (2,910 | ) | – | (2,910 | ) | ||||||||||||||||||||||
|
– to non-controlling interests |
– | – | – | – | – | (156 | ) | (156 | ) | |||||||||||||||||||||||
|
Purchase of own shares |
||||||||||||||||||||||||||||||||
|
– held in employee share ownership trusts |
– | – | – | (64 | ) | (64 | ) | – | (64 | ) | ||||||||||||||||||||||
|
Non-controlling interests – acquisitions |
24(c) | – | – | – | 4 | 4 | (4 | ) | – | |||||||||||||||||||||||
|
Other movements |
– | – | – | 3 | 3 | – | 3 | |||||||||||||||||||||||||
|
Balance at 31 December 2016 |
507 | 3,931 | 413 | 3,331 | 8,182 | 224 | 8,406 | |||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
| BAT Annual Report and Form 20-F 2018 | 125 | |
Table of Contents
|
Financial Statements
|
Group Balance Sheet
| At 31 December | ||||||||||||
|
2018 £m |
2017 £m |
|||||||||||
| Notes | Revised | |||||||||||
|
Assets |
||||||||||||
|
Intangible assets |
9 | 124,013 | 117,785 | |||||||||
|
Property, plant and equipment |
10 | 5,166 | 4,882 | |||||||||
|
Investments in associates and joint ventures |
11 | 1,737 | 1,577 | |||||||||
|
Retirement benefit assets |
12 | 1,147 | 1,123 | |||||||||
|
Deferred tax assets |
13 | 344 | 333 | |||||||||
|
Trade and other receivables |
14 | 685 | 756 | |||||||||
|
Investments held at fair value |
15 | 39 | 42 | |||||||||
|
Derivative financial instruments |
16 | 556 | 590 | |||||||||
|
Total non-current assets |
133,687 | 127,088 | ||||||||||
|
Inventories |
17 | 6,029 | 5,864 | |||||||||
|
Income tax receivable |
74 | 460 | ||||||||||
|
Trade and other receivables |
14 | 3,588 | 4,053 | |||||||||
|
Investments held at fair value |
15 | 178 | 65 | |||||||||
|
Derivative financial instruments |
16 | 179 | 228 | |||||||||
|
Cash and cash equivalents |
18 | 2,602 | 3,291 | |||||||||
| 12,650 | 13,961 | |||||||||||
|
Assets classified as held-for-sale |
5 | 5 | ||||||||||
|
Total current assets |
12,655 | 13,966 | ||||||||||
|
Total assets |
146,342 | 141,054 | ||||||||||
|
Equity – capital and reserves |
||||||||||||
|
Share capital |
614 | 614 | ||||||||||
|
Share premium, capital redemption and merger reserves |
26,606 | 26,602 | ||||||||||
|
Other reserves |
(333 | ) | (3,392 | ) | ||||||||
|
Retained earnings |
38,557 | 36,935 | ||||||||||
|
Owners of the parent |
65,444 | 60,759 | ||||||||||
|
Non-controlling interests |
244 | 222 | ||||||||||
|
Total equity |
19 | 65,688 | 60,981 | |||||||||
|
Liabilities |
||||||||||||
|
Borrowings |
20 | 43,284 | 44,027 | |||||||||
|
Retirement benefit liabilities |
12 | 1,665 | 1,821 | |||||||||
|
Deferred tax liabilities |
13 | 17,776 | 17,129 | |||||||||
|
Other provisions for liabilities |
21 | 331 | 354 | |||||||||
|
Trade and other payables |
22 | 1,055 | 1,058 | |||||||||
|
Derivative financial instruments |
16 | 214 | 79 | |||||||||
|
Total non-current liabilities |
64,325 | 64,468 | ||||||||||
|
Borrowings |
20 | 4,225 | 5,423 | |||||||||
|
Income tax payable |
853 | 720 | ||||||||||
|
Other provisions for liabilities |
21 | 318 | 399 | |||||||||
|
Trade and other payables |
22 | 10,631 | 8,908 | |||||||||
|
Derivative financial instruments |
16 | 302 | 155 | |||||||||
|
Total current liabilities |
16,329 | 15,605 | ||||||||||
|
Total equity and liabilities |
146,342 | 141,054 | ||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
The balance sheet as of 31 December 2017 has been revised as explained in notes 1 and 31.
On behalf of the Board
Richard Burrows
Chairman
27 February 2019
| 126 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
Group Cash Flow Statement
| For the years ended 31 December | ||||||||||||||||
| Notes |
2018
£m |
2017
£m
|
2016
£m |
|||||||||||||
| Profit from operations | 9,313 | 6,412 | 4,655 | |||||||||||||
| Adjustments for | ||||||||||||||||
| – depreciation, amortisation and impairment costs | 3(b) | 1,038 | 902 | 607 | ||||||||||||
| – (increase)/decrease in inventories | (192 | ) | 1,409 | (638 | ) | |||||||||||
| – decrease/(increase) in trade and other receivables | 502 | (732 | ) | 87 | ||||||||||||
| – increase in amounts recoverable in respect of Quebec class action | 14 | – | (130 | ) | (242 | ) | ||||||||||
| – increase/(decrease) in provision for Master Settlement Agreement | 3(d) | 1,364 | (934 | ) | – | |||||||||||
| – increase/(decrease) in trade and other payables | 123 | (685 | ) | 428 | ||||||||||||
| – decrease in net retirement benefit liabilities | (100 | ) | (131 | ) | (145 | ) | ||||||||||
| – (decrease)/increase in other provisions for liabilities | (107 | ) | (78 | ) | 141 | |||||||||||
| – other non-cash items | 31 | 86 | – | |||||||||||||
| Cash generated from operations | 11,972 | 6,119 | 4,893 | |||||||||||||
| Dividends received from associates | 214 | 903 | 962 | |||||||||||||
| Tax paid | (1,891 | ) | (1,675 | ) | (1,245 | ) | ||||||||||
| Net cash generated from operating activities | 10,295 | 5,347 | 4,610 | |||||||||||||
| Cash flows from investing activities | ||||||||||||||||
| Interest received | 52 | 83 | 62 | |||||||||||||
| Purchases of property, plant and equipment | (758 | ) | (791 | ) | (586 | ) | ||||||||||
| Proceeds on disposal of property, plant and equipment | 38 | 95 | 93 | |||||||||||||
| Purchases of intangibles | (185 | ) | (187 | ) | (88 | ) | ||||||||||
| Purchases of investments | (320 | ) | (170 | ) | (109 | ) | ||||||||||
| Proceeds on disposals of investments | 167 | 160 | 22 | |||||||||||||
| Acquisition of Reynolds American Inc. net of cash acquired | – | (17,657 | ) | – | ||||||||||||
| Investment in associates and acquisitions of other subsidiaries net of cash acquired | (32 | ) | (77 | ) | (57 | ) | ||||||||||
| Proceeds on disposal of non-core business net of cash disposed | 17 | – | – | |||||||||||||
|
Proceeds from associates’ share buy-backs |
– | – | 23 | |||||||||||||
| Net cash used in investing activities | (1,021 | ) | (18,544 | ) | (640 | ) | ||||||||||
| Cash flows from financing activities | ||||||||||||||||
| Interest paid | (1,559 | ) | (1,114 | ) | (641 | ) | ||||||||||
| Proceeds from increases in and new borrowings | 2,111 | 40,937 | 3,476 | |||||||||||||
| Inflows/(outflows) relating to derivative financial instruments | 49 | (406 | ) | (26 | ) | |||||||||||
| Purchases of own shares held in employee share ownership trusts | (139 | ) | (205 | ) | (64 | ) | ||||||||||
| Reductions in and repayments of borrowings | (5,596 | ) | (20,827 | ) | (3,840 | ) | ||||||||||
| Dividends paid to owners of the parent | 8 | (4,347 | ) | (3,465 | ) | (2,910 | ) | |||||||||
| Purchases of non-controlling interests | (11 | ) | – | (70 | ) | |||||||||||
| Dividends paid to non-controlling interests | (142 | ) | (167 | ) | (147 | ) | ||||||||||
|
Other |
4 | 6 | (7 | ) | ||||||||||||
| Net cash (used in)/from financing activities | (9,630 | ) | 14,759 | (4,229 | ) | |||||||||||
| Net cash flows generated (used in)/from operating, investing and financing activities | (356 | ) | 1,562 | (259 | ) | |||||||||||
|
Differences on exchange |
(138 | ) | (391 | ) | 180 | |||||||||||
| (Decrease)/increase in net cash and cash equivalents in the year | (494 | ) | 1,171 | (79 | ) | |||||||||||
|
Net cash and cash equivalents at 1 January |
2,822 | 1,651 | 1,730 | |||||||||||||
| Net cash and cash equivalents at 31 December | 18 | 2,328 | 2,822 | 1,651 | ||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
Cash flow for the twelve-month period ended 31 December 2017 has been revised as explained in notes 1 and 31.
| BAT Annual Report and Form 20-F 2018 | 127 | |
Table of Contents
|
Financial Statements
|
Notes on the Accounts
1 Accounting policies
Basis of preparation
The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”), IFRS as adopted by the European Union (EU). IFRS as adopted by the EU differs in certain respects from IFRS as issued by the IASB. The differences have no impact on the Group’s consolidated financial statements for the periods presented.
The consolidated financial statements have been prepared on a going concern basis under the historical cost convention except as described in the accounting policy below on financial instruments.
With effect from 1 January 2018, the Group has adopted IFRS 15
Revenue from Contracts with Customers. The Group has revised prior periods, as permitted by the Standard, to ensure comparability of the income statement across the periods presented. This Standard has changed the way the Group accounts for consideration payable to customers, and requires certain payments to indirect customers, previously shown as marketing expenses, to be shown as deductions from revenue. This has reduced revenue for the year ended 31 December 2017 by £664 million (2016: £621 million), with a corresponding reduction in other operating expenses. In addition, due to the timing of the recognition of certain payments to indirect customers, revenue and operating profit for the year ended 31 December 2017 has been reduced by a further £64 million. For further details, refer to note 31.
In addition, with effect from 1 January 2018, the Group has adopted IFRS 9 Financial Instruments with no revision of prior periods, as permitted by the Standard. The cumulative impact of adopting the Standard, including the effect of tax entries, has been recognised as a restatement of opening reserves in 2018, and is £38 million, arising from the impairment of financial assets under the expected loss model required under IFRS 9, which accelerates recognition of potential impairment on loans and trade receivables when compared with the incurred loss model under IAS 39 Financial Instruments. A simplified “lifetime expected loss model” has been used for balances arising as a result of revenue recognition, as permitted by the Standard, by applying a standard rate of provision on initial recognition of trade debtors based upon the Group’s historical experience of credit loss modified by expectations of the future, and increasing this provision to take account of overdue receivables. Applying the requirements of IFRS 9 has resulted in a decrease of trade and other receivables of £45 million as at 1 January 2018.
IFRS 9 has also changed the classification and measurement of financial assets. The category of available-for-sale investments (where fair value changes were deferred in reserves until disposal of the investment) has been replaced with the category of financial assets at Fair Value through Profit and Loss (for most investments) and the category of financial assets at Fair Value through Other Comprehensive Income (for qualifying equity investments). The available-for-sale reserve at 1 January 2018 has been reclassified as appropriate into retained earnings. In addition, certain loans and receivables which do not meet the measurement tests for amortised cost classification under IFRS 9 have been reclassified as financial assets at Fair Value through Profit and Loss at the same date. Given the immateriality of the various investment classes and to avoid clutter on the face of the balance sheet, the Group will use the term “investments held at fair value” to refer to all of these financial assets both pre- and post- the adoption of IFRS 9.
For further details on the impact on the Group’s balance sheet of these changes, refer to note 31. The Group has adopted the hedge accounting requirements of IFRS 9 prospectively from 1 January 2018. All of the Group’s hedging relationships at the end of 2017 are considered to be continuing hedge relationships on the adoption of IFRS 9.
In addition, with effect from 1 January 2018, the Group has changed certain estimates of useful economic lives for cigarette-making machinery across the Group, harmonising depreciation rates used by the historic BAT Group and by Reynolds American Inc. from 14 years and 30 years, respectively, to a standard 20-year life. The effect of the change is not material to the Group, and is estimated to be around £66 million for the year. Reynolds American Inc. recognised an impairment charge of £13 million in adopting the new estimate of useful economic lives.
The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of revenues, expenses, assets and liabilities, and the disclosure of contingent liabilities at the date of the financial statements. The key estimates and assumptions are set out in the accounting policies below, together with the related notes to the accounts.
The critical accounting estimates include:
| – |
the review of asset values, especially indefinite life assets such as goodwill and certain trademarks and similar intangibles. The key assumptions used in respect of the impairment testing are the determination of cash-generating units, the budgeted cash flows of these units, the long-term growth rate for cash flow projections and the rate used to discount the cash flow projections. These are described in note 9; |
| – |
the estimation of and accounting for retirement benefit costs. The determination of the carrying value of assets and liabilities, as well as the charge for the year, and amounts recognised in other comprehensive income, involves judgements made in conjunction with independent actuaries. These involve estimates about uncertain future events based on the environment in different countries, including life expectancy of scheme members, salary and pension increases, inflation, as well as discount rates and asset values at the year end. The assumptions used by the Group and sensitivity analysis are described in note 12; |
| – |
the estimation of amounts to be recognised in respect of taxation and legal matters, and the estimation of other provisions for liabilities and charges are subject to uncertain future events, may extend over several years and so the amount and/or timing may differ from current assumptions. The accounting policy for taxation is explained below. The recognised deferred tax assets and liabilities, together with a note of unrecognised amounts, are shown in note 13, and a contingent tax asset is explained in note 6(b). Other provisions for liabilities and charges are as set out in note 21. The accounting policy on contingent liabilities, which are not provided for, is set out below and the contingent liabilities of the Group are explained in note 28. The application of these accounting policies to the payments made and credits recognised under the Master Settlement Agreement by Reynolds American Inc. (“Reynolds”) is described in note 3(d); and |
| – |
the estimation of the fair values of acquired net assets arising in a business combination and the allocation of the purchase consideration between the underlying net assets acquired, including intangible assets other than goodwill, on the basis of their fair values. These estimates are prepared in conjunction with the advice of independent valuation experts where appropriate. The relevant transactions for 2018, 2017 and 2016 are described in note 24. |
| 128 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
1 Accounting policies continued
The critical accounting judgements include:
| – |
the definition of adjusting items, which are separately disclosed as memorandum information, is explained below and the impact of these on the calculation of adjusted earnings per share is described in note 7; |
| – |
the determination as to whether control (subsidiaries), joint control (joint arrangements), or significant influence (associates) exists in relation to the investments held by the Group. This is assessed after taking into account the Group’s ability to appoint Directors to the entity’s Board, its relative shareholding compared with other shareholders, any significant contracts or arrangements with the entity or its other shareholders and other relevant facts and circumstances; and |
| – |
the review of applicable exchange rates for transactions with and translation of entities in territories where there are restrictions on the free access to foreign currency, or multiple exchange rates. |
Such estimates and assumptions are based on historical experience and various other factors that are believed to be reasonable in the circumstances and constitute management’s best judgement at the date of the financial statements. In the future, actual experience may deviate from these estimates and assumptions, which could affect the financial statements as the original estimates and assumptions are modified, as appropriate, in the year in which the circumstances change.
These consolidated financial statements were authorised for issue by the Board of Directors on 27 February 2019.
Basis of consolidation
The consolidated financial information includes the financial statements of British American Tobacco p.l.c. and its subsidiary undertakings, collectively “the Group”, together with the Group’s share of the results of its associates and joint arrangements.
A subsidiary is an entity controlled by the Group. The Group controls an entity when the Group is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity.
Associates comprise investments in undertakings, which are not subsidiary undertakings or joint arrangements, where the Group’s interest in the equity capital is long term and over whose operating and financial policies the Group exercises a significant influence. They are accounted for using the equity method.
Joint arrangements comprise contractual arrangements where two or more parties have joint control and where decisions regarding the relevant activities of the entity require unanimous consent. Joint operations are jointly-controlled arrangements where the parties to the arrangement have rights to the underlying assets and obligations for the underlying liabilities relating to the arrangement. The Group accounts for its share of the assets, liabilities, income and expenses of any such arrangement. Joint ventures comprise arrangements where the parties to the arrangement have rights to the net assets of the arrangement. They are accounted for using the equity method.
Foreign currencies and hyperinflationary territories
The functional currency of the Parent Company is sterling and this is also the presentation currency of the Group. The income and cash flow statements of Group undertakings expressed in currencies other than sterling are translated to sterling using exchange rates applicable to the dates of the underlying transactions. Average rates of exchange in each year are used where the average rate approximates the relevant exchange rate at the date of the underlying transactions. Assets and liabilities of Group undertakings are translated at the applicable rates of exchange at the end of each year. In territories where there are restrictions on the free access to foreign currency or multiple exchange rates, the applicable rates of exchange are regularly reviewed.
The differences between retained profits translated at average and closing rates of exchange are taken to reserves, as are differences arising on the retranslation to sterling (using closing rates of exchange) of overseas net assets at the beginning of the year, and are presented as a separate component of equity. They are recognised in the income statement when the gain or loss on disposal of a Group undertaking is recognised.
Foreign currency transactions are initially recognised in the functional currency of each entity in the Group using the exchange rate ruling at the date of the transaction. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation of foreign currency assets and liabilities at year end rates of exchange are recognised in the income statement, except when deferred in equity as qualifying cash flow hedges, on intercompany net investment loans and qualifying net investment hedges. Foreign exchange gains or losses recognised in the income statement are included in profit from operations or net finance costs depending on the underlying transactions that gave rise to these exchange differences.
In addition, for hyperinflationary countries where the effect on the Group results would be significant, the financial statements in local currency are adjusted to reflect the impact of local inflation prior to translation into sterling, in accordance with IAS 29 Financial Reporting in Hyperinflationary Economies . Where applicable, IAS 29 requires all transactions to be indexed by an inflationary factor to the balance sheet date, potentially leading to a monetary gain or loss on indexation. In addition, the Group assesses the carrying value of fixed assets after indexation and applies IAS 36 Impairment of Assets , where appropriate, to ensure that the carrying value correctly reflects the economic value of such assets.
The results and balance sheets of operations in hyperinflationary territories are translated at the period end rate. In the case of Venezuela, the Group uses an estimated exchange rate calculated by reflecting the development of the general price index since the Group last achieved meaningful repatriation of dividends.
Revenue
Revenue principally comprises sales of cigarettes, other tobacco products, and nicotine products, to external customers. Revenue excludes duty, excise and other taxes and is after deducting rebates, returns and other similar discounts and payments to direct and indirect customers. Revenue is recognised when control of the goods is transferred to a customer; this is usually evidenced by a transfer of the significant risks and rewards of ownership upon delivery to the customer, which in terms of timing is not materially different to the date of shipping.
| BAT Annual Report and Form 20-F 2018 | 129 | |
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1 Accounting policies continued
Retirement benefit costs
The Group operates both defined benefit and defined contribution schemes including post-retirement healthcare schemes. The net deficit or surplus for each defined benefit pension scheme is calculated in accordance with IAS 19 Employee Benefits based on the present value of the defined benefit obligation at the balance sheet date less the fair value of the scheme assets adjusted, where appropriate, for any surplus restrictions or the effect of minimum funding requirements.
For defined benefit schemes, the actuarial cost charged to profit from operations consists of current service cost, net interest on the net defined benefit liability or asset, past service cost and the impact of any settlements.
Some benefits are provided through defined contribution schemes and payments to these are charged as an expense as they fall due.
Share-based payments
The Group has equity-settled and cash-settled share-based compensation plans.
Equity-settled share-based payments are measured at fair value at the date of grant. The fair value determined at the grant date of the equity-settled share-based payments is expensed over the vesting period, based on the Group’s estimate of awards that will eventually vest. For plans where vesting conditions are based on total shareholder returns, the fair value at date of grant reflects these conditions, whereas earnings per share vesting conditions are reflected in the calculation of awards that will eventually vest over the vesting period. For cash-settled share-based payments, a liability equal to the portion of the services received is recognised at its current fair value determined at each balance sheet date. Fair value is measured by the use of the Black-Scholes option pricing model, except where vesting is dependent on market conditions when the Monte-Carlo option pricing model is used.
The expected life used in the models has been adjusted, based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioural considerations.
Research and development
Research expenditure is charged to income in the year in which it is incurred. Development expenditure is charged to income in the year it is incurred, unless it meets the recognition criteria of IAS 38 Intangible Assets to be capitalised as an intangible asset.
Taxation
Taxation is that chargeable on the profits for the period, together with deferred taxation.
The current income tax charge is calculated on the basis of tax laws enacted or substantively enacted at the balance sheet date in the countries where the Group’s subsidiaries, associates and joint arrangements operate and generate taxable income.
Deferred taxation is provided in full using the liability method for temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amount used for taxation purposes. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised.
Deferred tax is determined using the tax rates that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realised or deferred tax liability is settled.
Tax is recognised in the income statement except to the extent that it relates to items recognised in other comprehensive income or directly in equity, in which case it is recognised in the statement of other comprehensive income or the statement of changes in equity.
The Group has exposures in respect of the payment or recovery of a number of taxes. Liabilities or assets for these payments or recoveries are recognised at such time as an outcome becomes probable and when the amount can reasonably be estimated.
Goodwill
Goodwill arising on acquisitions is capitalised and any impairment of goodwill is recognised immediately in the income statement and is not subsequently reversed.
Goodwill in respect of subsidiaries is included in intangible assets. In respect of associates and joint ventures, goodwill is included in the carrying value of the investment in the associated company or joint venture. On disposal of a subsidiary, associate or joint venture, the attributable amount of goodwill is included in the determination of the profit or loss on disposal.
Intangible assets other than goodwill
The intangible assets shown on the Group balance sheet consist mainly of trademarks and similar intangibles, including certain intellectual property, acquired by the Group’s subsidiary undertakings and computer software.
Acquired trademarks and similar assets are carried at cost less accumulated amortisation and impairment. Trademarks with indefinite lives are not amortised but are reviewed annually for impairment. Other trademarks and similar assets are amortised on a straight-line basis over their remaining useful lives, consistent with the pattern of economic benefits expected to be received, which do not exceed 20 years. Any impairments of trademarks are recognised in the income statement but increases in trademark values are not recognised.
Computer software is carried at cost less accumulated amortisation and impairment, and, with the exception of global software solutions, is amortised on a straight-line basis over periods ranging from three years to five years. Global software solutions are software assets designed to be implemented on a global basis and used as a standard solution by all of the operating companies in the Group. These assets are amortised on a straight-line basis over periods not exceeding ten years.
Property, plant and equipment
Property, plant and equipment are stated at cost less accumulated depreciation and impairment. Depreciation is calculated on a straight-line basis to write off the assets over their useful economic life. No depreciation is provided on freehold land or assets classified as held-for-sale. Freehold and leasehold property are depreciated at rates between 2.5% and 4% per annum, and plant and equipment at rates between 3% and 25% per annum.
As noted above, with effect from 1 January 2018, cigarette-making machinery within this category is depreciated at 5% per annum (previously, between 3% and 7% per annum) as disclosed in note 3(b).
Capitalised interest
Borrowing costs which are directly attributable to the acquisition, construction or production of intangible assets or property, plant and equipment that takes a substantial period of time to get ready for its intended use or sale, are capitalised as part of the cost of the asset.
| 130 | BAT Annual Report and Form 20-F 2018 | |
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Other Information
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1 Accounting policies continued
Leased assets
Assets where the Group has substantially all the risks and rewards of ownership of the leased asset are classified as finance leases and are included as part of property, plant and equipment. Finance lease assets are initially recognised at an amount equal to the lower of their fair value and the present value of the minimum lease payments at inception of the lease, then depreciated over the shorter of the lease term and their estimated useful lives. Leasing payments consist of capital and finance charge elements and the finance element is charged to the income statement.
Rental payments under operating leases are charged to the income statement on a straight-line basis over the lease term.
Impairment of non-financial assets
Assets are reviewed for impairment whenever events indicate that the carrying amount of a cash-generating unit may not be recoverable. In addition, assets that have indefinite useful lives are tested annually for impairment. An impairment loss is recognised to the extent that the carrying value exceeds the higher of the asset’s fair value less costs to sell and its value in use.
A cash-generating unit is the smallest identifiable group of assets that generates cash flows which are largely independent of the cash flows from other assets or groups of assets. At the acquisition date, any goodwill acquired is allocated to the relevant cash-generating unit or group of cash-generating units expected to benefit from the acquisition for the purpose of impairment testing of goodwill.
Impairment of financial assets
Financial assets are reviewed at each balance sheet date, or whenever events indicate that the carrying amount may not be recoverable.
With effect from 1 January 2018, loss allowances for expected credit losses on financial assets which are held at amortised cost are recognised on initial recognition of the underlying asset. As permitted by IFRS 9, the loss allowance on trade receivables arising from the recognition of revenue under IFRS 15 are initially measured at an amount equal to lifetime expected losses. Allowances in respect of loans and other receivables are initially recognised at an amount equal to 12-month expected credit losses. Allowances are measured at an amount equal to the lifetime expected credit losses where the credit risk on the receivables increases significantly after initial recognition.
Prior to 1 January 2018, financial assets were reviewed for impairment at each balance sheet date, or whenever events indicated that the carrying amount might not be recoverable.
Inventories
Inventories are stated at the lower of cost and net realisable value. Cost is based on the weighted average cost incurred in acquiring inventories and bringing them to their existing location and condition, which will include raw materials, direct labour and overheads, where appropriate. Net realisable value is the estimated selling price less costs to completion and sale. Tobacco inventories which have an operating cycle that exceeds 12 months are classified as current assets, consistent with recognised industry practice.
Financial instruments
The Group’s business model for managing financial assets is set out in the Group Treasury Manual which notes that the primary objective with regard to the management of cash and investments is to protect against the loss of principal. Additionally, the Group aims: to maximise Group liquidity by concentrating cash at the Centre, to align the maturity profile of external investments with that of the forecast liquidity profile, to wherever practicable, match the interest rate profile of external investments to that of debt maturities or fixings, and to optimise the investment yield within the Group’s investment parameters. The majority of financial assets are held in order to collect contractual cash flows (typically cash and cash equivalents and loans and other receivables) but some assets (typically investments) are held for investment potential.
Financial assets and financial liabilities are recognised when the Group becomes a party to the contractual provisions of the relevant instrument and derecognised when it ceases to be a party to such provisions. Such assets and liabilities are classified as current if they are expected to be realised or settled within 12 months after the balance sheet date. If not, they are classified as non-current.
Non-derivative financial assets are classified on initial recognition in accordance with the Group’s business model as investments at fair value through profit and loss, investments at fair value through OCI, loans and receivables, or cash and cash equivalents and accounted for as follows:
| – |
Investments: These are non-derivative financial assets that cannot be classified as loans and receivables or cash and cash equivalents. Dividend and interest income on these investments are included within finance income when the Group’s right to receive payments is established. This category includes financial assets at fair value through profit and loss, financial assets at fair value through other comprehensive income and, prior to 1 January 2018, available-for-sale investments as defined by IAS 39. |
| – |
Loans and other receivables: These are non-derivative financial assets with fixed or determinable payments that are solely payments of principal and interest on the principal amount outstanding, that are primarily held in order to collect contractual cash flows. These balances include trade and other receivables and are measured at amortised cost, using the effective interest rate method, and stated net of allowances for credit losses. |
| – |
Cash and cash equivalents: Cash and cash equivalents include cash in hand and deposits held on call, together with other short-term highly liquid investments including investments in certain money market funds. Cash equivalents normally comprise instruments with maturities of three months or less at date of acquisition. In the cash flow statement, cash and cash equivalents are shown net of bank overdrafts, which are included as current borrowings in the liabilities section on the balance sheet. |
Fair values for quoted investments are based on observable market prices. If there is no active market for a financial asset, the fair value is established by using valuation techniques principally involving discounted cash flow analysis.
Non-derivative financial liabilities , including borrowings and trade payables, are stated at amortised cost using the effective interest method. For borrowings, their carrying value includes accrued interest payable, as well as unamortised issue costs. As shown in note 20, certain borrowings are subject to fair value hedges, as defined below.
| BAT Annual Report and Form 20-F 2018 | 131 | |
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Notes on the Accounts continued
1 Accounting policies continued
Derivative financial assets and liabilities are initially recognised, and subsequently measured, at fair value, which includes accrued interest receivable and payable where relevant. Changes in their fair values are recognised as follows:
| – |
for derivatives that are designated as cash flow hedges, the changes in their fair values are recognised directly in other comprehensive income, to the extent that they are effective, with the ineffective portion being recognised in the income statement. Where the hedged item results in a non-financial asset, the accumulated gains and losses, previously recognised in other comprehensive income, are included in the initial carrying value of the asset (basis adjustment) and recognised in the income statement in the same periods as the hedged item. Where the underlying transaction does not result in such an asset, the accumulated gains and losses are reclassified to the income statement in the same periods as the hedged item; |
| – |
for derivatives that are designated as fair value hedges, the carrying value of the hedged item is adjusted for the fair value changes attributable to the risk being hedged, with the corresponding entry being made in the income statement. The changes in fair value of these derivatives are also recognised in the income statement; |
| – |
for derivatives that are designated as hedges of net investments in foreign operations, the changes in their fair values are recognised directly in other comprehensive income, to the extent that they are effective, with the ineffective portion being recognised in the income statement. Where non-derivatives such as foreign currency borrowings are designated as net investment hedges, the relevant exchange differences are similarly recognised. The accumulated gains and losses are reclassified to the income statement when the foreign operation is disposed of; and |
| – |
for derivatives that do not qualify for hedge accounting or are not designated as hedges, the changes in their fair values are recognised in the income statement in the period in which they arise. These are referred to as “held-for-trading”. |
In order to qualify for hedge accounting, the Group is required to document prospectively the economic relationship between the item being hedged and the hedging instrument. The Group is also required to demonstrate an assessment of the economic relationship between the hedged item and the hedging instrument, which shows that the hedge will be highly effective on an ongoing basis. This effectiveness testing is re-performed periodically to ensure that the hedge has remained, and is expected to remain, highly effective.
Hedge accounting is discontinued when a hedging instrument is derecognised (e.g. through expiry or disposal), or no longer qualifies for hedge accounting. Where the hedged item is a highly probable forecast transaction, the related gains and losses remain in equity until the transaction takes place, when they are reclassified to the income statement in the same manner as for cash flow hedges as described above. When a hedged future transaction is no longer expected to occur, any related gains and losses, previously recognised in other comprehensive income, are immediately reclassified to the income statement.
Derivative fair value changes recognised in the income statement are either reflected in arriving at profit from operations (if the hedged item is similarly reflected) or in finance costs.
All of the Group’s hedging relationships at the end of 2017 are considered to be continuing hedge relationships on the adoption of IFRS 9.
The Group’s accounting policies for financial instruments prior to the adoption of IFRS 9 on 1 January 2018, were as set out above, except for the following: non-derivative financial assets were classified on initial recognition as available-for-sale investments, loans and receivables or cash and cash equivalents. Available-for-sale investments were non-derivative financial assets that could not be classified as loans and receivables or cash and cash equivalents. Apart from available-for-sale investments, non-derivative financial assets were stated at amortised cost using the effective interest method, subject to reduction for allowances for estimated irrecoverable amounts. These estimates for irrecoverable amounts were recognised when there was objective evidence that the full amount receivable would not be collected according to the original terms of the asset. Available-for-sale investments were stated at fair value, with changes in fair value being recognised directly in other comprehensive income. When such investments were derecognised (e.g. through disposal) or became impaired, the accumulated gains and losses, previously recognised in other comprehensive income, were reclassified to the income statement within ‘finance income’. Dividend and interest income on available-for-sale investments were included within ‘finance income’ when the Group’s right to receive payments was established.
Dividends
Dividend distributions to the Company’s shareholders are recognised as a liability in the Group’s financial statements in the period in which they are approved by shareholders (final dividends) or confirmed by the Directors (interim dividends). With effect from 1 January 2018, the Company has moved to four interim quarterly dividend payments.
Segmental analysis
The Group is organised and managed on the basis of its geographic regions. These are the reportable segments for the Group as they form the focus of the Group’s internal reporting systems and are the basis used by the chief operating decision maker, identified as the Management Board, for assessing performance and allocating resources.
The Group is primarily a single product business providing cigarettes and other tobacco products. While the Group has clearly differentiated brands, global segmentation between a wide portfolio of brands is not part of the regular internally reported financial information. The results of Next Generation Products are reported as part of the results of each geographic region, and are not currently material to the Group.
The prices agreed between Group companies for intra-group sales of materials, manufactured goods, charges for royalties, commissions, services and fees, are based on normal commercial practices which would apply between independent businesses. Royalty income, less related expenditure, is included in the region in which the licensor is based.
Adjusting items
Adjusting items are significant items of income or expense in revenue, profit from operations, net finance costs, taxation and the Group’s share of the post-tax results of associates and joint ventures which individually or, if of a similar type, in aggregate, are relevant to an understanding of the Group’s underlying financial performance because of their size, nature or incidence. In identifying and quantifying adjusting items, the Group consistently applies a policy that defines criteria that are required to be met for an item to be classified as adjusting. These items are separately disclosed in the segmental analyses or in the notes to the accounts as appropriate.
| 132 | BAT Annual Report and Form 20-F 2018 | |
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Governance
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Other Information
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1 Accounting policies continued
The Group believes that these items are useful to users of the Group financial statements in helping them to understand the underlying business performance and are used to derive the Group’s principal non-GAAP measures of adjusted revenue, adjusted profit from operations, adjusted diluted earnings per share, operating cash flow conversion ratio and adjusted cash from operations, all of which are before the impact of adjusting items and which are reconciled from revenue, profit from operations, diluted earnings per share, cash conversion ratio and net cash generated from operating activities.
Provisions
Provisions are recognised when either a legal or constructive obligation as a result of a past event exists at the balance sheet date, it is probable that an outflow of economic resources will be required to settle the obligation and a reasonable estimate can be made of the amount of the obligation.
Contingent liabilities and contingent assets
Subsidiaries and associate companies are defendants in tobacco-related and other litigation. Provision for this litigation (including legal costs) is made at such time as an unfavourable outcome becomes probable and the amount can be reasonably estimated.
Contingent assets are possible assets whose existence will only be confirmed by future events not wholly within the control of the entity and are not recognised as assets until the realisation of income is virtually certain.
Where a provision has not been recognised, the Group records its external legal fees and other external defence costs for tobacco-related and other litigation as these costs are incurred.
Repurchase of share capital
When share capital is repurchased the amount of consideration paid, including directly attributable costs, is recognised as a deduction from equity. Repurchased shares which are not cancelled, or shares purchased for the employee share ownership trusts, are classified as treasury shares and presented as a deduction from total equity.
Future changes to accounting policies
Certain changes to IFRS will be applicable to the Group financial statements in future years. Set out below are those which are considered to be most relevant to the Group.
IFRS 16 Leases
This Standard was finalised and published in January 2016 with a mandatory effective date of implementation of 1 January 2019. In adopting IFRS 16, the Group will apply the modified retrospective approach consistently across the Group, with no restatement of prior periods, as permitted by the Standard. On the initial implementation of the Standard, virtually all previously recognised operating leases will be capitalised as right-to-use assets and financial liabilities will be recognised at the same initial value.
The Group will take advantage of certain practical expedients available under the Standard, including “grandfathering” previously recognised lease arrangements such that contracts will not be reassessed at the implementation date as to whether they are, or contain, a lease, and leases previously classified as finance leases under IAS 17 Leases will remain capitalised on the adoption of IFRS 16. In addition, as part of the implementation, the Group will apply a single discount rate to a portfolio of leases with reasonably similar characteristics, will assess whether a lease is onerous prior to applying the Standard, will apply hindsight in determining the lease term if the contract contains options to extend or terminate the lease, and will not apply the capitalisation requirements of the Standard to leases for which the lease term ends within 12 months of the date of initial application.
Going forward, the Group will also adopt several practical expedients under the Standard including not applying the requirements of IFRS 16 to leases of intangible assets, applying the portfolio approach where appropriate to do so, and not applying the recognition and measurement requirements of IFRS 16 to short-term leases (leases of less than 12 months maximum duration) and to leases of low-value assets. Except for property-related leases, non-lease components will not be separated from lease components. The Group will continue to report recognised assets and liabilities under leases within property, plant and equipment and borrowings respectively rather than show these as separate line items on the face of the balance sheet.
Had the Standard been applied to the 2018 results, profit for the year would have been £11 million lower and non-current assets and liabilities would have each been increased by £564 million at the start of the year. At the end of the year, non-current assets would have been increased by £551 million and non-current liabilities by £558 million.
The anticipated impact of the new Standard to the Group’s balance sheet at 1 January 2019, and a reconciliation to reported leasing commitments, is shown in note 31.
IFRIC 23 Uncertainty over Income Tax treatments
This interpretation was finalised and published in June 2017 with a mandatory effective date of implementation of 1 January 2019. The Interpretation clarifies how to apply the recognition and measurement requirements in IAS 12 when there is uncertainty over income tax treatments. In particular, the Interpretation addresses whether uncertain tax treatments should be considered separately or together with one or more other uncertain tax treatments, and addresses the assumptions an entity makes about how probable it is that a taxation authority will accept an uncertain tax treatment. The impact on the Group’s profit and equity is not expected to be material.
Other interpretations and revisions
In addition, a number of other interpretations and revisions to existing standards have been issued which will be applicable to the Group’s financial statements in future years, but will not have a material effect on reported profit or equity or on the disclosures in the financial statements.
| BAT Annual Report and Form 20-F 2018 | 133 | |
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Notes on the Accounts continued
2 Segmental analyses (revised)
With effect from 1 January 2018, the Group has adopted IFRS 15 Revenue from Contracts with Customers. The Group has fully restated (“revised”) prior periods, as explained in notes 1 and 31.
Due to the acquisition of RAI, the Group revised its organisational structure. RAI is reported as a separate region (United States). The markets which previously comprised EEMEA merged with the Americas, Western Europe and Asia-Pacific to form three new regions. The markets in the Middle East merged with Asia-Pacific to form the Asia-Pacific and Middle East region (APME). The markets in East and Central Africa, West Africa and Southern Africa merged with the Americas region to form the Americas and Sub-Saharan Africa region (AMSSA). The markets in Russia, Ukraine, Caucasus, Central Asia, Belarus, Turkey and North Africa merged with the Western Europe region to form the Europe and North Africa region (ENA). The segments disclosed below have been revised on this new basis.
As the chief operating decision maker, the Management Board reviews external adjusted revenues and adjusted profit from operations to evaluate segment performance and allocate resources to the overall business. The results of Next Generation Products are reported as part of the results of each geographic region and are not currently material to the Group. Consequently, it is not considered a reportable segment that requires separate disclosure under the requirements of IFRS 8 Operating Segments. Interest income, interest expense and taxation are centrally managed and accordingly such items are not presented by segment as they are excluded from the measure of segment profitability.
The four geographic regions are the reportable segments for the Group as they form the focus of the Group’s internal reporting systems and are the basis used by the Management Board for assessing performance and allocating resources. The Management Board reviews current and prior year adjusted segmental revenue, adjusted profit from operations of subsidiaries and joint operations, and adjusted post-tax results of associates and joint ventures at constant rates of exchange. The constant rate comparison provided for reporting segment information is based on a retranslation, at prior year exchange rates, of the current year results of the Group, including intercompany royalties payable in foreign currency to UK entities. However, the Group does not adjust for the normal transactional gains and losses in operations which are generated by movements in exchange rates.
In respect of the United States region, all financial statements and financial information provided by or with respect to the US business or RAI (and/or the RAI Group) are prepared on the basis of US GAAP and constitute the primary financial statements or financial information of the US business or RAI (and/or the RAI Group). Solely for the purpose of consolidation within the results of BAT p.l.c. and the BAT Group, this financial information is then converted to International Financial Reporting Standards as issued by the IASB and adopted by the European Union (IFRS). To the extent any such financial information provided in these financial statements relate to the US business or RAI (and/or the RAI Group) it is provided as an explanation of the US business’ or RAI’s (and/or the RAI Group’s) primary US GAAP based financial statements and information.
The following table shows 2018 revenue and adjusted revenue at current rates, and 2018 adjusted revenue translated using 2017 rates of exchange. The 2017 figures are stated at the 2017 rates of exchange.
|
2018
|
2017
|
|||||||||||||||||||||||||||||||||
|
Adjusted
£m |
Translation
exchange £m |
Adjusted
£m |
Adjusting
£m |
Revenue
£m |
Adjusted
Revenue £m |
Adjusting
£m |
Revenue
£m |
|||||||||||||||||||||||||||
|
United States |
9,838 | (343 | ) | 9,495 | – | 9,495 | 4,160 | – | 4,160 | |||||||||||||||||||||||||
|
APME |
5,250 | (368 | ) | 4,882 | – | 4,882 | 4,973 | – | 4,973 | |||||||||||||||||||||||||
|
AMSSA |
4,560 | (449 | ) | 4,111 | – | 4,111 | 4,323 | – | 4,323 | |||||||||||||||||||||||||
|
ENA |
6,112 | (288 | ) | 5,824 | 180 | 6,004 | 5,850 | 258 | 6,108 | |||||||||||||||||||||||||
|
Revenue |
25,760 | (1,448 | ) | 24,312 | 180 | 24,492 | 19,306 | 258 | 19,564 | |||||||||||||||||||||||||
Note: adjusting items in revenue are in respect of excise included in goods acquired from a third party under short term arrangements and then
passed on to customers. This is deemed as adjusting due to the distorting nature to revenue and operating margin.
The following table shows 2017 revenue and adjusted revenue at current rates, and 2017 adjusted revenue translated using 2016 rates of exchange. The 2016 figures are stated at the 2016 rates of exchange.
|
2017
|
2016
|
|||||||||||||||||||||||||
|
Adjusted
£m |
Translation
exchange £m |
Adjusted
£m |
Adjusting
£m |
Revenue
£m |
Revenue
£m |
|||||||||||||||||||||
|
United States |
3,958 | 202 | 4,160 | – | 4,160 | – | ||||||||||||||||||||
|
APME |
4,776 | 197 | 4,973 | – | 4,973 | 4,769 | ||||||||||||||||||||
|
AMSSA |
4,365 | (42 | ) | 4,323 | – | 4,323 | 4,038 | |||||||||||||||||||
|
ENA |
5,507 | 343 | 5,850 | 258 | 6,108 | 5,323 | ||||||||||||||||||||
|
Revenue |
18,606 | 700 | 19,306 | 258 | 19,564 | 14,130 | ||||||||||||||||||||
Note: adjusting items in revenue are in respect of excise included in goods acquired from a third party under short term arrangements and then passed on to customers. This is deemed as adjusting due to the distorting nature to revenue and operating margin.
| 134 | BAT Annual Report and Form 20-F 2018 | |
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Strategic Report
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Governance
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Financial Statements
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Other Information
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2 Segmental analyses (revised) continued
The following table shows 2018 profit from operations and adjusted profit from operations at current rates, and 2018 adjusted profit from operations translated using 2017 rates of exchange. The 2017 figures are stated at the 2017 rates.
|
2018
|
2017
|
|||||||||||||||||||||||||||||||||
|
Adjusted*
£m |
Translation
exchange £m |
Adjusted*
£m |
Adjusting*
£m |
Segment
£m |
Adjusted*
£m |
Adjusting*
£m |
Segment
result £m |
|||||||||||||||||||||||||||
|
United States |
4,686 | (175 | ) | 4,511 | (505) | 4,006 | 1,928 | (763) | 1,165 | |||||||||||||||||||||||||
|
APME |
2,099 | (151 | ) | 1,948 | (90) | 1,858 | 2,049 | (147) | 1,902 | |||||||||||||||||||||||||
|
AMSSA |
1,922 | (184 | ) | 1,738 | (194) | 1,544 | 1,782 | (134) | 1,648 | |||||||||||||||||||||||||
|
ENA |
2,217 | (67 | ) | 2,150 | (245) | 1,905 | 2,170 | (473) | 1,697 | |||||||||||||||||||||||||
|
Profit from operations |
10,924 | (577 | ) | 10,347 | (1,034) | 9,313 | 7,929 | (1,517) | 6,412 | |||||||||||||||||||||||||
|
Net finance costs |
(1,415) | 30 | (1,385) | 4 | (1,381 | ) | (889) | (205) | (1,094 | ) | ||||||||||||||||||||||||
|
United States |
– | – | – | – | – | 624 | 23,195 | 23,819 | ||||||||||||||||||||||||||
|
APME |
417 | (33 | ) | 384 | 32 | 416 | 384 | 29 | 413 | |||||||||||||||||||||||||
|
ENA |
3 | – | 3 | – | 3 | 4 | (27) | (23 | ) | |||||||||||||||||||||||||
| Share of post-tax results of associates and joint ventures | 420 | (33 | ) | 387 | 32 | 419 | 1,012 | 23,197 | 24,209 | |||||||||||||||||||||||||
|
Profit/(loss) before taxation |
9,929 | (580 | ) | 9,349 | (998) | 8,351 | 8,052 | 21,475 | 29,527 | |||||||||||||||||||||||||
| Taxation (charge)/credit on ordinary activities | (2,508) | 144 | (2,364) | 223 | (2,141 | ) | (2,091) | 10,220 | 8,129 | |||||||||||||||||||||||||
|
Profit for the year |
6,210 | 37,656 | ||||||||||||||||||||||||||||||||
| * |
The adjustments to profit from operations, net finance costs and the Group’s share of the post-tax results of associates and joint ventures are explained in notes 3(e) to 3(h), note 4(b), note 5(a), and note 6(b), 6(d) and 6(e), respectively. |
| BAT Annual Report and Form 20-F 2018 | 135 | |
Table of Contents
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Financial Statements
|
Notes on the Accounts continued
2 Segmental analyses (revised) continued
The following table shows 2017 profit from operations and adjusted profit from operations at current rates, and 2017 adjusted profit from operations translated using 2016 rates of exchange. The 2016 figures are stated at the 2016 rates of exchange.
|
2017
|
2016
|
|||||||||||||||||||||||||||||||||
|
Adjusted*
£m |
Translation
£m |
Adjusted*
rates £m |
Adjusting*
£m |
Segment
£m |
Adjusted*
£m |
Adjusting*
£m |
Segment
£m |
|||||||||||||||||||||||||||
|
United States |
1,827 | 101 | 1,928 | (763) | 1,165 | – | – | – | ||||||||||||||||||||||||||
|
APME |
1,962 | 87 | 2,049 | (147) | 1,902 | 1,972 | (198) | 1,774 | ||||||||||||||||||||||||||
|
AMSSA |
1,799 | (17 | ) | 1,782 | (134) | 1,648 | 1,684 | (262) | 1,422 | |||||||||||||||||||||||||
|
ENA |
2,017 | 153 | 2,170 | (473) | 1,697 | 1,824 | (345) | 1,479 | ||||||||||||||||||||||||||
| 7,605 | 324 | 7,929 | (1,517) | 6,412 | 5,480 | (805) | 4,675 | |||||||||||||||||||||||||||
|
Fox River** |
– | – | (20) | (20 | ) | |||||||||||||||||||||||||||||
|
Profit from operations |
7,605 | 324 | 7,929 | (1,517) | 6,412 | 5,480 | (825) | 4,655 | ||||||||||||||||||||||||||
|
Net finance (costs)/income |
(833 | ) | (56 | ) | (889) | (205) | (1,094 | ) | (529) | (108) | (637 | ) | ||||||||||||||||||||||
|
United States |
593 | 31 | 624 | 23,195 | 23,819 | 991 | 889 | 1,880 | ||||||||||||||||||||||||||
|
APME |
354 | 30 | 384 | 29 | 413 | 333 | 11 | 344 | ||||||||||||||||||||||||||
|
AMSSA |
– | – | – | – | – | – | – | – | ||||||||||||||||||||||||||
|
ENA |
4 | – | 4 | (27) | (23 | ) | 3 | – | 3 | |||||||||||||||||||||||||
| Share of post-tax results of associates and joint ventures | 951 | 61 | 1,012 | 23,197 | 24,209 | 1,327 | 900 | 2,227 | ||||||||||||||||||||||||||
|
Profit/(loss) before taxation |
7,723 | 329 | 8,052 | 21,475 | 29,527 | 6,278 | (33) | 6,245 | ||||||||||||||||||||||||||
|
Taxation on ordinary activities |
(2,017) | (74 | ) | (2,091) | 10,220 | 8,129 | (1,473) | 67 | (1,406 | ) | ||||||||||||||||||||||||
|
Profit for the year
|
37,656 | 4,839 | ||||||||||||||||||||||||||||||||
| * |
The adjustments to profit from operations, net finance (costs)/income and the Group’s share of the post-tax results of associates and joint ventures are explained in notes 3(e) to 3(h), note 4(b), note 5(a) and note 6(b), 6(d) and 6(e) respectively. |
| ** |
The Fox River charge in 2016 (see note 3(g) and note 28) has not been allocated to any segment as it neither relates to current operations nor the tobacco business. It has been presented separately from the segmental reporting which is used to evaluate segment performance and to allocate resources, and is reported to the chief operating decision maker on this basis. |
| 136 | BAT Annual Report and Form 20-F 2018 | |
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Strategic Report
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Governance
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Financial Statements
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Other Information
|
2 Segmental analyses (revised) continued
Adjusted profit from operations at constant rates of £10,924 million (2017: £7,605 million; 2016: £5,197 million) excludes certain depreciation, amortisation and impairment charges as explained in notes 3(e),(3f) and (3h). These are excluded from segmental profit from operations at constant rates as follows:
|
2018
|
2017
|
|||||||||||||||||||||||||||||||||
|
Adjusted
£m |
Translation
exchange £m |
Adjusted
£m |
Adjusting
£m |
Depreciation,
amortisation and impairment Current rates £m |
Adjusted
depreciation, amortisation and impairment £m |
Adjusting
£m |
Depreciation,
amortisation and impairment £m |
|||||||||||||||||||||||||||
|
United States |
158 | (4 | ) | 154 | 289 | 443 | 59 | 116 | 175 | |||||||||||||||||||||||||
|
APME |
111 | (6 | ) | 105 | 22 | 127 | 111 | 24 | 135 | |||||||||||||||||||||||||
|
AMSSA |
100 | 1 | 101 | 115 | 216 | 102 | 32 | 134 | ||||||||||||||||||||||||||
|
ENA |
148 | (5 | ) | 143 | 109 | 252 | 162 | 296 | 458 | |||||||||||||||||||||||||
| 517 | (14 | ) | 503 | 535 | 1,038 | 434 | 468 | 902 | ||||||||||||||||||||||||||
|
|
2017
|
|
|
2016
|
|
|||||||||||||||||||||||||||||
|
Adjusted
depreciation, amortisation and impairment Constant rates £m |
Translation
exchange £m |
Adjusted
depreciation, amortisation and impairment Current rates £m |
Adjusting
£m |
Depreciation,
amortisation and impairment Current rates £m |
Adjusted
depreciation, amortisation and impairment £m |
Adjusting
£m |
Depreciation,
amortisation and impairment £m |
|||||||||||||||||||||||||||
|
United States |
57 | 2 | 59 | 116 | 175 | – | – | – | ||||||||||||||||||||||||||
|
APME |
109 | 2 | 111 | 24 | 135 | 114 | 52 | 166 | ||||||||||||||||||||||||||
|
AMSSA |
99 | 3 | 102 | 32 | 134 | 121 | 48 | 169 | ||||||||||||||||||||||||||
|
ENA |
153 | 9 | 162 | 296 | 458 | 160 | 112 | 272 | ||||||||||||||||||||||||||
| 418 | 16 | 434 | 468 | 902 | 395 | 212 | 607 | |||||||||||||||||||||||||||
External revenue and non-current assets other than financial instruments, deferred tax assets and retirement benefit assets are analysed between the UK and all foreign countries at current rates of exchange as follows:
|
United Kingdom
|
All foreign countries
|
Group
|
||||||||||||||||||||||||||||||||||||||
| Revenue is based on location of sale |
2018
£m |
2017
£m |
2016
£m |
2018
£m |
2017
£m |
2016
£m |
2018
£m |
2017
£m |
2016
£m |
|||||||||||||||||||||||||||||||
|
External revenue |
184 | 203 | 266 | 24,308 | 19,361 | 13,864 | 24,492 | 19,564 | 14,130 | |||||||||||||||||||||||||||||||
|
United Kingdom
|
All foreign countries
|
Group
|
||||||||||||||||||||||||||
|
2018
£m |
2017
£m |
2018 £m |
2017 £m |
2018 £m |
2017 £m |
|||||||||||||||||||||||
|
Intangible assets |
529 | 514 | 123,484 | 117,271 | 124,013 | 117,785 | ||||||||||||||||||||||
|
Property, plant and equipment |
404 | 406 | 4,762 | 4,476 | 5,166 | 4,882 | ||||||||||||||||||||||
| Investments in associates and joint ventures | – | – | 1,737 | 1,577 | 1,737 | 1,577 | ||||||||||||||||||||||
The consolidated results of RAI companies operating in the United States met the criteria for separate disclosure under the requirements of IFRS 8 Operating Segments . Revenue arising from the operations of RAI in 2018 and in 2017 since the date of acquisition was £9,506 million and £4,160 million; respectively. Non-current assets attributable to the operations of RAI were £113,935 million (2017: £107,154 million).
The main acquisitions comprising the goodwill balance of £46,163 million (2017: £44,147 million), included in intangible assets, are provided in note 9. Included in investments in associates and joint ventures are amounts of £1,682 million (2017: £1,527 million) attributable to the investment in ITC Ltd. Further information is provided in notes 5 and 11.
| BAT Annual Report and Form 20-F 2018 | 137 | |
Table of Contents
|
Financial Statements
|
Notes on the Accounts continued
3 Profit from operations
Enumerated below are movements in costs that have impacted profit from operations in 2018, 2017 and 2016. These include changes in our underlying business performance, as well as the impact of adjusting items, as defined in note 1, in profit from operations (note 3(d) to 3(h)).
(a) Employee benefit costs
The total auditor’s remuneration to KPMG firms and associates included above are £25.2 million (2017: £29.9 million; 2016: £11.4 million).
During 2018 the Group incurred expenditure of £8.7 million (2017: £nil million, 2016: £nil million) within audit-related assurance services associated with the controls attestation of the Group’s implementation of Sarbanes-Oxley Section 404 during 2018.
During 2017, the Group incurred additional expenditure with the Group’s auditor, as part of the acquisition of the remaining shares in RAI not previously owned. This was due to the Securities and Exchange Commission (SEC) listing requirements to re-audit 2015 and 2016 under Public Company Accounting Oversight Board (“PCAOB”) standards, to audit the purchase price allocation, to provide assurance services on the registration documents and to provide, amongst other things, assurance services with regards to the planned 2018 implementation of Sarbanes-Oxley Section 404.
| 138 | BAT Annual Report and Form 20-F 2018 | |
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Strategic Report
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Governance
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Financial Statements
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Other Information
|
3 Profit from operations continued
Accordingly, the following costs, related to the acquisition of RAI and treated as an adjusting item, were incurred within the respective categories: audit-related assurance service £7.7 million and within other assurance services £3.5 million.
Under SEC regulations, the remuneration to KPMG firms and associates of £25.2 million in 2018 (2017: £30.1 million; 2016: £11.4 million) is required to be presented as follows: audit fees £24.7 million (2017: £29.2 million; 2016: £9.2 million), audit-related fees £0.4 million (2017: £0.5 million; 2016: £0.2 million), tax fees £nil million (2017: £0.2 million; 2016: £0.5 million) and all other fees £0.1 million (2017: £0.2 million; 2016: £1.5 million).
Total research and development costs including employee benefit costs and depreciation are £258 million (2017: £191 million; 2016: £144 million).
(d) Master Settlement Agreement
In 1998, the major US cigarette manufacturers (including R.J. Reynolds Tobacco Company, Lorillard and Brown & Williamson, businesses which are now part of Reynolds American) entered into the Master Settlement Agreement (MSA) with attorneys general representing most US states and territories. The MSA imposes a perpetual stream of future payment obligations on the major US cigarette manufacturers. The amounts of money that the participating manufacturers are required to annually contribute are based upon, amongst other things, the volume of cigarettes sold and market share (based on cigarette shipments in that year).
During 2012, R.J. Reynolds Tobacco Company, Santa Fe Natural Tobacco Company (SFNTC), various other tobacco manufacturers, 17 states, the District of Columbia and Puerto Rico reached an agreement related to the Non-Participating Manufacturer (NPM) adjustment under the MSA and three more states joined the agreement in 2013. Under this agreement, R.J. Reynolds Tobacco Company will receive credits, currently estimated to be more than US$1 billion, in respect of its Non-Participating Manufacturer (NPM) Adjustment claims related to the period from 2003 to 2012. These credits have been and will be applied against the companies’ MSA payments over a period of five years from 2013, subject to, and dependent upon, meeting the various ongoing performance obligations. During 2014, two additional states agreed to settle NPM disputes related to claims for the period 2003 to 2012. It is estimated that R.J. Reynolds Tobacco Company will receive US$170 million in credits, which will be applied over a five-year period from 2014. During 2015, another state agreed to settle NPM disputes related to claims for the period 2004 to 2014. It is estimated that R.J. Reynolds Tobacco Company will receive US$285 million in credits, which will be applied over a four-year period from 2015. During 2016, no additional states agreed to settle NPM disputes. During 2017, two more states agreed to settle NPM disputes related to claims for the period 2004 to 2014. It is estimated that R.J. Reynolds Tobacco Company will receive US$61 million in credits, which will be applied over a five-year period from 2017. During 2018, nine more states agreed to settle NPM disputes related to claims for the period 2004 to 2019, with an option through 2022, subject to certain conditions. It is estimated that R.J. Reynolds Tobacco Company will receive US$182 million in credits for settled periods through 2017, which will be applied over a five-year period from 2018. Also in 2018, one additional state agreed to settle NPM disputes related to claims for the period 2004 to 2024, subject to certain conditions. It is estimated that R.J. Reynolds Tobacco Company will receive US$205 million in credits for settled periods through 2017, which will be applied over a five-year period from 2019. Credits in respect of future years’ payments and the NPM Adjustment claims would be accounted for in the applicable year and will not be treated as adjusting items. Only credits in respect of prior year payments are included as adjusting items.
The BAT Group is subject to substantial payment obligations under the MSA and the state settlement agreements with the states of Mississippi, Florida, Texas and Minnesota (such settlement agreements, collectively State Settlement Agreements). RAl’s operating subsidiaries’ expenses and payments under the MSA and the State Settlement Agreements for 2017 amounted to US$2,856 million in respect of settlement expenses and US$4,612 million in respect of settlement cash payments. RAl’s operating subsidiaries’ expenses and payments under the MSA and the State Settlement Agreements for 2018 amounted to US$2,741 million in respect of settlement expenses and US$917 million in respect of settlement cash payments.
(e) Restructuring and integration costs
Restructuring costs reflect the costs incurred as a result of initiatives to improve the effectiveness and the efficiency of the Group as a globally integrated enterprise, including the relevant operating costs of implementing the new operating model. These costs represent additional expenses incurred, which are not related to the normal business and day-to-day activities.
The new operating model is underpinned by a global single instance of SAP with full deployment occurring during 2016 with benefits already realised within the business and future savings expected in the years to come. The initiatives also include a review of the Group’s trade marketing and manufacturing operations, supply chain, overheads and indirect costs, organisational structure and systems and software used.
The costs of the Group’s initiatives together with the costs of integrating acquired businesses into existing operations, including acquisition costs, are included in profit from operations under the following headings:
|
2018
|
2017
|
2016
|
||||||||||
| Employee benefit costs | 176 | 193 | 240 | |||||||||
| Depreciation, amortisation and impairment costs | 48 | 85 | 64 | |||||||||
| Other operating expenses | 145 | 330 | 325 | |||||||||
| Other operating income | (6 | ) | (8 | ) | (26 | ) | ||||||
| 363 | 600 | 603 | ||||||||||
Restructuring and integration costs in 2018 include integration costs associated with the acquisition of RAI and ongoing costs of implementing the revisions to the Group’s operating model. This includes the cost of packages in respect of permanent headcount reductions and permanent employee benefit reductions in the Group. The costs also cover downsizing activities in Russia, Germany and APME, partially offset by the income from sale of certain assets that have become available as part of the downsizing activities.
| BAT Annual Report and Form 20-F 2018 | 139 | |
Table of Contents
|
Financial Statements
|
Notes on the Accounts continued
3 Profit from operations continued
Restructuring and integration costs in 2017 include advisor fees and costs incurred related to the acquisition of the remaining shares in RAI not already owned by the Group, that completed on 25 July 2017 (note 24). It also includes the implementation of a new operating model and the cost of redundancy packages in respect of permanent headcount reductions and permanent employee benefit reductions in the Group. The costs also cover integration costs incurred as a result of the RAI acquisition, factory closure and downsizing activities in Germany and Malaysia, certain exit costs and asset write-offs related to the withdrawal from the Philippines.
Restructuring and integration costs in 2016 principally related to the restructuring initiatives directly related to implementation of a new operating model and the cost of initiatives in respect of permanent headcount reductions and permanent employee benefit reductions in the Group. The costs also covered factory closures and downsizing activities in Germany, Malaysia and Brazil, certain exit costs and asset write-offs related to the change in approach to the commercialisation of Voke, uncertainties surrounding regulatory changes and restructurings in Japan and Australia.
In 2018, other operating income includes gains from the sale of land and buildings in The Netherlands and in 2017, this included gains from the sale of land and buildings in Brazil. In 2016, this included gains from the sale of land and buildings in Malaysia.
(f) Amortisation and impairment of trademarks and similar intangibles
Acquisitions including RAI, TDR d.o.o. (TDR) and Skandinavisk Tobakskompagni (ST) in previous years, have resulted in the capitalisation of trademarks and similar intangibles which are amortised over their expected useful lives, which do not exceed 20 years. The amortisation and impairment charge of £377 million (2017: £383 million; 2016: £149 million) is included in depreciation, amortisation and impairment costs in profit from operations.
(g) Fox River
As explained in note 28, a Group subsidiary has certain liabilities in respect of indemnities given on the purchase and disposal of former businesses in the United States and in 2011, the subsidiary provided £274 million in respect of claims in relation to environmental clean-up costs of the Fox River.
On 30 September 2014, a Group subsidiary, NCR, Appvion and Windward Prospects entered into a Funding Agreement with regard to the costs for the clean-up of Fox River.
In January 2017, NCR and Appvion entered into a consent decree with the US Government to resolve how the remaining clean-up will be funded and to resolve further outstanding claims between them. The Consent Decree was approved by a US District Judge in August 2017 but is currently subject to appeal in the US Seventh Circuit Court of Appeals, refer to note 28 for further details.
In July 2016, the High Court ruled in a Group subsidiary’s favour that a dividend of € 135 million paid by Windward to Sequana in May 2009 was a transaction made with the intention of putting assets beyond the reach of the Group subsidiary and of negatively impacting its interests. On 10 February 2017, further to a hearing in January 2017 to determine the relief due, the Court found in the Group subsidiary’s favour, ordering that Sequana must pay an amount up to the full value of the dividend plus interest which equates to around US$185 million, related to past and future clean-up costs. The Court granted all parties leave to appeal and Sequana a stay in respect of the above payments. In June 2018, the Court of Appeal heard arguments in the Sequana Claims Appeal (as defined in note 28). On 6 February 2019, the Court of Appeal gave judgment upholding the High Court’s findings, with one immaterial change to the method of calculating the damages awarded. Sequana therefore remains liable to pay the above mentioned dividend. Due to the uncertain outcome of the case no asset has been recognised in relation to this ruling. In February 2017, Sequana entered into a process in France seeking court protection (the “Sauvegarde”), exiting the Sauvegarde in June 2017. No payments have been received.
The provision is £108 million at 31 December 2018 (2017: £138 million). Based on this Funding Agreement, £30 million has been paid in 2018, which includes legal costs of £5 million (2017: £25 million, including legal costs of £7 million; 2016: £17 million, including legal costs of £11 million). In addition, in 2016 the devaluation of sterling against the US dollar led to a charge of £20 million.
(h) Other adjusting items
In 2018, the Group incurred £294 million of other adjusting items, including £178 million related to Engle progeny litigation offset by credits related to the Non-Participating Manufacturers settlement, which have been adjusted within ‘other operating expenses’.
In 2018, the European Securities and Markets Authority (ESMA) recognised the specific issues related to Venezuela and proposed that companies with exposure to Venezuela use an “estimated” exchange rate rather than the official exchange rate, as otherwise required under IAS 21. Accordingly, the Group has used an exchange rate calculated with reference to the estimated inflation since the latest dividend payment in 2010. In addition, the net assets of the Group’s Venezuelan operations are subject to accounting adjustments IAS 29 Financial Reporting in Hyperinflationary Economies, as they are revalued, for accounting purposes, from their acquisition date to the balance sheet date. However, management believes that such a revaluation is not reflective of the recoverable value of those assets and have incurred an impairment charge of £110 million. This charge has been treated as an adjusting item as it does not reflect the underlying performance of the Group. The Group has also recognised a gain of £45 million within net finance costs (note 4), being the partial counter-party to the above non-monetary asset movement, generating a monetary gain due to hyperinflation accounting under IAS 29.
In 2017, the release of the fair value acquisition accounting adjustments to finished goods inventories of £465 million on the RAI acquisition has been adjusted within ‘Changes in inventories of finished goods and work in progress’. Also included in 2017 is the impairment of certain assets of £69 million related to a third-party distributor (Agrokor) in Croatia, that has been adjusted within ‘other operating expenses’.
In 2016, the Board of Audit and Inspection of Korea (“BAI”) concluded its tax assessment in relation to the 2014 year-end tobacco inventory, and imposed additional sales tax (excise and VAT) and penalties. This resulted in the recognition of a £53 million charge by a Group subsidiary. Management deems the tax and penalties to be unfounded and has appealed to the tax tribunal against the assessment. Based on the legal opinion from a local law firm, management believes that this appeal will be successful, and that the findings of the BAI will be reversed. On grounds of materiality and the high likelihood of the tax and penalties being reversed in future, the Group has classified the tax and penalties charge as an adjusting item in 2016.
| 140 | BAT Annual Report and Form 20-F 2018 | |
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Strategic Report
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Governance
|
Financial Statements
|
Other Information
|
4 Net finance costs
(a) Net finance costs/(income)
|
2018
|
2017
|
2016
|
||||||||||
| Interest expense | 1,593 | 1,081 | 645 | |||||||||
|
Facility fees |
13 | 13 | 5 | |||||||||
|
Interest related to adjusting tax payables (note 4(b)) |
41 | 43 | 25 | |||||||||
|
Loss on bond redemption (note 4(b)) |
– | – | 101 | |||||||||
|
Acquisition of RAI (note 4(b)) |
– | 153 | – | |||||||||
|
Fair value changes on derivative financial instruments and hedged items |
(154 | ) | (149 | ) | (458 | ) | ||||||
|
Hedge ineffectiveness (note 4(b)) |
– | 9 | – | |||||||||
|
Venezuela hyperinflation (note 4 (b)) |
(45 | ) | – | – | ||||||||
|
Exchange differences on financial liabilities |
36 | 47 | 363 | |||||||||
|
Finance costs |
1,484 | 1,197 | 681 | |||||||||
|
Interest under the effective interest method |
(68 | ) | (83 | ) | (68 | ) | ||||||
|
Dividend income
|
– | (1 | ) | – | ||||||||
|
Hedge ineffectiveness (note 4(b))
|
– | – | (18 | ) | ||||||||
|
Exchange differences on financial assets
|
(35 | ) | (19 | ) | 42 | |||||||
|
Finance income
|
(103 | ) | (103 | ) | (44 | ) | ||||||
| Net finance costs | 1,381 | 1,094 | 637 | |||||||||
The Group manages foreign exchange gains and losses and fair value changes on a net basis excluding adjusting items, which are explained in note 4(b); and the derivatives that generate the fair value changes are in note 16.
Facility fees principally relate to the Group’s central banking facilities.
(b) Adjusting items included in net finance costs
Adjusting items are significant items in net finance costs which individually or, if of a similar type, in aggregate, are relevant to an understanding of the Group’s underlying financial performance.
In 2018, the Group incurred interest on adjusting tax payables of £41 million (2017: £43 million; 2016: £25 million). This included interest of £25 million (2017: £25 million; 2016: £25 million) in relation to the Franked Investment Income Group Litigation Order (FII GLO) (note 6(b)) and interest of £12 million in relation to retrospective guidance by a tax authority on overseas withholding tax.
Also in 2018, the Group recognised a monetary gain of £45 million related to the application of hyperinflationary accounting in Venezuela (note 3(h)).
In 2017, the Group incurred pre-financing costs related to the acquisition of RAI of £153 million.
Also in 2017, the Group realised a £9 million charge in relation to the reversal of a gain recognised in 2016, related to hedge ineffectiveness on external swaps following the referendum regarding “Brexit”. The gain in 2016 of £18 million was deemed to be adjusting as it is not representative of the underlying performance of the business and so the partial reversal has also been deemed as an adjusting item.
In 2016, the Group redeemed a US$700 million bond, prior to its original maturity date of 15 November 2018. This led to a loss of US$130 million (£101 million), which has been treated as an adjusting item.
| BAT Annual Report and Form 20-F 2018 | 141 | |
Table of Contents
|
Financial Statements
|
Notes on the Accounts continued
5 Associates and joint ventures
|
2018 |
2017 |
2016 | ||||||||||||||||||||||||||
|
Total £m
|
Group’s share £m
|
Total £m
|
Group’s share £m
|
Total £m
|
Group’s share £m
|
|||||||||||||||||||||||
| Revenue | 7,235 | 2,058 | 14,085 | 4,794 | 16,491 | 5,997 | ||||||||||||||||||||||
| Profit from operations* | 2,128 | 630 | 4,342 | 24,854 | 9,379 | 3,740 | ||||||||||||||||||||||
| Net finance costs | (8 | ) | (3 | ) | (279 | ) | (116 | ) | (477 | ) | (200 | ) | ||||||||||||||||
| Profit on ordinary activities before taxation | 2,120 | 627 | 4,063 | 24,738 | 8,902 | 3,540 | ||||||||||||||||||||||
| Taxation on ordinary activities | (678 | ) | (201 | ) | (1,441 | ) | (522 | ) | (3,280 | ) | (1,308 | ) | ||||||||||||||||
| Profit on ordinary activities after taxation | 1,442 | 426 | 2,622 | 24,216 | 5,622 | 2,232 | ||||||||||||||||||||||
| Non-controlling interests | (24 | ) | (7 | ) | (22 | ) | (7 | ) | (17 | ) | (5 | ) | ||||||||||||||||
| Post-tax results of associates and joint ventures | 1,418 | 419 | 2,600 | 24,209 | 5,605 | 2,227 | ||||||||||||||||||||||
| Comprised of: | ||||||||||||||||||||||||||||
|
– adjusted share of post-tax results of associates and joint ventures |
1,308 | 387 | 2,785 | 1,012 | 3,461 | 1,327 | ||||||||||||||||||||||
|
– issue of shares and change in shareholding |
75 | 22 | 98 | 29 | 36 | 11 | ||||||||||||||||||||||
|
– gain on deemed divestment of RAI |
– | – | – | 23,288 | – | – | ||||||||||||||||||||||
|
– gain on disposal of assets |
– | – | – | – | 2,231 | 941 | ||||||||||||||||||||||
|
– other |
35 | 10 | (283 | ) | (120 | ) | (123 | ) | (52 | ) | ||||||||||||||||||
| 1,418 | 419 | 2,600 | 24,209 | 5,605 | 2,227 | |||||||||||||||||||||||
| * |
The gain on deemed divestment of RAI is recognised in the Group’s share of associates profit from operations. |
Enumerated below are movements that have impacted the post-tax results of associates and joint ventures in 2018, 2017 and 2016.
(a) Adjusting items
In 2018, the Group’s interest in ITC Ltd. (ITC) decreased from 29.71% to 29.57% (2017: 29.89% to 29.71%; 2016: 30.06% to 29.89%) as a result of ITC issuing ordinary shares under the ITC Employee Share Option Scheme. The issue of these shares and change in the Group’s share of ITC resulted in a gain of £22 million (2017: £29 million; 2016: £11 million), which is treated as a deemed partial disposal and included in the income statement. ITC has also recognised an adjusting gain in respect of the release of certain provisions related to a tax claim, the Group’s share of which was £10 million.
On 25 July 2017, the Group announced the completion of the acquisition of the 57.8% of RAI the Group did not already own. As at this date RAI ceased to be reported as an associate and has become a fully owned subsidiary. Accordingly, as at that date, the Group was deemed to divest its investment in RAI as an associate and consolidated RAI in accordance with IFRS 10 Consolidated Financial Statements. This resulted in a gain of £23,288 million that has been reported in the Group’s share of post-tax results of associates and joint ventures.
In 2017, due to a deterioration in the financial performance of Tisak d.d. (Tisak), linked to the financial difficulties associated with a third-party distributor (Agrokor) in Croatia, the Group impaired the carrying value of this investment. This resulted in a charge of £27 million to the income statement that has been reported as an “other” adjusting item.
In 2016, RAI recognised a gain in relation to the sale of the international rights to Natural American Spirit to the Japan Tobacco Group of companies (JT) of US$4,861 million. The Group’s share of this net gain amounted to £941 million (net of tax).
In 2017, RAI recognised, prior to acquisition by the Group, the following amounts in ‘other’: transaction costs associated with the acquisition by the Group of US$125 million, the Group’s share of which is £33 million (net of tax) (2016: £nil million), deferred tax charges in respect of temporary differences on trademarks of US$51 million, the Group’s share of which is £18 million (2016: £nil million), restructuring charges of US$79 million, the Group’s share of which is £14 million (net of tax) (2016: US$36 million, the Group’s share of which is £7 million) and costs in respect of a number of Engle progeny lawsuits and other tobacco litigation charges that amounted to US$162 million, the Group’s share of which is £32 million (net of tax) (2016: US$86 million, the Group’s share of which is £17 million (net of tax)). Additionally, there is income of US$17 million (2016: US$6 million) related to the Non-Participating Manufacturer (NPM) Adjustment claims of the states no longer challenging the findings of non-diligence entered against them by an Arbitration Panel, the Group’s share of which is £4 million (net of tax) (2016: £2 million). The remaining costs in 2016 includes income relating to the early termination of the Manufacturing Agreement between BATUS Japan Inc. and RJRT (note 27) of US$90 million, the Group’s share of which is £18 million (net of tax) and transaction costs of US$5 million and financing costs of US$243 million, connected with the acquisition of Lorillard, the Group’s share is £1 million (net of tax) and £47 million of financing costs.
(b) Master Settlement Agreement
For information on the Master Settlement Agreement applicable to RAI as an associate for the period up to and including 24 July 2017 (note 3(d)).
| 142 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
5 Associates and joint ventures continued
(c) Other financial information
The Group’s share of the results of associates and joint ventures is shown in the table below.
| BAT Annual Report and Form 20-F 2018 | 143 | |
Table of Contents
|
Financial Statements
|
Notes on the Accounts continued
6 Taxation on ordinary activities
(a) Summary of taxation on ordinary activities
|
2018 £m |
2017 £m Revised |
2016 £m |
||||||||||
| UK corporation tax | 60 | 26 | 7 | |||||||||
| Comprising: | ||||||||||||
| – current year tax expense | 66 | 26 | 7 | |||||||||
| – adjustments in respect of prior periods | (6 | ) | – | – | ||||||||
| Overseas tax | 2,455 | 1,617 | 1,395 | |||||||||
| Comprising: | ||||||||||||
| – current year tax expense | 2,460 | 1,615 | 1,382 | |||||||||
| – adjustments in respect of prior periods | (5 | ) | 2 | 13 | ||||||||
| Total current tax | 2,515 | 1,643 | 1,402 | |||||||||
|
Deferred tax |
(374 | ) | (9,772 | ) | 4 | |||||||
| Comprising: | ||||||||||||
| – deferred tax relating to origination and reversal of temporary differences | (304 | ) | (152 | ) | 4 | |||||||
| – deferred tax relating to changes in tax rates | (70 | ) | (9,620 | ) | – | |||||||
| 2,141 | (8,129 | ) | 1,406 | |||||||||
With effect from 1 January 2018, the Group has adopted IFRS 15 Revenue from Contracts with Customers. The Group has revised 2017, as explained in notes 1 and 31.
(b) Franked Investment Income Group Litigation Order
The Group is the principal test claimant in an action in the United Kingdom against HM Revenue and Customs (HMRC) in the Franked Investment Income Group Litigation Order (FII GLO). There are 25 corporate groups in the FII GLO. The case concerns the treatment for UK corporate tax purposes of profits earned overseas and distributed to the UK.
The original claim was filed in 2003. The trial of the claim was split broadly into issues of liability and quantification. The main liability issues were heard by the High Court, Court of Appeal and Supreme Court in the UK and the European Court of Justice in the period to November 2012. The detailed technical issues of the quantification mechanics of the claim were heard by the High Court during May and June 2014 and the judgment handed down on 18 December 2014. The High Court determined that in respect of issues concerning the calculation of unlawfully charged corporation tax and advance corporation tax, the law of restitution including the defence on change of position and questions concerning the calculation of overpaid interest, the approach of the Group was broadly preferred. The conclusion reached by the High Court would, if upheld, produce an estimated receivable of £1.2 billion for the Group. Appeals on a majority of the issues were made to the Court of Appeal, which heard the arguments in June 2016. The Court of Appeal determined in November 2016 on the majority of issues that the conclusion reached by the High Court should be upheld. HMRC have sought permission to appeal to the Supreme Court on all issues. A decision on whether permission will be granted is anticipated in early 2019. If permission is granted the Supreme Court will not be expected to hand down its judgment until 2020. In July 2018, the Supreme Court handed down its judgment in the Prudential Assurance Company Ltd case, which is closely related to the FII GLO. Applying the Prudential judgment reduces the value of the FII claim to approximately £0.6 billion, mainly as the result of the application of simple interest.
During 2015, HMRC paid to the Group a gross amount of £1,224 million in two separate payments. The payments made by HMRC have been made without any admission of liability and are subject to refund were HMRC to succeed on appeal. The second payment in November 2015 followed the introduction of a new 45% tax on the interest component of restitution claims against HMRC. HMRC held back £261 million from the second payment contending that it represents the new 45% tax on that payment, leading to total cash received by the Group of £963 million. Actions challenging the legality of the withholding of the 45% tax have been lodged by the Group. The First Tier Tribunal found in favour of HMRC in July 2017 and the Group’s appeal to the Upper Tribunal was heard in July 2018 and judgment has not yet been handed down.
Due to the uncertainty of the amounts and eventual outcome the Group has not recognised any impact in the Income Statement in the current or prior period. The receipt, net of the deduction by HMRC, is held as deferred income as disclosed in note 22. Any future recognition as income will be treated as an adjusting item, due to the size of the amount, with interest of £25 million for the 12 months to 31 December 2018 (2017: £25 million; 2016: £25 million) accruing on the balance, which was also treated as an adjusting item.
| 144 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
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Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
6 Taxation on ordinary activities continued
(c) Factors affecting the taxation charge
The taxation charge differs from the standard 19% (2017: 19%; 2016: 20%) rate of corporation tax in the UK. The major causes of this difference are listed below:
|
2018 |
|
2017 |
|
2016 |
||||||||||||||||||||||||
| £m | % | £m | % | £m | % | |||||||||||||||||||||||
| Profit before tax | 8,351 | 29,527 | 6,245 | |||||||||||||||||||||||||
| Less: share of post-tax results of associates and joint ventures | ||||||||||||||||||||||||||||
| (see note 5) | (419 | ) | (24,209 | ) | (2,227 | ) | ||||||||||||||||||||||
| 7,932 | 5,318 | 4,018 | ||||||||||||||||||||||||||
|
Tax at 19% (2017: 19%; 2016: 20%) on the above |
1,507 | 19.0 | 1,010 | 19.0 | 804 | 20.0 | ||||||||||||||||||||||
| Factors affecting the tax rate: | ||||||||||||||||||||||||||||
| Tax at standard rates other than UK corporation tax rate | 384 | 4.8 | 389 | 7.3 | 93 | 2.3 | ||||||||||||||||||||||
| Other national tax charges | 204 | 2.6 | 119 | 2.2 | 74 | 1.9 | ||||||||||||||||||||||
| Permanent differences | 7 | 0.1 | 40 | 0.8 | 143 | 3.6 | ||||||||||||||||||||||
| Overseas tax on distributions | – | – | 25 | 0.5 | 41 | 1.0 | ||||||||||||||||||||||
| Overseas withholding taxes | 155 | 1.9 | 191 | 3.6 | 200 | 5.0 | ||||||||||||||||||||||
| Double taxation relief on UK profits | (35 | ) | (0.4 | ) | (29 | ) | (0.5 | ) | (8 | ) | (0.2 | ) | ||||||||||||||||
| (Utilised)/unutilised tax losses | 5 | 0.1 | (38 | ) | (0.7 | ) | 32 | 0.8 | ||||||||||||||||||||
| Adjustments in respect of prior periods | (11 | ) | (0.1 | ) | 2 | 0.0 | 13 | 0.3 | ||||||||||||||||||||
| Deferred tax relating to changes in tax rates | (70 | ) | (0.9 | ) | (9,620 | ) | (180.9 | ) | – | – | ||||||||||||||||||
| Deemed US repatriation tax | – | – | 34 | 0.6 | – | – | ||||||||||||||||||||||
| Release of deferred tax on unremitted earnings of associates | – | – | (180 | ) | (3.4 | ) | – | – | ||||||||||||||||||||
| Additional net deferred tax (credits)/charges | (5 | ) | (0.1 | ) | (72 | ) | (1.4 | ) | 14 | 0.3 | ||||||||||||||||||
| 2,141 | 27.0 | (8,129 | ) | (152.9 | ) | 1,406 | 35.0 | |||||||||||||||||||||
With effect from 1 January 2018, the Group has adopted IFRS 15 Revenue from Contracts with Customers. The Group has revised 2017, as explained in notes 1 and 31.
In 2016, permanent differences include non-tax deductible expenses for a number of items including expenditure relating to restructuring and integration costs such as factory rationalisation and the implementation of a new operating model and also included the net charge in respect of Fox River, South Korea sales tax assessment and uncertain items connected with the Group’s trading business.
(d) Adjusting items included in taxation
In 2018, adjusting items in taxation relate to a £79 million credit due to changes in US state tax rates in the period, relating to the revaluation of deferred tax liabilities arising on trademarks recognised in the RAI acquisition in 2017, and a £55 million charge related to retrospective guidance issued by a tax authority in the ENA region regarding the application of withholding tax (WHT) between 2015 and 2017.
On 22 December 2017, the United States Government enacted comprehensive tax legislation which, among other things, changed the Federal tax rate to 21% from 1 January 2018. This revised rate has been used to revalue net deferred tax liabilities in the United States, leading to a credit to the income statement of £9,620 million. The net deferred tax liabilities largely relate to the difference in tax value versus the fair market value of trademarks accounted for under IFRS as part of the RAI acquisition. The legislation also imposed a one-time deemed repatriation tax on accumulated foreign earnings. The impact of the repatriation tax, less foreign tax credits, was £34 million. IFRS also requires entities to provide deferred taxation on the undistributed earnings of associates and joint ventures. From the date of the acquisition of the remaining shares in RAI not already owned by the Group, the Group has consolidated the results of RAI as a wholly owned subsidiary and as such the deferred tax liability of £180 million on unremitted earnings of RAI as an associate was released to the income statement in 2017.
In 2016, the Group’s share of the gain on the divestiture of intangibles and other assets by RAI to Japan Tobacco International was £941 million. Given that the profit on this item was recognised as an adjusting item by the Group, the additional deferred tax charge of £61 million on the potential distribution of these undistributed earnings was also treated as adjusting.
| BAT Annual Report and Form 20-F 2018 | 145 | |
Table of Contents
|
Financial Statements
|
Notes on the Accounts continued
6 Taxation on ordinary activities continued
(e) Tax on adjusting items
In addition, the tax on adjusting items, separated between the different categories, as per note 7, amounted to £199 million (2017: £454 million; 2016: £128 million). The adjustment to the adjusted earnings per share (note 7) also includes £6 million (2017: £4 million; 2016: £1 million) in respect of the non-controlling interests’ share of the adjusting items net of tax.
(f) Tax on items recognised directly in other comprehensive income
|
2018 |
2017 | 2016 | ||||||||||
| £m | £m | £m | ||||||||||
| Current tax | (8 | ) | (4 | ) | (53 | ) | ||||||
| Deferred tax | (7 | ) | (133 | ) | 70 | |||||||
| (Charged)/credited to other comprehensive income | (15 | ) | (137 | ) | 17 | |||||||
The tax relating to each component of other comprehensive income is disclosed in note 19.
7 Earnings per share
|
2018 |
2017 |
2016 | ||||||||||||||||||||||||||||||||||||||
|
Earnings £m |
Weighted average number of shares m |
Earnings per share pence |
Earnings £m Revised |
Weighted average number of shares m |
Earnings
per share
Revised |
Earnings £m |
Weighted average number of shares m |
Earnings per share pence |
||||||||||||||||||||||||||||||||
| Basic earnings per share | ||||||||||||||||||||||||||||||||||||||||
| (ordinary shares of 25p each) | 6,032 | 2,285 | 264.0 | 37,485 | 2,044 | 1,833.9 | 4,648 | 1,858 | 250.2 | |||||||||||||||||||||||||||||||
| Share options | – | 7 | (0.8 | ) | – | 7 | (6.3 | ) | – | 7 | (1.0 | ) | ||||||||||||||||||||||||||||
| Diluted earnings per share | 6,032 | 2,292 | 263.2 | 37,485 | 2,051 | 1,827.6 | 4,648 | 1,865 | 249.2 | |||||||||||||||||||||||||||||||
With effect from 1 January 2018, the Group has adopted IFRS 15 Revenue from Contracts with Customers . The Group has revised 2017, as explained in notes 1 and 31.
| 146 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
7 Earnings per share continued
Adjusted earnings per share calculation
Earnings have been affected by a number of adjusting items, which are described in notes 3 to 6. Adjusting items are significant items in the profit from operations, net finance costs, taxation and the Group’s share of the post-tax results of associates and joint ventures which individually or, if of a similar type, in aggregate, are relevant to an understanding of the Group’s underlying financial performance. The Group believes that these items are useful to users of the Group financial statements in helping them to understand the underlying business performance. To illustrate the impact of these items, an adjusted earnings per share calculation is shown below.
|
Basic
|
||||||||||||||||||||||||||||||||
|
2018
|
|
2017
|
|
2016
|
||||||||||||||||||||||||||||
| Notes |
Earnings £m |
Earnings per share pence |
Earnings £m Revised |
Earnings per share pence Revised |
Earnings £m |
Earnings per share pence |
||||||||||||||||||||||||||
| Basic earnings per share | 6,032 | 264.0 | 37,485 | 1,833.9 | 4,648 | 250.2 | ||||||||||||||||||||||||||
| Effect of restructuring and integration costs | 3(e) | 363 | 15.9 | 600 | 29.4 | 603 | 32.4 | |||||||||||||||||||||||||
| Tax and non-controlling interests on restructuring and integration costs | (83 | ) | (3.6 | ) | (133 | ) | (6.5 | ) | (90 | ) | (4.9 | ) | ||||||||||||||||||||
| Effect of amortisation and impairment of trademarks and similar intangibles | 3(f) | 377 | 16.5 | 383 | 18.7 | 149 | 8.0 | |||||||||||||||||||||||||
| Tax on amortisation and impairment of trademarks and similar intangibles | (78 | ) | (3.4 | ) | (90 | ) | (4.4 | ) | (32 | ) | (1.7 | ) | ||||||||||||||||||||
| Effect of associates’ adjusting items net of tax | 5(a) | (32 | ) | (1.4 | ) | (23,197 | ) | (1,134.9 | ) | (900 | ) | (48.4 | ) | |||||||||||||||||||
| Effect of hyperinflation on Venezuela’s retained earnings | 3(h),4(b) | 65 | 2.8 | – | – | – | – | |||||||||||||||||||||||||
| Other adjusting items | 3(h) | 184 | 8.0 | 534 | 26.1 | 53 | 2.9 | |||||||||||||||||||||||||
| Tax effect on other adjusting items | (44 | ) | (1.9 | ) | (184 | ) | (8.9 | ) | (5 | ) | (0.3 | ) | ||||||||||||||||||||
| Deferred tax relating to changes in tax rates | 13 | (79 | ) | (3.5 | ) | (9,586 | ) | (469.0 | ) | – | – | |||||||||||||||||||||
| Release of deferred tax on unremitted earnings from associates | 6(d) | – | – | (180 | ) | (8.8 | ) | – | – | |||||||||||||||||||||||
| Effect of Fox River | 3(g) | – | – | – | – | 20 | 1.1 | |||||||||||||||||||||||||
| Effect of additional deferred tax charge from gain on divestiture of assets by associate (RAI) | 6(d) | – | – | – | – | 61 | 3.3 | |||||||||||||||||||||||||
| Effect of interest on FII GLO settlement and other | 4(b) | 41 | 1.8 | 43 | 2.1 | 25 | 1.3 | |||||||||||||||||||||||||
| Effect of retrospective guidance on WHT | 6(d) | 55 | 2.4 | – | – | – | – | |||||||||||||||||||||||||
| Effect of adjusting finance costs in relation to acquisition of RAI | 4(b) | – | – | 153 | 7.5 | – | – | |||||||||||||||||||||||||
| Tax Effect of adjusting finance costs in relation to acquisition of RAI | – | – | (49 | ) | (2.4 | ) | – | – | ||||||||||||||||||||||||
| Effect of hedge ineffectiveness | 4(b) | – | – | 9 | 0.4 | (18 | ) | (1.0 | ) | |||||||||||||||||||||||
| Tax effect on hedge ineffectiveness | – | – | (2 | ) | (0.1 | ) | – | – | ||||||||||||||||||||||||
| Effect of US bond buy back | 4(b) | – | – | – | – | 101 | 5.5 | |||||||||||||||||||||||||
| Adjusted earnings per share (basic) | 6,801 | 297.6 | 5,786 | 283.1 | 4,615 | 248.4 | ||||||||||||||||||||||||||
With effect from 1 January 2018, the Group has adopted IFRS 15 Revenue from Contracts with Customers . The Group has revised 2017, as explained in notes 1 and 31.
| BAT Annual Report and Form 20-F 2018 | 147 | |
Table of Contents
|
Financial Statements
|
Notes on the Accounts continued
7 Earnings per share continued
|
Diluted |
||||||||||||||||||||||||||||||||||||||||
|
2018
|
2017
|
2016
|
||||||||||||||||||||||||||||||||||||||
| Earnings | Earnings |
Earnings
|
Earnings | |||||||||||||||||||||||||||||||||||||
| Earnings | per share | £m | pence | Earnings | per share | |||||||||||||||||||||||||||||||||||
| Notes | £m | pence | Revised | Revised | £m | pence | ||||||||||||||||||||||||||||||||||
|
Diluted earnings per share
|
6,032 | 263.2 | 37,485 | 1,827.6 | 4,648 | 249.2 | ||||||||||||||||||||||||||||||||||
|
Effect of restructuring and integration costs
|
3(e) | 363 | 15.8 | 600 | 29.3 | 603 | 32.3 | |||||||||||||||||||||||||||||||||
|
Tax and non-controlling interests on restructuring and integration costs
|
(83 | ) | (3.6 | ) | (133 | ) | (6.5 | ) | (90 | ) | (4.8 | ) | ||||||||||||||||||||||||||||
|
Effect of amortisation and impairment of trademarks and similar intangibles
|
3(f) | 377 | 16.4 | 383 | 18.7 | 149 | 8.0 | |||||||||||||||||||||||||||||||||
|
Tax on amortisation and impairment of trademarks and similar intangibles
|
(78 | ) | (3.4 | ) | (90 | ) | (4.4 | ) | (32 | ) | (1.7 | ) | ||||||||||||||||||||||||||||
|
Effect of associates’ adjusting items net of tax
|
5(a) | (32 | ) | (1.4 | ) | (23,197 | ) | (1,131.0 | ) | (900 | ) | (48.3 | ) | |||||||||||||||||||||||||||
|
Effect of hyperinflation on Venezuela’s retained earnings
|
3(h),4(b) | 65 | 2.8 | – | – | – | – | |||||||||||||||||||||||||||||||||
|
Other adjusting items
|
3(h) | 184 | 8.0 | 534 | 26.0 | 53 | 2.9 | |||||||||||||||||||||||||||||||||
|
Tax effect on other adjusting items
|
(44 | ) | (1.9 | ) | (184 | ) | (8.9 | ) | (5 | ) | (0.3 | ) | ||||||||||||||||||||||||||||
|
Deferred tax relating to changes in tax rates
|
13 | (79 | ) | (3.4 | ) | (9,586 | ) | (467.4 | ) | – | – | |||||||||||||||||||||||||||||
|
Release of deferred tax on unremitted earnings from associates
|
6(d) | – | – | (180 | ) | (8.8 | ) | – | – | |||||||||||||||||||||||||||||||
|
Effect of Fox River
|
3(g) | – | – | – | – | 20 | 1.1 | |||||||||||||||||||||||||||||||||
|
Effect of additional deferred tax charge from gain on divestiture of assets by associate (RAI)
|
6(d) | – | – | – | – | 61 | 3.3 | |||||||||||||||||||||||||||||||||
|
Effect of interest on FII GLO settlement and other
|
4(b) | 41 | 1.8 | 43 | 2.1 | 25 | 1.3 | |||||||||||||||||||||||||||||||||
|
Effect of retrospective guidance on WHT
|
6(d) | 55 | 2.4 | – | – | – | – | |||||||||||||||||||||||||||||||||
|
Effect of adjusting finance costs in relation to acquisition of RAI
|
4(b) | – | – | 153 | 7.5 | – | – | |||||||||||||||||||||||||||||||||
|
Tax Effect of adjusting finance costs in relation to acquisition of RAI
|
– | – | (49 | ) | (2.4 | ) | – | – | ||||||||||||||||||||||||||||||||
|
Effect of hedge ineffectiveness
|
4(b) | – | – | 9 | 0.4 | (18 | ) | (1.0 | ) | |||||||||||||||||||||||||||||||
|
Tax effect on hedge ineffectiveness
|
– | – | (2 | ) | (0.1 | ) | – | – | ||||||||||||||||||||||||||||||||
| Effect of US bond buy back | 4(b) | – | – | – | – | 101 | 5.5 | |||||||||||||||||||||||||||||||||
| Adjusted earnings per share (diluted) | 6,801 | 296.7 | 5,786 | 282.1 | 4,615 | 247.5 | ||||||||||||||||||||||||||||||||||
With effect from 1 January 2018, the Group has adopted IFRS 15 Revenue from Contracts with Customers . The Group has revised 2017, as explained in notes 1 and 31.
| 148 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
7 Earnings per share continued
Headline earnings per share as required by the JSE Limited
The presentation of headline earnings per share, as an alternative measure of earnings per share, is mandated under the JSE Listing Requirements. It is calculated in accordance with Circular 4/2018 ‘Headline Earnings’, as issued by the South African Institute of Chartered Accountants.
|
Basic
|
||||||||||||||||||||||||||||||||
|
2018
|
2017
|
2016
|
||||||||||||||||||||||||||||||
|
Earnings
|
Earnings
|
Earnings
|
Earnings
|
Earnings
|
Earnings
|
|||||||||||||||||||||||||||
|
Basic earnings per share
|
6,032 | 264.0 | 37,485 | 1,833.9 | 4,648 | 250.2 | ||||||||||||||||||||||||||
|
Effect of impairment of intangibles, property, plant and equipment and assets held-for-sale
|
238 | 10.3 | 179 | 8.7 | 126 | 6.8 | ||||||||||||||||||||||||||
|
Tax and non-controlling interests on impairment of intangibles and property, plant and equipment
|
(65 | ) | (2.8 | ) | (35 | ) | (1.7 | ) | (35 | ) | (1.9 | ) | ||||||||||||||||||||
|
Effect of gains on disposal of property, plant and equipment and held-for-sale assets
|
(11 | ) | (0.5 | ) | (48 | ) | (2.3 | ) | (59 | ) | (3.2 | ) | ||||||||||||||||||||
|
Tax and non-controlling interests on disposal of property, plant and equipment and held-for-sale assets
|
4 | 0.2 | 13 | 0.6 | 30 | 1.6 | ||||||||||||||||||||||||||
|
Effect of gains on disposal of businesses, non-current investments and brands
|
(10 | ) | (0.4 | ) | – | – | – | – | ||||||||||||||||||||||||
|
Tax on gains on disposal of businesses, non-current investments and brands
|
2 | 0.1 | – | – | – | – | ||||||||||||||||||||||||||
|
Gain on deemed disposal of RAI associate
|
– | – | (23,288 | ) | (1,139.3 | ) | – | – | ||||||||||||||||||||||||
|
Write-off of investment in associate
|
– | – | 27 | 1.3 | – | – | ||||||||||||||||||||||||||
|
Share of associates’ gains on disposal of assets
|
– | – | – | – | (941 | ) | (50.6 | ) | ||||||||||||||||||||||||
|
Tax effect of associates’ disposal of assets
|
– | – | – | – | 61 | 3.3 | ||||||||||||||||||||||||||
| Issue of shares and change in shareholding in associate | (22 | ) | (1.0 | ) | (29 | ) | (1.4 | ) | (11 | ) | (0.6 | ) | ||||||||||||||||||||
| Headline earnings per share (basic) | 6,168 | 269.9 | 14,304 | 699.8 | 3,819 | 205.6 | ||||||||||||||||||||||||||
With effect from 1 January 2018, the Group has adopted IFRS 15 Revenue from Contracts with Customers. The Group has revised 2017, as explained in notes 1 and 31.
|
Diluted
|
||||||||||||||||||||||||||||||||
|
2018
|
2017
|
2016
|
||||||||||||||||||||||||||||||
|
Earnings
|
Earnings
|
Earnings
|
Earnings
|
Earnings
|
Earnings
|
|||||||||||||||||||||||||||
|
Diluted earnings per share
|
6,032 | 263.2 | 37,485 | 1,827.6 | 4,648 | 249.2 | ||||||||||||||||||||||||||
|
Effect of impairment of intangibles, property, plant and equipment and assets held-for-sale
|
238 | 10.3 | 179 | 8.6 | 126 | 6.8 | ||||||||||||||||||||||||||
|
Tax and non-controlling interests on impairment of intangibles and property, plant and equipment
|
(65 | ) | (2.8 | ) | (35 | ) | (1.7 | ) | (35 | ) | (1.9 | ) | ||||||||||||||||||||
|
Effect of gains on disposal of property, plant and equipment and held-for-sale assets
|
(11 | ) | (0.5 | ) | (48 | ) | (2.3 | ) | (59 | ) | (3.2 | ) | ||||||||||||||||||||
|
Tax and non-controlling interests on disposal of property, plant and equipment and held-for-sale assets
|
4 | 0.2 | 13 | 0.6 | 30 | 1.6 | ||||||||||||||||||||||||||
|
Effect of gains on disposal of businesses, non-current investments and brands
|
(10 | ) | (0.4 | ) | – | – | – | – | ||||||||||||||||||||||||
|
Tax on gains on disposal of businesses, non-current investments and brands
|
2 | 0.1 | – | – | – | – | ||||||||||||||||||||||||||
|
Gain on deemed disposal of RAI associate
|
– | – | (23,288 | ) | (1,135.4 | ) | – | – | ||||||||||||||||||||||||
|
Write-off of investment in associate
|
– | – | 27 | 1.3 | – | – | ||||||||||||||||||||||||||
|
Share of associates’ gains on disposal of assets
|
– | – | – | – | (941 | ) | (50.4 | ) | ||||||||||||||||||||||||
|
Tax effect of associates’ disposal of assets
|
– | – | – | – | 61 | 3.3 | ||||||||||||||||||||||||||
| Issue of shares and change in shareholding in associate | (22 | ) | (1.0 | ) | (29 | ) | (1.4 | ) | (11 | ) | (0.6 | ) | ||||||||||||||||||||
| Headline earnings per share (diluted) | 6,168 | 269.1 | 14,304 | 697.3 | 3,819 | 204.8 | ||||||||||||||||||||||||||
With effect from 1 January 2018, the Group has adopted IFRS 15 Revenue from Contracts with Customers . The Group has revised 2017, as explained in notes 1 and 31.
| BAT Annual Report and Form 20-F 2018 | 149 | |
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Financial Statements
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Notes on the Accounts continued
8 Dividends and other appropriations
|
2018
|
2017
|
2016
|
||||||||||||||||||||||||||
| Dividends paid to owner of the parent |
Pence per share
|
£m
|
Pence per share
|
£m
|
Pence per share
|
£m
|
||||||||||||||||||||||
| Ordinary shares | ||||||||||||||||||||||||||||
| Interim | ||||||||||||||||||||||||||||
| 2018 paid 15 November 2018 | 48.8 | 1,114 | ||||||||||||||||||||||||||
| 2018 paid 8 August 2018 | 48.8 | 1,118 | ||||||||||||||||||||||||||
| 2018 paid 9 May 2018 | 48.8 | 1,111 | ||||||||||||||||||||||||||
| 2017 paid 8 February 2018 | 43.6 | 1,004 | ||||||||||||||||||||||||||
| 2017 paid 28 September 2017 | 56.5 | 1,284 | ||||||||||||||||||||||||||
| 2016 paid 28 September 2016 | 51.3 | 961 | ||||||||||||||||||||||||||
| Final | ||||||||||||||||||||||||||||
| 2016 paid 4 May 2017 | 118.1 | 2,181 | ||||||||||||||||||||||||||
| 2015 paid 5 May 2016 | 104.6 | 1,949 | ||||||||||||||||||||||||||
|
|
190.0
|
|
|
4,347
|
|
|
174.6
|
|
|
3,465
|
|
|
155.9
|
|
|
2,910
|
|
|||||||||||
From 1 January 2018, the Group moved to four interim quarterly dividend payments of 48.8p per ordinary share. As part of the transition, and to ensure shareholders receive the equivalent amount of total cash payments in 2018 as they would have under the previous payment policy, an additional interim dividend of 43.6 pence per share was announced on 5 December 2017 which was paid on 8 February 2018.
The dividend declared in 2018 for payment on 9 May 2018, 8 August 2018, 15 November 2018 and 7 February 2019 was £1,117 million, £1,112 million, £1,115 million and £1,119 million respectively and is estimated based on the number of shares and the proportion of dividends to be paid in foreign currency using the applicable exchange rate. This takes the total dividend declared in respect of 2018 to £4,463 million.
9 Intangible assets
| 150 | BAT Annual Report and Form 20-F 2018 | |
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Strategic Report
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Governance
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Financial Statements
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Other Information
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9 Intangible assets continued
Included in computer software and assets in the course of development are internally developed assets with a carrying value of £523 million (2017: £459 million). The costs of internally developed assets include capitalised expenses of employees working full time on software development projects, third-party consultants, and software licence fees from third-party suppliers.
The Group has £6 million future contractual commitments (2017: £16 million) related to intangible assets.
Trademarks and similar intangibles with indefinite lives
Included in the net book value of trademarks and similar intangibles are trademarks relating to the acquisition of RAI with indefinite lives amounting to £73,885 million (2017: £69,562 million).
The trademarks and similar intangibles have been tested for impairment in line with the following methodology. The recoverable amounts of trademarks and similar intangibles with indefinite lives have been determined on a value-in-use basis. The value-in-use calculations use cash flows based on detailed brand budgets prepared by management using projected sales volumes and projected brand profitability covering a five-year to 10-year horizon depending on the brand and, thereafter, grown into perpetuity. The brand budgets include an allocation for corporate costs based on volumes. The discount rate of 6.5% and long-term growth rates applied to the brand value-in-use calculations have been determined by local management based on experience, specific market and brand trends, pricing expectations and costs. The brand budgets are incorporated into the budget information used in the goodwill impairment review below. Following the application of a reasonable range of sensitivities, there was no indication of impairment.
Trademarks and similar intangibles with definite lives
Included in the net book value of trademarks and similar intangibles are trademarks relating to the acquisition of RAI £3,013 million
(2017: £3,097 million), Skandinavisk Tobakskompagni (ST) £209 million (2017: £230 million) and TDR d.o.o. £40 million (2017: £61 million).
During 2018, a purchase price allocation adjustment was recognised in respect of the provisional goodwill recognised as a result of the Group acquiring certain tobacco assets, including a distribution company, from Bulgartabac Holdings AD in Bulgaria. The provisional goodwill of £22 million was reclassified to trademarks and similar intangibles with definite lives.
Impairment testing for goodwill
Goodwill of £46,163 million (2017: £44,147 million) is included in intangible assets in the balance sheet of which the following are the significant acquisitions: RAI £35,117 million (2017: £33,062 million); Rothmans Group £4,856 million (2017: £4,834 million); Imperial Tobacco Canada £2,307 million (2017: £2,367 million); ETI (Italy) £1,478 million (2017: £1,462 million) and ST (principally Scandinavia) £1,111 million (2017: £1,102 million). The principal allocations of goodwill in the Rothmans’ acquisition are to the cash-generating units of Europe and South Africa, with the remainder mainly relating to operations in the domestic and export markets in the United Kingdom and operations in APME.
As a consequence of the Group’s new regional structure effective 1 January 2018, goodwill allocated to the Western Europe cash-generating unit (2017: £4,033 million and pre-tax discount rate of 7.3%) has been combined with the goodwill allocated to the Eastern Europe cash-generating unit (2017: £980 million and pre-tax discount rate of 8.1%) to create the new Europe cash-generating unit.
In 2018, goodwill was allocated for impairment testing purposes to 19 (2017: 19) individual cash-generating units – one in the United States (2017: one), five in APME (2017: five), six in AMSSA (2017: six) and seven in ENA (2017: seven).
| BAT Annual Report and Form 20-F 2018 | 151 | |
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| Notes on the Accounts continued | ||||||||||||||
9 Intangible assets continued
|
2018
|
2017
|
|||||||||||||||||
|
Carrying
|
Pre-tax discount rate %
|
Carrying
|
Pre-tax
|
|||||||||||||||
|
Cash Generating Unit
|
||||||||||||||||||
|
RAI
|
35,117 | 7.7 | 33,062 | 7.7 | ||||||||||||||
|
Canada
|
2,307 | 7.5 | 2,367 | 7.5 | ||||||||||||||
|
Europe
|
5,069 | 7.5 | 5,013 | 7.3 / 8.1 | ||||||||||||||
|
South Africa
|
605 | 10.6 | 661 | 9.6 | ||||||||||||||
|
Australia
|
740 | 7.9 | 775 | 7.9 | ||||||||||||||
|
Singapore
|
615 | 6.6 | 591 | 6.6 | ||||||||||||||
|
Malaysia
|
448 | 8.2 | 431 | 8.3 | ||||||||||||||
|
Other
|
1,262 | 1,247 | ||||||||||||||||
| Total | 46,163 | 44,147 | ||||||||||||||||
The recoverable amounts of all cash-generating units have been determined on a value-in-use basis. The key assumptions for the recoverable amounts of all units are the budgeted volumes, operating margins and long-term growth rates, which directly impact the cash flows, and the discount rates used in the calculation. The long-term growth rate is used purely for the impairment testing of goodwill under IAS 36 Impairment of Assets and does not reflect long-term planning assumptions used by the Group for investment proposals or for any other assessments.
Pre-tax discount rates of between 6.6% and 22.0% (2017: 6.6% and 19.2%) were used, based on the Group’s weighted average cost of capital, taking into account the cost of capital and borrowings, to which specific market-related premium adjustments are made. These adjustments are derived from external sources and are based on the spread between bonds (or credit default swaps, or similar indicators) issued by the US or comparable governments and by the local government, adjusted for the Group’s own credit market risk. For ease of use and consistency in application, these results are periodically calibrated into bands based on internationally recognised credit ratings. The long-term growth rates and discount rates have been applied to the budgeted cash flows of each cash-generating unit. These cash flows have been determined by local management based on experience, specific market and brand trends, pricing expectations and costs, and have been endorsed by Group management as part of the consolidated Group budget.
The value-in-use calculations use cash flows based on detailed financial budgets prepared by management covering a one-year period extrapolated over a 10-year horizon with growth of 4% in years 2 to 10, including 2% inflation (2017: 1% inflation), where after a total growth rate of 2% (2017: 2%) has been assumed. A 10-year horizon is considered appropriate based on the Group’s history of profit and cash growth, its well-balanced portfolio of brands and the industry in which it operates. In some instances, such as recent acquisitions, start-up ventures or in specific cases, the valuation is expanded to reflect the medium-term plan of the country or market management spanning five years or beyond. If discounted cash flows for cash-generating units should fall by 10%, or the discount rate was increased at a post-tax rate of 1%, there would be no impairment.
On 15th November 2018, the U.S. Food and Drug Administration (FDA) announced an intention to ban flavoured vaping products and menthol cigarettes. Market speculation in the days leading up to the announcement over the financial impact of a possible menthols ban had a significant negative impact on the share price of the Group.
However, the Group does not believe that there is an impairment trigger at this stage on either the Newport brand or the US goodwill for the following reasons:
– the multitude of procedures embedded in the comprehensive rule-making process;
– the possibility that any proposed regulation fails to withstand judicial review;
– the possibility that any proposed regulation would not apply to the US market for several years;
– the uncertainty surrounding how any potential regulation will affect the manufacture and marketing of Newport; and
– the lack of any other indicators of impairment in relation to the US business.
The Group will continue to monitor developments in relation to the proposed ban on flavoured vaping products and menthol cigarettes.
| 152 | BAT Annual Report and Form 20-F 2018 | |
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Strategic Report
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Governance
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Financial Statements
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Other Information
|
10 Property, plant and equipment
Net book value of assets held under finance leases for 2018 was £16 million (2017: £29 million).
The Group’s finance lease arrangements relate principally to the lease of tobacco vending machines by the Group’s subsidiary in Japan. In 2017, the Group’s finance lease arrangements related principally to the lease of tobacco vending machines and buildings in Japan and Peru respectively. Assets held under finance leases are secured under finance lease obligations included in note 20.
As explained in note 12, contributions to the British American Tobacco UK Pension Fund are secured by a charge over the Group’s Head Office (Globe House). Globe House is included in freehold property above with a carrying value of £185 million (2017: £187 million).
| BAT Annual Report and Form 20-F 2018 | 153 | |
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Financial Statements
|
||||||||||||||
| Notes on the Accounts continued | ||||||||||||||
10 Property, plant and equipment continued
On 25 July 2017, the Group announced the completion of the acquisition of the remaining 57.8% of RAI the Group did not already own. As at that date, RAI ceased to be reported as an associate and has become a fully owned subsidiary. Accordingly, as at that date, RAI has been consolidated in accordance with IFRS 10 Consolidated Financial Statements. Included in the £30,521 million is the gain arising on the deemed disposal of RAI of £23,288 million. This gain includes amounts restated in accordance with IAS 21 The Effects of Changes in Foreign Exchange Rates (see note 19).
Prior to 25 July 2017, the Group accounted for RAI as an associate, having concluded that it did not have de facto control of RAI because of the operation of the governance agreement between the Group and RAI which ensured that the Group did not have the practical ability to direct relevant activities of RAI.
The Group’s investment in Tisak d.d. (Tisak) was acquired as part of the TDR transaction (note 24). During 2016, the Group entered into an agreement with Tisak’s parent Agrokor d.d. (Agrokor) to convert certain outstanding trading balances into long-term loans and an additional shareholding in Tisak. As part of the agreement, Agrokor had the right to reacquire the additional shareholding in Tisak. As a consequence of this, while the Group had legal ownership of the additional shareholding, it did not consider that the shares provided any additional equity interest and continued to account for 26% of the equity of Tisak. In 2017, due to the financial difficulties of Agrokor and Tisak, the Group fully impaired this investment. This resulted in a charge of £27 million to the income statement that has been reported as an adjusting item in note 5. In July 2018, Agrokor’s creditors approved a settlement plan proposed by Agrokor’s administrators that is expected to be implemented during 2019. In its current form, the settlement plan is unlikely to return any value to the Group on this investment.
Included within the dividends amount of £211 million (2017: £688 million) are £nil million (2017: £477 million) attributable to dividends declared by RAI and £204 million (2017: £204 million) attributable to dividends declared by ITC.
The principal associate undertaking of the Group is ITC Ltd. (ITC) as shown under associates undertakings and joint ventures.
| 154 | BAT Annual Report and Form 20-F 2018 | |
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Other Information
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11 Investments in associates and joint ventures continued
ITC Ltd.
ITC is an Indian conglomerate based in Kolkata and maintains a presence in cigarettes, hotels, paper and packaging, agri-business and other fast-moving goods (e.g. confectionery, IT, branded apparel, personal care, greetings cards and safety matches). BAT’s interest in ITC is 29.57%.
ITC prepares accounts on a quarterly basis with a 31 March year end. As permitted by IAS 28, results up to 30 September 2018 have been used in applying the equity method. This is driven by the availability of information at the half year, to be consistent with the treatment in the Group’s interim accounts. Any further information available after the date used for reporting purposes is reviewed and any material items adjusted for in the final results. The latest published information available is at 31 December 2018.
|
2018 £m
|
2017 £m
|
|||||||
| Non-current assets | 4,106 | 3,738 | ||||||
| Current assets | 2,823 | 3,089 | ||||||
| Non-current liabilities | (238 | ) | (240 | ) | ||||
| Current liabilities | (1,002 | ) | (1,446 | ) | ||||
| 5,689 | 5,141 | |||||||
|
Group’s share of ITC Ltd. (2018: 29.57%; 2017: 29.71%) |
1,682 | 1,527 | ||||||
12 Retirement benefit schemes
The Group’s subsidiary undertakings operate over 190 retirement benefit arrangements worldwide. The majority of scheme members belong to defined benefit schemes, most of which are funded externally and many of which are closed to new entrants. The Group also operates a number of defined contribution schemes.
The liabilities arising in the defined benefit schemes are determined in accordance with the advice of independent, professionally qualified actuaries, using the projected unit credit method. It is Group policy that all schemes are formally valued at least every three years.
The principal schemes are in the USA, UK, Germany, Canada, The Netherlands and Switzerland. Together, schemes in these territories account for over 85% of the total obligations of the Group’s defined benefit schemes. These obligations consist mainly of final salary pension schemes which provide benefits to members in the form of a guaranteed level of pension payable for life. The level of benefits provided depends on members’ length of service and their salary in the final years leading up to retirement.
In addition, the Group operates several healthcare benefit schemes, of which the most significant are in the USA and Canada. The liabilities in respect of healthcare benefits are also assessed by qualified independent actuaries, applying the projected unit credit method.
All of these arrangements, including funded schemes where formal trusts or equivalents are required, have been developed and are operated in accordance with local practices and regulations where applicable in the countries concerned. For example, in the USA, the main funded pension schemes are the Reynolds American Retirement Plan and the Retirement Income Plan for Certain RAI Affiliates, and the main funded healthcare scheme is the Brown & Williamson Tobacco Corporation Welfare & Fringe Benefit Plan, all of which are established with corporate trustees that are required to run the schemes in accordance with the Plan’s rules and to comply with all relevant legislation, including the Employee Retirement Income Security Act 1974 and US law. Similarly, in the UK, the main pension scheme is the British American Tobacco UK Pension Fund, which is established under trust law and has a corporate trustee that is required to run the scheme in accordance with the Fund’s Trust Deed and Rules and to comply with the Pension Scheme Act 1993, Pensions Act 1995, Pensions Act 2004 and all the relevant legislation.
Responsibility for the governance of the schemes across the Group, including investment decisions and contribution schedules, generally lies with the trustees. The trustees for each arrangement will usually consist of representatives appointed by both the sponsoring company and the beneficiaries. In the USA, the corporate trustees act as custodians with a committee of local management acting in a fiduciary capacity with regard to investment decisions, risk mitigation and administration of the arrangements.
The majority of schemes are subject to local regulations regarding funding requirements. Contributions to defined benefit schemes are determined after consultation with the respective trustees and actuaries of the individual externally funded schemes, and after taking into account regulatory requirements in each territory.
The Group’s contributions to funded retirement benefit schemes in 2019 are expected to be £88 million in total compared to £221 million in 2018.
Contributions to the various funded schemes in the USA are agreed with the relevant corporate Trustee, the named fiduciary, scheme actuaries and the committee of local management after taking account of statutory requirements including the Pensions Protection Act of 2006, as amended. Through its subsidiaries in the USA, the Group intends to make significant regular contributions, when required, with the aim of maintaining a funding status of at least 90%, and becoming fully funded long-term. The Group contributed £87 million to its funded pension plans and £40 million to its funded post-retirement plans in 2018. However, during 2019, the Group does not expect to contribute to its funded pension and post-retirement plans in the USA.
| BAT Annual Report and Form 20-F 2018 | 155 | |
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Financial Statements
|
Notes on the Accounts continued
12 Retirement benefit schemes continued
Contributions to the British American Tobacco UK Pension Fund for 2017 and 2016 were agreed with the Trustee as part of a recovery plan to include £30 million a year to cover ongoing service costs, with additional contributions to eliminate a funding shortfall. Additional contributions were £78 million in both 2017 and 2016. These contributions were to be used to achieve the statutory funding objective and thereafter to support attaining a lower risk investment strategy (noted below). With effect from July 2018, the Group will pay £18 million a year to meet the cost of future benefit accruals. Additional annual contributions are payable until the Fund is valued to 115% on a Technical Provisions basis, and are expected to be £11 million in 2019.
Total contributions payable to the UK Pension Fund are secured by a charge over the Group’s Head Office (Globe House) up to a maximum of £150 million. The charge would be triggered in the event that the Group defaults on agreed contributions due to the Fund or if an insolvency event occurs with respect to the UK entity responsible for making the payments. The charge is due to be released in 2039 but may be released earlier by negotiation or if the assets of the Fund are sufficient to achieve certain funding levels. Under the rules of the scheme, any future surplus would be returnable to the Group by refund at the end of the life of the scheme. The funding commitment is therefore not considered onerous, and in accordance with IFRIC 14 no additional liabilities or surplus restriction have been recognised in respect of this commitment.
Payments made to pensioners by the operating companies in Germany, net of income on scheme assets, are deemed to be company contributions to the Contractual Trust Arrangements and are anticipated to be around £25 million in 2019 and ranging from £24 million per annum, decreasing to £21 million in 2023. Contributions to pension schemes in Canada, The Netherlands and Switzerland in total are anticipated to be around £25 million in 2019 and then around £10 million per annum for the four years after that.
The majority of benefit payments are from trustee administered funds, however, there are also a number of unfunded schemes where the sponsoring company meets the benefit payment obligation as it falls due. For unfunded schemes in the USA, UK and Canada, 41% of the liabilities reported at year end are expected to be settled by the Group within 10 years, 29% between 10 and 20 years, 17% between 20 and 30 years, and 13% thereafter.
The funded arrangements in the Group have policies on investment management, including strategies over a preferred long-term investment profile, and schemes in certain territories including Canada and The Netherlands manage their bond portfolios to match the weighted average duration of scheme liabilities. For funded schemes in the USA, the Group employs a risk mitigation strategy which seeks to balance pension plan returns with a reasonable level of funded status volatility. Based on this framework, the asset allocation has two primary components. The first component is the hedging portfolio, which uses extended duration fixed income holdings (typically US Government and investment grade corporate bonds) and to a lesser extent derivatives to match a portion of the interest rate risk associated with the benefit obligations, thereby reducing expected funded status volatility. The second component is the return seeking portfolio, which is designed to enhance portfolio returns. The return seeking portfolio is broadly diversified across asset classes. In addition, the main scheme in the UK had a target investment strategy such that, by 31 December 2018, the scheme would have moved to 20% return-seeking assets and 80% risk-reducing assets. This objective was achieved during the first quarter of 2018 and the Trustee has subsequently selected an investment strategy with a high-level target of broadly 10% return-seeking and 90% risk-reducing assets. Investments are diversified by type of investment, by investment sector, and where appropriate by country.
Through its defined benefit pension schemes and healthcare schemes, the Group is exposed to a number of risks, including:
Asset volatility:
The plan liabilities are calculated using discount rates set by reference to bond yields. If plan assets underperform this yield, e.g. due to stock market volatility, this will create a deficit. However, most schemes hold a proportion of assets which are expected to outperform bonds in the long term, and the majority of schemes by value are subject to local regulation regarding funding deficits.
Changes in bond yields:
A decrease in corporate bond yields will increase scheme liabilities, although this will be partially offset by an increase in the value of the schemes’ bond holdings or other hedging instruments.
Inflation risk:
Some of the Group’s pension obligations are linked to inflation and higher inflation will lead to higher liabilities, although in most cases, caps on the level of inflationary increases are in place in the scheme rules, while some assets and derivatives provide specific inflation protection.
Life expectancy:
The majority of the schemes’ obligations are to provide benefits for the life of the member, so increases in life expectancy will result in an increase in the plans’ liabilities. Assumptions regarding mortality and mortality improvements are regularly reviewed in line with actuarial tables and scheme specific experience.
| 156 | BAT Annual Report and Form 20-F 2018 | |
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Governance
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Other Information
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12 Retirement benefit schemes continued
The amounts recognised in the balance sheet are determined as follows:
The above charges are recognised within employee benefit costs in note 3(a) and include a charge of £3 million in 2018 (2017: £12 million charge) in respect of settlements, past service costs and defined contribution costs reported as part of the restructuring costs charged in arriving at profit from operations (note 3(e)). Included in current service costs in 2018 is £16 million (2017: £16 million) of administration costs.
| BAT Annual Report and Form 20-F 2018 | 157 | |
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| Notes on the Accounts continued | ||||||||||||||
12 Retirement benefit schemes continued
The movements in scheme liabilities are as follows:
Approximately 95% of scheme liabilities in both years relate to guaranteed benefits.
| 158 | BAT Annual Report and Form 20-F 2018 | |
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12 Retirement benefit schemes continued
The movements in funded scheme assets are as follows:
Scheme assets have been diversified into equities, bonds and other assets and are typically invested via fund investment managers into both pooled and segregated mandates of listed and unlisted equities and bonds.
In the USA, pension plan assets are invested using active investment strategies and multiple investment management firms. Managers within each asset class cover a range of investment styles and approaches. Allowable investment types include global equity, fixed income, real assets, private equity and absolute return. The range of allowable investment types utilised for pension assets provides enhanced returns and more widely diversifies the plan.
In addition, certain scheme assets, including a portion of the assets held in the main UK pension scheme, are further diversified by investing in equities listed on non-UK stock exchanges via investment funds. The main UK scheme also makes use of liability driven investment funds and inflation opportunity funds as part of its investment portfolio.
In the above analysis investments via equity-based investment funds are shown under listed equities, and investments via bond-based investment funds are shown under listed bonds. Other assets include cash and other deposits, derivatives and other hedges, recoverable taxes, reinsurance contracts, infrastructure investments and investment property.
The actuarial gains and losses in both years principally relate to movements in the fair values of scheme assets and actual returns are stated net of applicable taxes and fund management fees. The fair values of listed scheme assets were derived from observable data including quoted market prices and other market data, including market values of individual segregated investments and of pooled investment funds where quoted. The fair values of unlisted assets were derived from cash flow projections of estimated future income after taking into account the estimated recoverable value of these assets.
| BAT Annual Report and Form 20-F 2018 | 159 | |
Table of Contents
|
Financial Statements
|
||||||||||||||
| Notes on the Accounts continued | ||||||||||||||
12 Retirement benefit schemes continued
The movements in the unrecognised scheme surpluses, recognised in other comprehensive income, are as follows:
The principal actuarial assumptions (weighted to reflect individual scheme differences) used in the following principal countries are shown below. In both years, discount rates are determined by reference to normal yields on high quality corporate bonds at the balance sheet date. For countries where there is not a deep market in such corporate bonds, the yield on government bonds is used.
|
2018
|
2017
|
|||||||||||||||||||||||||||||||||||||||||||||||||
|
USA
|
UK
|
Germany
|
Canada
|
The Netherlands
|
Switzerland
|
USA
|
UK
|
Germany
|
Canada
|
The Netherlands
|
Switzerland
|
|||||||||||||||||||||||||||||||||||||||
| Rate of increase in salaries (%) | 3.9 | 3.2 | 1.7 | 3.0 | 2.1 | 1.3 | 3.9 | 3.2 | 2.5 | 3.0 | 2.0 | 1.3 | ||||||||||||||||||||||||||||||||||||||
| Rate of increase in pensions in payment (%) | 2.5 | 3.2 | 1.1 | Nil | 1.1 | Nil | 2.5 | 3.2 | 1.8 | Nil | 1.2 | Nil | ||||||||||||||||||||||||||||||||||||||
| Rate of increase in deferred pensions (%) | – | 2.2 | 1.1 | Nil | 1.1 | – | – | 2.2 | 1.8 | Nil | 1.2 | – | ||||||||||||||||||||||||||||||||||||||
| Discount rate (%) | 4.3 | 2.9 | 1.3 | 3.8 | 1.8 | 0.9 | 3.7 | 2.5 | 1.9 | 3.3 | 2.0 | 0.6 | ||||||||||||||||||||||||||||||||||||||
| General inflation (%) | 2.5 | 3.2 | 1.1 | 2.0 | 2.0 | 1.1 | 2.5 | 3.2 | 1.8 | 2.0 | 2.0 | 1.0 | ||||||||||||||||||||||||||||||||||||||
|
2018
|
2017
|
|||||||||||||||||||||||||||||||||||||||||||||||||
|
USA
|
UK
|
Germany
|
Canada
|
The Netherlands
|
Switzerland
|
USA
|
UK
|
Germany
|
Canada
|
The Netherlands
|
Switzerland
|
|||||||||||||||||||||||||||||||||||||||
| Weighted average duration of liabilities (years) | 10.8 | 16.0 | 8.2 | 10.5 | 17.5 | 12.8 | 11.3 | 16.9 | 13.7 | 11.0 | 17.8 | 13.5 | ||||||||||||||||||||||||||||||||||||||
| 160 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
12 Retirement benefit schemes continued
For healthcare inflation in the USA, the assumption is 6.5% (2017: 7.0%) and in Canada, the assumption is 5.0% (2017: 5.0%).
Mortality assumptions are subject to regular review. The principal schemes used the following tables at year-end:
| USA |
RP-2018 mortality tables without collar or amounts adjusted projected with MP-2018 generational projection (2017: RP-2017 and MP-2017)
|
|
| UK |
S2PA (YOB) with the CMI (2017) improvement model with a 1.25% long term improvement rate (2017: CMI (2016))
|
|
| Germany |
RT Heubeck 2018 G (2017: Heubeck 2005 G)
|
|
| Canada |
CPM-2014 Private Table (both years)
|
|
| The Netherlands |
AG Prognosetafel 2018 (2017: AG Prognosetafel 2016)
|
|
| Switzerland | LPP/BVG 2015 base table with CMI projection factors for mortality improvements with a 1.5% long-term improvement rate (both years) |
Based on the above, the weighted average life expectancy, in years, for mortality tables used to determine benefit obligations is as follows:
|
USA
|
UK
|
Germany
|
Canada
|
The Netherlands
|
Switzerland
|
|||||||||||||||||||||||||||||||||||||||||||||
|
Male
|
Female
|
Male
|
Female
|
Male
|
Female
|
Male
|
Female
|
Male
|
Female
|
Male
|
Female
|
|||||||||||||||||||||||||||||||||||||||
| 31 December 2018 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Member age 65 (current life expectancy) | 20.7 | 22.7 | 22.6 | 24.1 | 17.0 | 20.6 | 21.5 | 23.9 | 20.8 | 24.5 | 21.8 | 23.8 | ||||||||||||||||||||||||||||||||||||||
| Member age 45 (life expectancy at age 65) | 22.3 | 24.2 | 24.2 | 25.4 | 19.8 | 22.8 | 22.5 | 24.8 | 23.1 | 26.5 | 23.6 | 25.6 | ||||||||||||||||||||||||||||||||||||||
| 31 December 2017 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Member age 65 (current life expectancy) | 20.7 | 22.7 | 22.7 | 24.2 | 19.3 | 23.3 | 21.4 | 23.8 | 20.8 | 24.8 | 21.7 | 23.7 | ||||||||||||||||||||||||||||||||||||||
| Member age 45 (life expectancy at age 65) | 22.3 | 24.2 | 24.3 | 25.5 | 21.9 | 25.8 | 22.5 | 24.8 | 23.3 | 27.0 | 23.5 | 25.5 | ||||||||||||||||||||||||||||||||||||||
For the remaining territories, typical assumptions are that real salary increases will be from 0.5% to 6.3% (2017: 0.5% to 4.0%) per annum and discount rates will be from 0.6% to 7.6% (2017: 0.5% to 10.0%) above inflation. Pension increases, where allowed for, are generally assumed to be in line with inflation. Assumptions of life expectancy are in line with best practice in each territory.
The valuation of retirement benefit schemes involves judgements about uncertain future events. Sensitivities in respect of the key assumptions used to measure the principal pension schemes as at 31 December 2018 are set out below. These sensitivities show the hypothetical impact of a change in each of the listed assumptions in isolation, with the exception of the sensitivity to inflation which incorporates the impact of certain correlating assumptions such as salary increases. While each of these sensitivities holds all other assumptions constant, in practice such assumptions rarely change in isolation, while asset values also change, and the impacts may offset to some extent.
|
1
year
|
1
year
|
0.25
|
0.25
|
|||||||||||||
|
Average life expectancy – increase/(decrease) of scheme liabilities
|
|
339
|
|
|
(340
|
)
|
||||||||||
|
Rate of inflation – increase/(decrease) of scheme liabilities
|
|
169
|
|
|
(159
|
)
|
||||||||||
|
Discount rate – (decrease)/increase of scheme liabilities
|
|
(267
|
)
|
|
286
|
|
||||||||||
A one percentage point increase in healthcare inflation would increase healthcare scheme liabilities by £42 million, and a one percentage point decrease would decrease liabilities by £36 million. The income statement effect of this change in assumption is not material.
| BAT Annual Report and Form 20-F 2018 | 161 | |
Table of Contents
|
Financial Statements
|
||||||||||||||
| Notes on the Accounts continued | ||||||||||||||
13 Deferred tax
Net deferred tax assets/(liabilities) comprise:
|
Stock
£m |
Excess of
|
Tax
|
Undistributed
|
Retirement
benefits £m |
Trademarks
£m |
Other
temporary differences £m |
Total £m |
|||||||||||||||||||||||||
| At 31 December 2017 | (91 | ) | (174 | ) | 113 | (241 | ) | 264 | (17,323 | ) | 656 | (16,796 | ) | |||||||||||||||||||
| Accounting policy change (IFRS 9) (note 31) | – | – | – | – | – | – | 7 | 7 | ||||||||||||||||||||||||
| At 1 January 2018 | (91 | ) | (174 | ) | 113 | (241 | ) | 264 | (17,323 | ) | 663 | (16,789 | ) | |||||||||||||||||||
| Differences on exchange | (7 | ) | (10 | ) | 4 | 6 | 15 | (1,066 | ) | 47 | (1,011 | ) | ||||||||||||||||||||
| Subsidiaries acquired (note 24) | – | – | – | – | – | (3 | ) | 4 | 1 | |||||||||||||||||||||||
| Credited/(charged) to the income statement | 27 | (16 | ) | (11 | ) | (46 | ) | (36 | ) | 67 | 319 | 304 | ||||||||||||||||||||
| Credited/(charged) relating to changes in tax rates | 1 | (10 | ) | (1 | ) | – | 4 | 79 | (3 | ) | 70 | |||||||||||||||||||||
| (Charged)/credited to other comprehensive income | – | – | – | – | (25 | ) | – | 18 | (7 | ) | ||||||||||||||||||||||
| At 31 December 2018 | (70 | ) | (210 | ) | 105 | (281 | ) | 222 | (18,246 | ) | 1,048 | (17,432 | ) | |||||||||||||||||||
| Revised | ||||||||||||||||||||||||||||||||
| At 1 January 2017 | 31 | (58 | ) | 89 | (392 | ) | 117 | (95 | ) | 92 | (216 | ) | ||||||||||||||||||||
| Differences on exchange | 2 | 15 | (6 | ) | 13 | (12 | ) | 862 | (22 | ) | 852 | |||||||||||||||||||||
| Subsidiaries acquired (note 24) | (375 | ) | (234 | ) | – | – | 514 | (28,091 | ) | 1,115 | (27,071 | ) | ||||||||||||||||||||
| Credited/(charged) to the income statement | 180 | 19 | 30 | 138 | 10 | 66 | (291 | ) | 152 | |||||||||||||||||||||||
| Credited/(charged) relating to changes in tax rates | 71 | 84 | – | – | (194 | ) | 9,935 | (276 | ) | 9,620 | ||||||||||||||||||||||
| (Charged)/credited to other comprehensive income | – | – | – | – | (171 | ) | – | 38 | (133 | ) | ||||||||||||||||||||||
| At 31 December 2017 | (91 | ) | (174 | ) | 113 | (241 | ) | 264 | (17,323 | ) | 656 | (16,796 | ) | |||||||||||||||||||
With effect from 1 January 2018, the Group has adopted IFRS 15 Revenue from Contracts with Customers. The Group has revised 2017, as explained in notes 1 and 31.
In 2017, as part of the acquisition of RAI, the Group had to account for the assets and liabilities of the RAI companies at fair market value at the acquisition date of 25 July 2017 (note 24). The increase in the net asset value versus the tax bases created net deferred tax liabilities, valued within the purchase price allocation process at the prevailing Federal and State corporation tax rate at the date of the acquisition. Subsequently on 22 December 2017, the Federal corporation tax rate was changed to 21% from 1 January 2018. This revised rate has been used to revalue the net deferred tax liabilities in the United States, reducing the liability leading to a credit in the income statement of £9,620 million.
The net deferred tax liabilities are reflected in the Group balance sheet as follows: deferred tax asset of £344 million and deferred tax liability of £17,776 million (2017: deferred tax asset of £333 million and deferred tax liability of £17,129 million), after offsetting assets and liabilities where there is a legally enforceable right to offset current tax assets and liabilities and where the deferred income taxes relate to the same fiscal authority.
At the balance sheet date, the Group has not recognised a deferred tax asset in respect of unused tax losses of £308 million (2017: £301 million) which have no expiry date and unused tax losses of £502 million (2017: £616 million) which will expire within the next 10 years.
At the balance sheet date, the Group has not recognised a deferred tax asset in respect of deductible temporary differences of £nil million (2017: £nil million), which have no expiry date and £184 million (2017: £140 million), which will expire within the next 10 years.
At the balance sheet date, the Group has unused tax credits of £80 million (2017: £80 million) which have no expiry date. No amount of deferred tax has been recognised in respect of these unused tax credits.
At the balance sheet date, the aggregate amount of undistributed earnings of subsidiaries which would be subject to dividend withholding tax and for which no withholding tax liability has been recognised was £0.7 billion (2017: £0.7 billion).
| 162 | BAT Annual Report and Form 20-F 2018 | |
Table of Contents
|
Strategic Report
|
Governance
|
Financial Statements
|
Other Information
|
14 Trade and other receivables
|
2018
|
2017
|
|||||||
| Trade receivables | 2,868 | 3,306 | ||||||
| Loans and other receivables | 1,082 | 1,214 | ||||||
| Prepayments and accrued income | 323 | 289 | ||||||
| 4,273 | 4,809 | |||||||
| Current | 3,588 | 4,053 | ||||||
| Non-current | 685 | 756 | ||||||
| 4,273 | 4,809 | |||||||
In certain countries, the Group has entered into factoring arrangements and periodically sells certain trade receivables to banks and other financial institutions, without recourse, for cash. These trade receivables have been derecognised from the statement of financial position, because the Group has transferred substantially all of the risks and rewards of the receivables, including credit risk. The cash inflows have been recognised within operating cash flows. Typically in these arrangements, the Group also acts as a collection agent for the bank. At 31 December, the value of trade receivables derecognised through the factoring arrangements where the Group acts as a collection agent was £428 million and where the Group does not act as a collection agent was £40 million (2017: £139 million, £nil million respectively). Included in trade receivables above is £270 million (2017: £54 million) of trade debtor balances which were available for factoring under these arrangements.
Included in loans and other receivables are £553 million of litigation related deposits (2017: £603 million). The Group has determined that these payments are recoverable on conclusion of ongoing appeals and the deposits have not been discounted. Litigation related deposits include £436 million (2017: £449 million) in respect of payments made by a Group subsidiary in relation to the Quebec Class Action, as detailed in note 28. While there is uncertainty over the timeframe of the appeal process, it is estimated that had discounting been applied the carrying value of the asset would have been reduced by approximately £24 million (2017: £21 million). Amounts receivable from related parties including associated undertakings are shown in note 27.
Trade and other receivables have been reported in the balance sheet net of allowances as follows:
|
2018
|
2017
|
|||||||
| Trade receivables – gross | 2,898 | 3,345 | ||||||
| Trade receivables – allowance | (30 | ) | (39 | ) | ||||
| Loans and other receivables – gross | 1,092 | 1,260 | ||||||
| Loans and other receivables – allowance | (10 | ) | (46 | ) | ||||
| Prepayments and accrued income | 323 | 289 | ||||||
| Net trade and other receivables per balance sheet | 4,273 | 4,809 | ||||||
The movements in the allowance account are as follows:
|
Trade
£m |
Loans and other
2018 £m |
Total
£m |
Trade receivables
£m |
Loans and other
2017 £m |
Total
£m |
|||||||||||||||||||||
| 1 January | 39 | 46 | 85 | 87 | – | 87 | ||||||||||||||||||||
| Accounting policy change (IFRS 9) (notes 1 and 31) | 37 | 8 | 45 | – | – | – | ||||||||||||||||||||
| Revised 1 January | 76 | 54 | 130 | 87 | – | 87 | ||||||||||||||||||||
| Differences on exchange | 2 | – | 2 | 4 | – | 4 | ||||||||||||||||||||
| Provided in the year | 16 | 10 | 26 | – | 46 | 46 | ||||||||||||||||||||
| Released | (64 | ) | (54 | ) | (118 | ) | (52 | ) | – | (52 | ) | |||||||||||||||
| 31 December | 30 | 10 | 40 | 39 | 46 | 85 | ||||||||||||||||||||
As permitted by IFRS 9, the loss allowance on trade receivables arising from the recognition of revenue under IFRS 15 is initially measured at an amount equal to lifetime expected losses. Allowances in respect of loans and other receivables are initially recognised at an amount equal to 12-month expected credit losses. Allowances are measured at an amount equal to the lifetime expected credit losses where the credit risk on the receivables increases significantly after initial recognition.
Prior to the adoption of IFRS 9 on 1 January 2018, loans and receivables were stated net of allowances for estimated irrecoverable amounts due to the identification of a loss event (the incurred loss method).
The Group holds bank guarantees, other guarantees and credit insurance in respect of some of the past due debtor balances.
Trade and other receivables are predominantly denominated in the functional currencies of subsidiary undertakings apart from the following: US dollar: 3.5% (2017: 1.4%), UK sterling: 4.2% (2017: 4.3%), Euro: 1.6% (2017: 1.5%) and other currencies: 6.6% (2017: 9.6%).
| BAT Annual Report and Form 20-F 2018 | 163 | |
Table of Contents
|
Financial Statements
|
Notes on the Accounts continued
14 Trade and other receivables continued
There is no material difference between the above amounts for trade and other receivables and their fair value due to the short-term duration of the majority of trade and other receivables as determined using discounted cash flow analysis. There is no concentration of credit risk with respect to trade receivables as the Group has a large number of internationally dispersed customers.
15 Investments held at fair value
|
Investments |
||||||||||||||||||||||||||
|
Fair value
through P&L |
Fair value
through OCI |
Available-for-
sale |
Total
£m |
Available-for-
£m |
||||||||||||||||||||||
| 31 December | 107 | 107 | 58 | |||||||||||||||||||||||
| Accounting policy change (IFRS 9) (note 31) | 237 | 16 | (107 | ) | 146 | – | ||||||||||||||||||||
| 1 January | 237 | 16 | – | 253 | 58 | |||||||||||||||||||||
| Differences on exchange | (53 | ) | – | – | (53 | ) | – | |||||||||||||||||||
| Additions | 278 | 4 | – | 282 | 90 | |||||||||||||||||||||
| Revaluations | 36 | – | – | 36 | (27 | ) | ||||||||||||||||||||
| Disposals | (285 | ) | (16 | ) | – | (301 | ) | (14 | ) | |||||||||||||||||
| 31 December | 213 | 4 | – | 217 | 107 | |||||||||||||||||||||
| Current | 178 | – | – | 178 | 65 | |||||||||||||||||||||
| Non-current | 35 | 4 | – | 39 | 42 | |||||||||||||||||||||
| 213 | 4 | |||||||||||||||||||||||||