British American Tobacco : Annual Financial Report

BRITISH AMERICAN TOBACCO p.l.c.

Annual Report for the Year Ended 31 December 2013 and Annual General Meeting 2014

British American Tobacco p.l.c. (the "Company") reports that the following documents are being mailed to its shareholders (as applicable) today, Monday 24 March 2014. Those documents with a web-link shown will also available to be viewed or downloaded on the British American Tobacco website as indicated:

(4)    Proxy Form 

(5)    Proxy Form - South Africa 

(6)    Voting Instruction Form - South Africa 

In compliance with Listing Rule 9.6.1, copies of each of the above documents will be submitted to the National Storage Mechanism as soon as practicable and will be available for inspection via the following link: www.morningstar.co.uk/uk/nsm.

The Company made its Preliminary Announcement of its audited results (which included a Directors' responsibility statement) in respect of the year ended 31 December 2013 (the "Preliminary Announcement") on 26 February 2014. Further to the Preliminary Announcement and with reference to the requirements of Rules 4.1 and 6.3.5 of the Disclosure and Transparency Rules ("DTR"), the following disclosures are made in the Appendices below.

Appendix A to this announcement contains a description of the Key Group risk  factors (page 24 of the Annual Report 2013) and Appendix B is a statement of related party disclosures (page 184 Annual Report 2013). Together these constitute the material required by DTR 6.3.5 to be communicated to the media in unedited full text through a Regulatory Information Service. This material is not a substitute for reading the full Annual Report 2013. Any page numbers and cross-references in the extracted information below refer to page numbers in the Annual Report 2013.

The Annual General Meeting of the Company is scheduled to be held at The Banqueting House, Whitehall, London SW1A 2ER on Wednesday 30 April 2014 at 11.30am.

G C W Cunnington

Deputy Secretary

24 March 2014

Press Office:

Will Hill/Annie Brown 020 7845 2888

Investor Relations:

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Rachael Brierley 020 7845 1519

APPENDIX A

KEY GROUP RISK FACTORS

Overview

The key risk factors that may affect the Group are set out below.

Each risk is considered in the context of the Group's strategy, as set out in the Strategic Report. Following a description of each risk, its causes and potential impact on the Group are summarised. We also explain the activities we are undertaking to mitigate each risk.

The Group has identified, actively monitors and is taking action to mitigate many different risks. This section does not include them all, but focuses on those risks that the Directors believe to be the most important ones that the business faces currently. Not all of these risks are within the control of the Group, and other factors besides those listed may affect the Group's performance. Some risks may be unknown at present. Others, currently regarded as immaterial, could become material risks in the future.

The risk factors listed in this section and the activities being undertaken to mitigate 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. This section should also be read in the context of the accompanying cautionary statement below regarding forward-looking statements.

Developments in the assessment of Group risk

Cautionary statement

A. Marketplace Risk Factors

Competition from illicit tobacco trade

Illicit trade in the form of counterfeit products, smuggled genuine products and locally manufactured products on which applicable taxes are evaded, represents a significant and growing threat to the legitimate tobacco industry. Most illicit products are sold at the bottom end of the market and in contravention of applicable regulatory requirements.

Excise increases can encourage more consumers to switch to cheaper illegal tobacco products, providing greater rewards for smugglers. The risk is exacerbated where current economic conditions have resulted in high unemployment and/or reduced disposable incomes.

Global volume of illicit trade is estimated to be up to 12% of consumption. In the next decade, we believe that the problem is likely to increase, driven by the increased regulatory and compliance burden

for legitimate manufacturers and further significant excise increases.

Time frame: Long term

Principal causes

·   Sudden and disproportionate excise increases and widening excise differentials between markets.

·   Unintended consequences of regulation, e.g. plain packaging, display bans and ingredients restrictions.

·   Extra compliance costs imposed on legitimate industry giving competitive advantages to illicit manufacturers.

·   Economic downturn.

·   Lack of law enforcement and weak border controls.

Potential impact

·   Erosion of brand equity, with lower volumes and reduced profits.

·   Reduced ability to take price increases.

·   Investment in trade marketing and distribution is undermined.

·   Product is commoditised.

Strategic impact:Growth (organic revenue growth)

Mitigation activities

·   Dedicated Anti-Illicit Trade (AIT) teams operating at global, regional, area and key market levels and internal cross-functional coordination.

·   Active engagement with key external stakeholders.

·   Cross-industry and multi-sector cooperation on a wide range of AIT issues.

·   Global AIT strategy development supported by a research programme to further the understanding of the size and scope of the problem.

·   AIT Intelligence Unit (including a dedicated analytical laboratory) works with enforcement agencies in pursuit of priority targets.

·   Strong internal business conduct and customer approval policies.

Risk owner: Legal Director

Failure to lead developing non-tobacco nicotine market

The Group recognises the risk of not capitalising on the opportunities in developing and commercialising successful and consumer-appealing next-generation products, including those recognised by scientific and

regulatory authorities as posing substantially reduced risks to health.

Time frame: Long term

Principal causes

·   Draft EU Tobacco Products Directive limits the regulations associated with e-cigarettes and barriers to entry are low. Potential advertising restrictions, similar to tobacco, will impact brand building ability.

·   In other markets, regulations limit the size of the potential market for reduced risk products by restricting channel access, marketing opportunities or by imposing excise levies.

·   Inability to understand changes in consumer habits and preferences leading to lack of consumer-relevant product offerings.

·   Inability to build consumer brands.

·   Speed to market and speed of innovations is slower than competitors.

·   Inadequate financial and human resources devoted to the Group's non-combustible business.

·   Inability to manufacture and supply new non-combustible products in sufficient quantity.

Potential impact

·   Consumer base, market share, profitability and achievement of growth targets will be undermined if competitors are more successful in establishing new categories or if advertising or access to all channels is restricted.

·   While considered unlikely, alignment of non-combustible regulatory framework with traditional cigarettes would reduce business opportunities in the non-combustible category. Alignment of e-cigarettes to medicines would increase complexity and increase research and development costs, whilst reducing channel access.

Strategic impact:Growth (revenue growth) and Sustainability (reduced-risk products)

Mitigation activities

·   Nicoventures, a wholly-owned subsidiary, focuses exclusively on the development and commercialisation of innovative regulatory approved nicotine products that will enable the Group to offer a consumer-acceptable alternative to cigarettes with lower health risks.

·   Appointment of Managing Director of Next-Generation Products and a strengthened senior management team for non-combustibles.

·   Development of a full non-combustible strategy and business case.

·   Market roll-out plans for licensed and unlicensed nicotine products.

·   Vype launched in the UK, with further market launches planned.

·   Constant M&A dialogue on potential non-combustible opportunities.

Risk owner: Managing Director - Next-Generation Products

B. Excise and Tax Risk factors

Excise shocks from tax rate increases or structure changes

Tobacco products are subject to substantial excise and sales taxes in most countries in which the Group operates. In many of these countries, taxes are generally increasing, but the rate of increase varies between countries and between different types of tobacco products.

A number of significant excise increases have taken place over the past two years, for example in Brazil, Egypt, Greece, Mexico, Romania, Russia and Turkey. To date, the Group has been able to balance these increases with its geographic spread, and continues developing effective measures to address the risk.

Time frame: Short term and long term

Principal causes

·   Fiscal pressures for higher government revenues.

·   Increases advocated within context of national health policies.

·   Insufficient capacity to engage with stakeholders in meaningful dialogue.

·   Requirements of the WHO's Framework Convention on Tobacco Control (FCTC), Article 6 (on Tobacco Taxation) to move to 70% excise tax and predominantly specific excise.

Potential impact

·   Consumers reject the Group's legitimate tax-paid products for products from illicit sources.

·   Reduced legal industry volumes.

·   Reduced sales volume or alteration of sales mix or portfolio erosion.

Strategic impact:Growth (organic revenue growth)

Mitigation activities

·   Requirement for Group companies to have in place formal pricing and excise strategies including contingency plans.

·   Pricing and excise committees at regional, area and market levels.

·   Engagement with local tax and customs authorities, where appropriate.

·   Annual management review of brand portfolio, brand health and equity.

·   Portfolio reviews incorporate potential impact of changes to excise rates and structures.

·   Assessment of Article 6 impact for key markets undertaken and fed back to the regions and end markets.

Risk owner: Regional Directors

Onerous 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.
Time frame: Short term

Principal causes

·   Unfavourable ruling by tax authorities in disputed areas and aggressive auditing and/or pursuit of tax claims.

Potential impact

·   Significant fines and potential legal penalties.

·   Disruption and loss of focus on the business due to diversion of management time.

·   Impact on profit and dividend.

Strategic impact: Productivity (capital effectiveness)

Mitigation activities

·   Tax committees.

·   Internal tax function provides dedicated advice and guidance, and external advice sought where needed.

·   Engagement with tax authorities at Group, regional and individual market level.

Risk owner: Finance Director

C. Finance Risk Factors

Translational foreign exchange rate exposures

The Group faces translational foreign exchange (FX) rate exposures for earnings/cash flows from its global business.

Time frame: Short term

Principal causes

·   FX rate exposures arise from exchange rate movements against sterling, the Group's reporting currency.

Potential impact

·   Fluctuations in FX rates of key currencies against sterling introduce volatility in reported EPS, cash flow and the balance sheet driven by translation into sterling of our financial results.

·   The dividend may be impacted if the payout ratio is not adjusted.

·   Differences in translation between earnings and net debt may affect key ratios used by credit rating agencies.

Strategic impact: Productivity (capital effectiveness)

Mitigation activities

·   While translational FX exposure is not hedged, its impact is identified in results presentations and financial disclosures; earnings are restated at constant rates for comparability.

·   Debt and interest are matched to assets and cash flows to mitigate volatility where possible.

Risk owner:Finance Director

Access to end market cash resources

Liquidity - access to cash and sources of finance - is essential to maintaining the Group as a going concern and for sustainably funding local operations. Inability to access all the Group's cash resources will impact the Group's capital structure, cost of capital, debt and equity quality and shareholder returns.
Time frame: Short term

Principal causes

·   End markets with economies that are closely regulated by the state, with substantial government intervention in foreign exchange markets and limitation on the convertibility of local currency.

·   Insufficient hard currency available to local operating companies to pay for imported goods, dividend remittances, royalties and fees.

Potential impact

·   Economic losses as a result of devaluation of assets (including cash) valued or held in local currency.

·   Inability to mitigate accounting or financial exposures.

·   Loss of commercial opportunities to manufacture and sell tobacco products.

·   Additional costs as a result of paying premiums to obtain hard currency.

Strategic impact: Productivity (capital effectiveness)

Mitigation activities

·   On-going monitoring of restricted cash, with established maximum exposure limits in affected end markets.

·   Controls in place to ensure full compliance in the repatriation of funds from countries subject to sanctions regimes.

·   Projects designed to tackle currency conversion issues in specific markets and reduce foreign currency requirements.

Risk owner: Finance Director

D. Operations Risk Factors

Geopolitical tensions

Geopolitical tensions, including international sanctions, social unrest, terrorism and organised crime have the potential to disrupt the Group's business in multiple markets.

Time frame: Long term

Principal causes

·   Regional and/or global conflicts.

·   Terrorism and political violence.

·   Criminal activity leading to attacks on our people, supply chain or other assets.

·   International trade sanctions.

·   Economic policy changes, including nationalisation of assets and withdrawal from international trade agreements.

Potential impact

·   Potential loss of life, loss of assets and disruption to normal business processes.

·   Increased costs due to more complex supply chain arrangements and/or the cost of building new facilities or maintaining inefficient facilities.

·   Reduced volumes and impact on profits as a result of not being able to trade in a country.

·   Reputational impact of inability to protect staff and assets from serious harm.

Strategic impact: Growth (organic revenue growth)

Mitigation activities

·   Globally integrated sourcing strategy and contingency sourcing arrangements.

·   Security risk modelling, including external risk assessments and the monitoring of geopolitical and economic policy developments worldwide.

·   Insurance cover and business continuity planning, including scenario planning and testing and risk awareness training.

·   Security controls for field force, direct store sales, supply chain, with an emphasis on the protection of Group employees.

Risk owner: Legal Director

Risk of injury, illness or death in the workplace

The Group is committed to operating responsibly by maintaining the necessary controls that safeguard the health, safety and welfare of the people who work for the Group and alongside it, as well as minimising the impact on the natural environment and the local communities in which the Group conducts business activities. 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 affect on its operations.
Time frame: Short term

Principal causes

·   Failure to assess the risk and implement appropriate control measures.

·   Failure to monitor, assess and implement the requirements of regulations that apply to Group sites and operations resulting in non-compliance with environment, health and safety (EHS) standards.

·   Insufficient information, instruction and training in health and safety.

Potential impact

·   Serious injuries, ill-health, disability or loss of life suffered by employees and the people who work with the Group.

·   Exposure to civil and criminal liability and the risk of prosecution from enforcement bodies, and the cost of associated fines and/or penalties.

·   Interruption of Group operations if issues are not addressed quickly.

·   Cost of remediation work, such as replacing or upgrading plant and equipment, rehabilitation and medical costs.

·   High staff turnover or difficulty recruiting employees if perceived to have a poor EHS record.

Strategic impact: Sustainability

Mitigation activities

·   Risk control systems in place to ensure equipment and infrastructure are provided and maintained.

·   An EHS strategy ensures that employees at all levels receive appropriate EHS training and information.

·   Behavioural based safety programme to drive operations safety performance and culture closer to zero accidents.

·   Analysis of incidents undertaken regionally and globally to identify increasing incident trends or high potential risks that require coordinated action to address.

·   Dedicated global team to support management of EHS risks.

·   Key issues and incidents monitored regionally and reported globally to oversee compliance.

Risk owner: Operations Director

E. Regulation Risk Factors

Tobacco controls inhibit growth strategy

The enactment of regulation that places the Group at a competitive disadvantage, against both legal and illicit trade competitors, interferes with our ability to communicate with consumers, differentiate our products, launch future products, and increases our business costs and complexity.
Time frame: Long term

Principal causes

·   Pressure from international organisations, governments and the private sector to pursue regulation which is not evidence-based.

·   Adoption of differing regulatory regimes in different countries/groups of countries and/or lack of consensus on interpretation/application.

·   Exclusion of the industry from participating in engagement with regulators and policy makers.

·   Product regulation aimed at reducing the ability to differentiate cigarettes through severe restrictions on ingredients and design.

·   Regulation on the content and design of tobacco products which increases complexity and cost.

·   Adoption of the WHO's Framework Convention on Tobacco Control (FCTC) guidelines on packaging, labelling, advertising and promotion.

·   Adoption of more stringent national regulations, such as point-of-sale display bans and plain packaging.

Potential impact

·   Erosion of brand value through inability to launch innovations, differentiate products, build brand equity and leverage price.

·   Adverse impact on ability to compete within the legitimate tobacco industry, and also with increased illicit trade.

·   Reduced consumer acceptability of new product specifications, leading to consumers seeking alternatives in illicit trade.

·   Shocks to share price on enactment of regulation.

·   Reduced ability to compete in future product categories and make new market entries.

·   Increased scope and severity of compliance regimes in new regulation leading to higher costs, greater complexity, and potential reputational damage or fines for inadvertent breach.

Strategic impact: Growth (organic revenue growth) and Sustainability (balanced regulation)

Mitigation activities

·   A dedicated Regulatory Futures team working to manage our global approach to the Group's regulatory campaigns.

·   Engagement coordinated and aligned across the Group to drive a balanced global policy framework for tobacco control.

·   Prioritisation of key regulatory issues such as retail display bans, ingredients bans and pack space appropriation.

·   Stakeholder mapping and prioritisation, developing robust advocacy materials, and regulatory engagement programmes.

·   Regulatory risk assessment of marketing plans to ensure decisions are informed by an understanding of the potential regulatory environments.

·   Development of an integrated regulatory strategy, balancing the commercial requirements of the combustible and non-combustible businesses.

·   A 'Ready for Regulation' workstream helping to ensure that the business is ready for the effects of regulation and its impact on consumers.

·   A research programme established in order to address regulatory compliance and farmer sustainability.

Risk owner: CORA Director, Operations Director and Marketing Director

APPENDIX B

RELATED PARTY DISCLOSURES

The Group has a number of transactions and relationships with related parties, as defined in IAS 24 Related Party Disclosures , all of which are undertaken in the normal course of business.

Transactions and balances with associates relate mainly to the sale and purchase of cigarettes and tobacco leaf. Amounts receivable from associates in respect of dividends included in the table below were £86 million (2012: £84 million). The Group's share of dividends from associates, included in other net income in the table below, was £512 million (2012: £487 million).

On 17 December 2012, a wholly owned subsidiary of the Group, BATUS Japan Inc. (BATUSJ), entered into an Amendment and Extension Agreement (referred to as the Amendment) with a wholly owned subsidiary of Reynolds American, R.J. Reynolds Tobacco Company (referred to as RJRTC). The Amendment modifies the American blend Cigarette Manufacturing Agreement (referred to as the 2010 Agreement), effective as of 1 January 2010.

Prior to the Amendment, the term of the 2010 Agreement was scheduled to expire on 31 December 2014, subject to early termination and extension provisions. Pursuant to the Amendment, the Manufacturing Agreement will remain in effect beyond 31 December 2014, provided that either RJRTC or BATUSJ may terminate the Manufacturing Agreement by furnishing three years' notice to the other party, with any such notice to be given no earlier than 1 January 2016.

In 2012, the Group acquired non-controlling interests of shareholders in British American Tobacco Bangladesh for £24 million. This transaction is shown as a £21 million reduction to reserves attributable to the owners of the parent and a £3 million reduction in reserves attributable to non-controlling interests in note 20.

During the year, the Group received proceeds of £189 million (2012: £262 million) in respect of its participation in the share buy-back programme conducted by Reynolds American Inc.

The key management personnel of British American Tobacco consist of the members of the Board of Directors of British American Tobacco p.l.c. and the members of the Management Board. No such person had any material interest during the year in a contract of significance (other than a service contract) with the Company or any subsidiary company. The term key management personnel in this context includes the respective members of their households.

There were no other long-term benefits applicable in respect of key personnel other than those disclosed in the Remuneration Report in the Annual Report.