Gallaher Group PLC
03 March 2004
3 March 2004
GALLAHER GROUP PLC
PRELIMINARY ANNOUNCEMENT OF RESULTS
FOR THE YEAR ENDED 31 DECEMBER 2003
FINANCIAL HIGHLIGHTS
2003 2002
• Volumes 160.2bn 152.7bn up 4.9 %
• Total turnover £9,048m £8,422m up 7.4%
• Net turnover(1) £3,641m £3,321m up 9.6%
• EBITA(2) £627m £582m up 7.6%
• PBTA(3) £501m £455m up 9.8%
• Adjusted profit before tax(4) £418m £378m up 10.4%
• Profit before tax £379m £378m up 0.1%
• Adjusted earnings per share(5) 55.5p 51.2p up 8.6%
• Basic earnings per share(6) 38.0p 39.3p down 3.1%
• Proposed final dividend 20.15p 18.75p up 7.5%
• Proposed total dividend 29.60p 27.55p up 7.4%
(1) Total turnover less duty paid by Group companies.
(2) Total operating profit before amortisation of intangible assets and
exceptional charge.
(3) Profit before tax, amortisation of intangible assets and exceptional
charge.
(4) Profit before tax and exceptional charge.
(5) Adjusted: before amortisation of intangible assets and exceptional charge
(net of tax).
(6) Basic: includes amortisation of intangible assets and exceptional charge.
Note: Amortisation of intangible assets was £83m (2002: £77m) and exceptional
charge was £39m (2002: nil).
Commenting on the results, Nigel Northridge, Chief Executive, said:
'I am pleased with the excellent progress Gallaher made in 2003. We have
increased the momentum of our growth strategy across Europe, the CIS and Asia,
and can report gains in all our operating divisions. Adjusted earnings per share
increased by 8.6% and we are committed to continue to build shareholder value.'
Enquiries:
Claire Jenkins - Director, Investor Relations Tel: 01932 832637
Anthony Cardew - CardewChancery Tel: 020 7930 0777
PERFORMANCE HIGHLIGHTS
• Gallaher's strategy of developing its interests in established and
emerging markets across Europe and Asia delivered a strong set of results -
EBITA up 7.6% to £627m, with gains achieved in all operating divisions.
• Proposed final dividend of 20.15p (2002: 18.75p), leading to a total
dividend increase of 7.4% to 29.60p (2002: 27.55p).
• Restructuring of European operations and administration functions
expected to achieve annualised savings of at least £20m per annum by the
end of 2005. (Estimated total exceptional costs of £65m, of which £39m
charged in 2003.)
• Total volume growth of 4.9% to 160.2bn cigarettes (2002: 152.7bn).
• Marginal improvement in Gallaher's UK market share against the overall
reduction in total UK duty paid market. Good brand performance in the
cigarette, cigar and tobacco markets. UK EBITA increased to £287m (2002:
£283m).
• Continental Europe growth reflects volume gains, price increases and
strengthening euro. Distribution also benefited from improved margins. CED
EBITA grew 13.7% to £243m (2002: £213m).
• Sharp volume growth in Kazakhstan and Ukraine. Significant sales mix
improvement in Russia. CIS EBITA increased to £44m (2002: £42m) affected by
the weakness of the dollar.
• Republic of Ireland price increases, lower costs and currency benefits
more than offset Rest of World volume decline and adverse currency impact
on AMELA. RoW EBITA grew to £53m (2002: £44m).
• Reciprocal trademark license agreements signed with Shanghai Tobacco.
Memphis to be launched in Shanghai in 2004.
• Group cigarette productivity increased 8.2% and real term unit costs
were reduced 5.0%
• Operating cash inflow before exceptional items of £712m (2002: £519m).
• Current trading is in line with expectations.
2003 RESULTS
Group
Gallaher's Eurasian strategy produced a strong overall performance. Total
turnover for 2003 at £9,048m represented an increase of 7.4% compared with 2002,
with cigarette volume sales - of 160.2bn sticks - up 4.9%.
Earnings before interest, tax, intangible asset amortisation and exceptional
charge ('EBITA') increased 7.6% to £627m (2002: £582m) with gains achieved in
all operating divisions.
Profit before tax, amortisation of intangible assets and exceptional charge
('PBTA') grew 9.8% to £501m (2002: £455m).
Total operating profit was £505m (2002: £505m) and profit before tax was £379m
(2002: £378m) - both reflecting trading improvements offset by an exceptional
charge of £39m made in 2003 (2002: nil) relating to the restructuring of
Gallaher's European operations.
Adjusted earnings per share increased 8.6% to 55.5p (2002: 51.2p). After
deducting intangible asset amortisation and the exceptional charge, net of tax,
basic earnings per share were 38.0p (2002: 39.3p) down 3.1%.
The Board of Gallaher recommends a final dividend of 20.15p per ordinary share,
amounting to a total dividend for the full year of 29.60p per ordinary share
(118.40p per ADS). This represents an increase of 7.4% over the 2002 total
dividend of 27.55p per ordinary share (110.20p per ADS).
Subject to shareholders' approval at Gallaher's AGM on 12 May 2004, the final
dividend will be paid on 21 May 2004 to ordinary shareholders on the register at
close of business on 19 March 2004. For ADS holders, The Bank of New York will
convert the 80.60p ADS final dividend into US dollars, and distribute it to ADS
holders on 28 May 2004.
Gallaher's divisional performance has been impacted by the effects of foreign
exchange translation - positively in respect of the stronger euro and negatively
by the weaker US dollar. These divisional effects, however, are partly offset by
group hedging activity, so that overall adjusted earnings per share growth
largely reflects underlying performance.
Management believes that reporting results before amortisation and exceptional
charges (EBITA, PBTA and adjusted earnings per share) provides a better
comparison of underlying business performance for the period under review.
European restructuring
In May 2003, following an extensive review, Gallaher announced the restructuring
of the Group's European operations, ceasing all manufacturing in the Republic of
Ireland and reducing jobs in Austria and the UK. There will be a loss of around
430 operational jobs by the end of 2005.
Since the year end Gallaher has extended its restructuring programme to include
administration functions in the UK and Continental Europe. Around a further 100
jobs will be lost following this review.
Including this latest initiative, the total cost of the restructuring is now
expected to be in the region of £65m by the end of 2005, relating predominantly
to redundancy payments and the impairment of operational plant and machinery. Of
this total, £39m has been recorded as an exceptional charge at 31 December 2003
(UK: £18m/CED: £3m/RoW: £18m). Once the project has been completed, by the end
of 2005, Gallaher expects to achieve annualised savings of at least £20m.
Segmental review
UK CED CIS RoW Total
(£m) (£m) (£m) (£m) (£m)
Gross turnover
2003 3,611 4,534 373 530 9,048
2002 3,720 3,899 331 472 8,422
Net turnover(1)
2003 578 2,637 295 131 3,641
2002 593 2,325 281 122 3,321
EBITA(2)
2003 287 243 44 53 627
2002 283 213 42 44 582
Total operating profit
2003 267 169 34 35 505
2002 281 148 32 44 505
EBITA margin(3)
2003 (%) 49.7 9.2 14.8 40.3 17.2
2002 (%) 47.7 9.2 14.9 35.9 17.5
(1) Gross turnover less duty paid by Group companies.
(2) Total operating profit before amortisation of intangible assets and
exceptional charge.
(3) Total operating profit before amortisation of intangible assets and
exceptional charge expressed as a percentage of net turnover.
United Kingdom
While Gallaher's UK market share marginally improved in 2003, UK turnover
excluding duty ('net turnover') decreased 2.4% to £578m (2002: £593m). The
decrease largely reflects lower cigarette volume sales - down 5.1%, to 20.3bn
sticks (2002: 21.4bn) - and downtrading by consumers to cheaper cigarettes,
partially offset by price increases.
The volume decline primarily reflects the phasing of trade sales at the end of
2002 in advance of pack labelling changes, and a reduction in the size of the UK
duty paid market in 2003 - estimated at around 2% to 3%. The lower UK market
reflects the full year impact of the increase in duty paid allowances for UK
travellers returning from the EU announced by the UK Government in October 2002.
Excluding the estimated effect of the phasing of trade sales, Gallaher's
underlying cigarette volume sales in 2003 reduced some 1%.
EBITA grew 1.6% to £287m (2002: £283m), reflecting an improvement in EBITA
margin to 49.7% (2002: 47.7%). The increase in margin principally reflects the
benefits of manufacturer's price increases and lower operating expenses, partly
offset by lower volumes and downtrading.
After an exceptional charge of £18m, UK operating profit was £267m (2002:
£281m).
Continental Europe ('CED')
As a result of volume growth, price increases and the strengthening euro, CED
net turnover increased 13.4% to £2,637m (2002: £2,325m), comprising: CED tobacco
net turnover of £434m (2002: £343m) and distribution net turnover of £2,203m
(2002: £1,982m).
CED cigarette volume sales were 47.4bn (2002: 45.7bn).
CED EBITA grew 13.7% to £243m (2002: £213m) of which £172m (2002: £156m) came
from the tobacco operations and £71m (2002: £57m) came from the distribution
businesses.
The tobacco operations' improvement in EBITA was mainly due to volume growth,
improved margins and the favourable impact of foreign currency translation,
partly offset by start up losses for the Polish operation acquired in July 2003
and the first full year share of investment in the Group's joint venture with RJ
Reynolds ('RGI') formed in July 2002.
The distribution businesses also benefited from improved margins and foreign
currency translation.
Reflecting the weighting of the distribution businesses within the divisional
results, CED's EBITA margin was 9.2% (2002: 9.2%). The tobacco operations' EBITA
margin, after adding back inter-company sales to the distribution businesses,
was 31.9% (2002: 30.1%).
CED total operating profit was £169m (2002: £148m), after deducting an
exceptional charge of £3m in 2003.
Commonwealth of Independent States ('CIS')
CIS recorded a strong performance - total volumes grew 10.9% to 82.5bn (2002:
74.3bn), with sharp volume sales growth in Kazakhstan and Ukraine more than
offsetting the planned reduction in Russian non-filter oval sales. This volume
growth, coupled with significant sales mix improvement in Russia, led to a 4.7%
increase in net turnover to £295m (2002: £281m) although results were adversely
affected by foreign exchange movements (the translation of the mainly US dollar
denominated results into sterling).
CIS EBITA increased 4.0% to £44m and EBITA margin remained steady at 14.8%.
Russian operations were adversely impacted by a substantial duty increase in
January 2003, which was largely absorbed by the industry. This was partially
offset over the year by significant improvement in the mix of sales, with the
oval cigarette segment representing only 6.1% of volume sales (2002: 18.1%).
Gallaher continued its marketing investment behind the Group's brands to
capitalise on the growing popularity of higher priced hard box cigarettes.
Kazakhstan continued to deliver good growth, while Ukraine moved into profit in
2003, following its start up phase in 2002.
Rest of World ('RoW')
In spite of a decrease in volume sales to 10.0bn (2002: 11.3bn) - mainly
reflecting a sharp reduction in lower margin Middle East volumes - RoW net
turnover grew 7.1% to £131m (2002: £122m), partly reflecting favourable exchange
movements in the Republic of Ireland.
In the Republic of Ireland, manufacturer's price increases, currency benefits
and lower operating expenses more than compensated for lower volumes in the
reduced Irish market following the significant increase in duty at the end of
2002.
In addition to lower volumes, impacted by the conflict in the Middle East, the
AMELA operations have suffered from adverse foreign exchange movements with
invoiced sales being denominated in the weakening US dollar, and much of the
cost base in the strengthening euro.
RoW EBITA rose 20.2% to £53m (2002: £44m), and EBITA margin increased to 40.3%
(2002: 35.9%).
After an exceptional charge of £18m, RoW operating profit was £35m (2002: £44m).
Interest
The Group's net interest charge in 2003 was £126m (2002: £127m). The 2003 net
interest charge includes a net retirement benefit financing credit of £5m (2002:
£7m) from returns on pension scheme assets less interest charged on pension
scheme liabilities and other post-retirement obligations.
The decrease in the interest cost, excluding the financing credit, to £131m
(2002: £134m) reflects a reduction in average net debt at constant exchange
rates and a lower average borrowing cost of 5.5% (2002: 5.8%), largely offset by
foreign exchange movements applicable to the Group's euro denominated debt
portfolio.
EBITA interest cover - combining both interest and operating components of FRS
17 into a net pension expense within EBITA - was 4.8 times (2002: 4.4 times),
within the Group's target range of between 4.5 and 5.5 times.
Taxation
The tax charge of £126m (2002: £119m) represents an effective rate of 33.3%,
compared with 31.6% for 2002. The increase largely arises from a low rate of tax
applicable to the exceptional charge, reflecting the lower corporation tax rate
applicable to those costs incurred in the Republic of Ireland.
Removal of intangible amortisation charges and the net exceptional charge gives
rise to an adjusted effective tax rate of 26.7% (2002: 26.2%).
Over the medium term, the adjusted effective rate is expected to remain broadly
stable.
Returns to shareholders
After deducting minority interests of £6m (2002: £4m) earnings for 2003
decreased to £247m (2002: £255m), and - following a 0.2% increase in the
weighted average number of shares in issue - basic earnings per share was 38.0p
(2002: 39.3p).
After removing intangible asset amortisation charges of £83m (2002: £77m) and
the 2003 net of tax exceptional charge of £31m, adjusted earnings per share
increased 8.6% to 55.5p (2002: 51.2p). The increase in amortisation charges
reflects the impact of foreign currency and the acquisition of KT Merkury in
Poland.
Cash flow
The Group continued to be highly cash generative in 2003, with a net cash inflow
from operating activities before exceptional items of £712m (2002: £519m). This
largely reflects an 8.6% increase in EBITDA (earnings before interest, taxation,
depreciation, amortisation and exceptional items), excluding joint ventures and
associates, to £699m (2002: £644m), assisted by a favourable net movement in
working capital year on year. Cash costs of £21m were incurred during the year
in relation to the Group's restructuring programme.
The high levels of working capital seen across the Group at the end of 2002
largely reversed in the early part of 2003. These increased levels of investment
in 2002 were largely attributable to: high trade debtors in the UK; increased
levels of duty paid finished goods in Continental Europe and the Republic of
Ireland; and, increased trade debtors in the CIS. However, this reduction has
been largely offset by additional working capital at the end of 2003, mainly
associated with the new Polish factory and higher levels of duty paid finished
goods and trade debtors in the Republic of Ireland following a duty increase in
December 2003.
Capital expenditure and financial investment was £118m (2002: £109m). Investment
in tangible fixed assets amounted to £117m (2002: £130m) although this was
partly financed by proceeds of £10m (2002: £29m) principally from the disposal
of non-core property assets by Austria Tabak. The UK saw continued investment in
its production facilities and merchandising kiosks and gantries. CED continued
to invest in vending machines, to meet regulatory requirements impacting in
2007, and in the newly acquired Polish factory. The CIS invested in its
production facilities in Russia, Kazakhstan and Ukraine.
Expenditure of £15m on acquisitions in 2003 included the acquisition of a
factory for cigarette manufacture in Poland (£11m, including £3m of debt
acquired).
Slightly lower net financing payments of £131m (2002: £135m) reflect the Group's
strong cash flow generation in the period combined with lower average interest
rates, partly offset by adverse exchange on euro denominated debt. Increased
dividend payments of £183m (2002: £169m) were partly offset by dividends
received from L-T of £14m (2002: £12m).
The Group's strong cash flow generation, coupled with the proceeds of a £250m
Eurobond issued in February 2003, allowed bank loans amounting to £297m to be
repaid during 2003.
The Group's net debt reduced to £2,452m at the year end (2002: £2,493m). A net
cash inflow of £162m was partly offset by the stronger euro, which resulted in
exchange revaluations increasing net debt by £121m. The Group's weighted average
level of net debt in 2003 was £2,407m.
OPERATING REVIEW
Group
Gallaher's strategy is to create value for its investors through the development
of a balanced portfolio of interests in established and emerging markets across
Europe and Asia - organically and through acquisitions and strategic alliances -
capitalising on its proven ability to build brand equity.
Gallaher's leading positions in key mature markets underpinned volume growth and
market share gains in Continental Europe and the CIS during 2003. Total Group
volumes increased 4.9% to 160.2bn cigarettes, despite challenging trading
conditions in some key markets, including the Republic of Ireland, France,
Germany and Russia.
Gallaher is committed to remaining at the forefront of operational efficiency.
Following the announcement of plans to restructure the Group's European
manufacturing operations in May 2003, Gallaher conducted a review of its
management and administrative organisation during the second half of the year.
Opportunities to enhance Gallaher's competitive position by re-profiling its
organisational structure to meet the changing needs of the Group will be
implemented during 2004. These will include: the streamlining and centralisation
of UK office functions; a reduction in size and relocation of the Group's
Continental European office; a move to more functional UK and European marketing
and operational structures; and, the formation of a combined developing markets
function.
Divisional cigarette volumes
2003 2002 Change
(bn) (bn) (%)
UK(1) 20.3 21.4 (5.1)
Continental Europe(2) 47.4 45.7 3.7
CIS 82.5 74.3 10.9
Rest of World(3) 10.0 11.3 (11.1)
Total Group 160.2 152.7 4.9
(1) Excluding the estimated impact of the phasing of trade sales in December
2002, Gallaher's underlying UK volumes reduced some 1% in 2003.
(2) Excluding the impact of new Polish volume in 2003, and in 2002 the
discontinued Swedish contact manufacturing operations, and export sales to
AMELA (which are now reported under the Rest of World Division) underlying
Continental European volumes grew 6.7% to 45.7bn cigarettes (2002: 42.8bn).
(3) Underlying Rest of World volumes reduced 23.5% (2002, including export sales
to AMELA from Continental Europe: 13.1bn cigarettes).
United Kingdom
In the UK, Gallaher aims to increase its shares of the growing value cigarette
and handrolling tobacco sectors, and to defend its leading positions in the
premium cigarette and cigar sectors - achieving an appropriate balance between
sales volumes and the margins achieved on those volumes.
Gallaher's brands performed well in the cigarette, cigar and tobacco markets
during 2003.
The Group's leading premium UK brands, Benson & Hedges, Silk Cut and Hamlet,
benefited from investment in a final round of advertising ahead of the
commencement of the ban in February 2003. This expenditure is expected to
underpin the long-term equity of these brands. Gallaher's brands were also
assisted by positioning at the point of sale.
- Cigarette
The continued taxation driven price gap between cigarettes sold in the UK
and other EU markets, combined with the increase in personal tobacco import
allowances in October 2002, contributed to a decline in UK duty-paid
cigarette market volumes of approximately 2% to 3% in 2003.
Moderate downtrading from the premium and mid price sectors into value
price cigarettes continued. The respective shares of retail sales accounted
for by each price sector were: value: 56.6% (2002: 53.8%); mid price: 11.2%
(2002: 12.9%); and, premium: 32.2% (2002: 33.3%).
Gallaher's total UK volumes decreased 5.1% to 20.3bn cigarettes, reflecting
the overall market decline and the timing of sales into the trade in
advance of pack labelling changes. Excluding the phasing of trade sales in
December 2002, Gallaher's underlying volumes reduced some 1%.
Gallaher's overall UK retail market share increased marginally to 38.1%
(2002: 37.9%), reflecting good performances by the Group's principal UK
houses, Benson & Hedges and Mayfair, which were partly offset by market
share declines from a number of other brands.
The Benson & Hedges house was strengthened by the introduction of Silver, a
new reduced tar brand, in February. Together, Benson & Hedges Silver and
Gold, the UK's leading premium cigarette, achieved a house retail market
share of 9.3% (2002, Benson & Hedges Gold: 9.0%).
Mayfair increased its retail market share to 10.4% (2002: 8.5%), and
volumes 13.7%, benefiting from competitive pricing and the growth of the
value sector. Mayfair's growth drove a rise in Gallaher's total value
sector share to 33.2% (2002: 31.3%).
- Cigar
The total UK cigar market declined around 7% in 2003, and the consumer
trend from the higher margin medium cigar sector to the small cigar sector
continued.
Gallaher extended its lead of the cigar market with a 47.0% share of sales
to consumers (2002: 46.3%) - supported by the launch of Hamlet Miniatures
Filter and Hamlet Aromatic in December 2002.
Original Hamlet held its lead of the medium cigar sector with a share of
54.5% (2002: 53.3%) and Hamlet Miniatures grew its share of the small cigar
sector to 32.0% (2002: 31.7%).
- Tobacco
The total UK handrolling tobacco market grew modestly in 2003, and moderate
downtrading into lower priced brands continued.
Gallaher's market share was 31.3% (2002: 31.6%) reflecting the continued
success of Amber Leaf - which increased market share to 15.9% (2002: 13.9%)
- and the decline of the mature Old Holborn brand.
Gallaher increased its lead of the declining pipe tobacco market, growing
its share of sales to consumers to 49.6% (2002: 49.1%) - largely due to a
good performance from Mellow Virginia, and underpinned by the leading house
Condor.
Continental Europe
In Continental Europe, Gallaher aims to defend its market leading positions in
Austria and Sweden - balancing volumes and margins - and to grow share
elsewhere.
The Group traded strongly in Continental Europe during 2003, despite the
negative impact of above inflation duty increases on total market volumes in
certain European states, notably France and Germany.
Gallaher defended the positions of its established brands and continued to build
the equity of its younger developing brands. Total divisional volumes grew 3.7%
to 47.4bn cigarettes, and underlying volumes grew 6.7% (see page 10 for
definition).
- Tobacco products
Gallaher maintained its lead of the Austrian cigarette market with a 46.5%
share of sales (2002: 48.6%). During the second half of 2003, market share
stabilised for the first time in recent years.
A range of marketing and advertising initiatives supported Gallaher's
leading brand Memphis, assisting the growth of Memphis Blue and
underpinning Memphis Classic. Memphis Classic Full Flavour's market share
was stabilised during 2003 and the Memphis Blue brands increased market
share to 6.6% (2002: 5.7%).
Gallaher launched several brands in Austria during 2003, including Benson &
Hedges Red 20s, Memphis Blue 100s and Old Holborn.
In Sweden, Gallaher maintained its leading cigarette market position with a
39.1% share of sales to consumers (2002: 41.4%).
Level again performed well, growing market share to 7.1% (2002: 6.1%) and
volumes 13.0%. The Group's total branded Swedish volumes were impacted by
the ongoing decline of the mature brand Blend and lower overall market
volumes. Gallaher launched a new value brand, Vermont, in September.
Gallaher's moist oral snuff operations continued to make solid progress,
supported by new product launches. Volume sales of Gustavus increased
sharply during 2003, and the brand established a 1.6% retail market share
by December 2003/January 2004.
Elsewhere in the EU, Gallaher's trading performance was robust. In Germany,
the Group performed well - increasing its share of the total market held
through generic cigarettes to 7.3% (2002: 6.5%), while maintaining the
share of its branded cigarettes at 0.7%.
Gallaher broadly maintained cigarette market share in Greece at 5.0% (2002:
5.1%) and the growing demand for Old Holborn increased its leading share of
the handrolling tobacco market to 38.1% (2002: 36.3%).
Sales of the Virginia blended Benson & Hedges Metal range underpinned the
Group's strength in Western Europe, while volume growth from
Reynolds-Gallaher International ('RGI') drove an increase in the Group's
total cigarette market shares to: 3.0% in France; 3.2% in Italy; and, 1.6%
in Spain (2002: 2.9%, 1.1% and 1.2% respectively).
Gallaher and RGI launched a variety of both Virginia and American blended
cigarettes, and cigars, in these markets during 2003, including: Benson &
Hedges Menthol in France; Benson & Hedges American Blend 10s, Mayfair and
Hamlet 5s in Italy; Benson & Hedges Silver in Spain; and Reynolds in all
three markets. RGI launched a new value brand, Austin, in France at the
beginning of 2004.
The Group has continued to develop its operations in Central and Eastern
Europe.
Following the acquisition of KT Merkury in July, Gallaher made good
progress in Poland. In the second half of 2003 the Group sold 1.6bn
cigarettes in the market (2002, July to December KT Merkury sales: 0.7bn
cigarettes). Gallaher's Polish retail market share reached 2.6% by
December, up from 1.7% at the time of the acquisition, assisted by the
launch of brands from the Group's international portfolio, including LD
and Level.
Excluding volumes sales in Poland, Gallaher's Central and Eastern European
volume sales grew 9.8% to 6.5bn cigarettes (2002: 5.9bn). Strong growth in
Romania drove an increase in Gallaher's pan-Balkan market share to 4.9%
(2002: some 4.0%).
- Distribution
Gallaher's distribution businesses performed well.
In Austria, TOBA achieved enhanced margins driven by efficiency savings and
improved fees. This more than offset the impact of lower cigarette market
volumes. TOBA continued to leverage its comprehensive distribution network
to build sales of non-tobacco products, including pre-paid phone cards and
motorway toll stickers.
In Germany, ATG - the vending company in which Gallaher has a 63.9%
holding - continued to make good progress. ATG increased its share of
vending to 25.5% (2002: 24.2%) and outperformed the German market -
increasing total market share to 5.9% (2002: 5.6%). ATG's ongoing
programme of machine park rationalisation and improvement resulted in
increased machine productivity.
Lekkerland-Tobaccoland ('L-T') - an associate in which Gallaher has a 25.1%
holding - delivered a resilient performance in 2003. Efficiency savings and
growth in sales of pre-paid phone cards largely offset the impact of lower
German cigarette market volumes and the introduction of new German
government regulations regarding can recycling.
In January 2004, L-T announced the acquisition of Lekkerland Europa Holding
GmbH, using its own financing, in order to expand operations outside
Germany. Lekkerland Europa principally operates in EU and EU accession
countries.
Commonwealth of Independent States
In the CIS, Gallaher aims to grow regional market share while increasing
the proportion of its brands sold in the intermediate and higher priced
sectors across the region.
Consumer uptrading continued in the CIS during 2003 with smokers
increasingly favouring higher priced and international brands.
Gallaher's trading performance was impressive, with retail market share
gains in Russia, Kazakhstan and Ukraine. Divisional volumes grew 10.9% to
82.5bn cigarettes, with strong growth in Kazakhstan, Ukraine and hard box
filter cigarettes in Russia more than offsetting a planned reduction in
Russian non-filter oval sales.
- Russia
In Russia, Gallaher increased its total share of consumer sales to 15.0%
(2002: 14.0%), despite intense competition following a substantial increase
in cigarette taxation on 1 January 2003.
Within its sales mix, Gallaher continued to increase the proportion of its
brands sold in the intermediate and higher price sectors. Sales in these
sectors accounted for 93.9% of the Group's Russian volumes (2002: 81.9%).
Sales of hard box filter cigarettes increased 16.1%. This growth was more
than offset by a planned strategic reduction in sales of non-filter oval
cigarettes of 68.7%. This, and the phasing of trade sales in December 2002,
drove a reduction of 6.8% in total volumes to 58.8bn cigarettes.
Gallaher's leading Russian brand, LD, maintained a market share of over 5%
during 2003, underpinning strong growth from St George in the intermediate
price sector and advances in the higher price sector.
In 2003, the premium sub-sector grew its share of the total Russian market
to 8.8% (2002: 7.7%). Gallaher increased its share of this sub-sector to
2.6% (2002: 0.7%). By December 2003, the Group's share of the premium
sub-sector reached over 3%, assisted by the success of new Sobranie Slims
variants.
- Kazakhstan
Gallaher grew market share to 30.0% in Kazakhstan (2002: 20.4%). Volume
sales increased 64.6% to 9.6bn cigarettes, driven by strong demand for the
Group's brands including Sovereign, LD, Novost, and Sobranie.
Sovereign extended its market leading position, growing share to 14.8%
(2002: 12.2%) and LD increased share to 7.1% (2002: 4.2%).
- Ukraine
The Group grew its share of the Ukrainian market to 11.6% (2002: 7.5%).
Volume sales increased over 150% to 14.2bn cigarettes as brands including
LD, St George and Troika gained market share.
Rest of World
In its Rest of World division, Gallaher seeks growth in Asia Pacific and AMELA,
while defending its leading position in the high margin Republic of Ireland
market - balancing volumes and margins.
RoW volumes reduced 11.1% to 10.0bn cigarettes, largely due to a reduction in
lower margin Middle East volumes, impacted by the conflict in the region.
Underlying volumes fell 23.5% (see page 10 for definition).
- Republic of Ireland
Trading conditions in the Republic of Ireland were challenging in 2003.
Market sales to consumers, after adjusting for trade inventory levels,
declined over 6%, following substantial excise duty increases in December
2002 and 2003.
Gallaher's trading performance was resilient, underpinned by the top two
houses in the market, Silk Cut and Benson & Hedges. The Group's cigarette
market share was 50.1% (2002: 50.7%).
Gallaher also maintained its leadership of the cigar market with a 71.3%
share (2002: 72.9%).
- AMELA
AMELA and contract manufacture volumes reduced 12.9% to 6.5bn cigarettes
(2002: 7.5bn) entirely due to the reduction in Middle East volumes.
Pro-forma volumes were down 30.0% (2002, including export sales to AMELA
from Continental Europe: 9.3bn cigarettes).
Gallaher performed well in its core African market Guinea, maintaining its
leadership position and increasing volumes. The Group also performed
strongly in Nigeria, where volume sales more than doubled. Total African
volumes increased 20.1% to 4.5bn cigarettes.
- Asia Pacific
Gallaher made good progress in Asia Pacific during 2003. Total volumes
continued to increase, albeit from a low base, driven by strong growth in
Taiwan and China.
Following the signing of reciprocal trademark license agreements between
Gallaher and Shanghai Tobacco in November 2003, Gallaher's Memphis brand
will be launched in Shanghai during the first half of 2004.
In January 2004, Japan Tobacco ('JT') and Gallaher entered into a long-term
licensing agreement under which Gallaher will operate JT's domestic cigar
business. This offers leadership of the small Japanese cigar market, and an
interesting platform for the future.
Manufacturing
During 2003 Gallaher continued to maximise value from its operational
base - maintaining its position at the forefront of efficiency, while
retaining the flexibility to meet changing market demands.
Gallaher strengthened its already competitive position, increasing Group
cigarette productivity 8.2% (defined as output per worked hour). This
enhanced productivity, together with competitive pricing of raw materials,
including leaf and packaging, underpinned a real term reduction in total
unit costs of 5.0%.
The strong Group performance particularly reflected improvements in the UK
and Continental Europe, ahead of the full benefits of the restructuring
programme announced in May to reduce jobs in the UK and Austria and to
cease manufacturing in the Republic of Ireland.
The restructuring is progressing as planned, enabling Gallaher to integrate
manufacturing capabilities and maximise use of its most efficient assets.
The transfer of manufacturing from the Republic of Ireland to the UK was
completed on target at the end of the year. This restructuring programme
will be completed by the end of 2005.
A new and robust cross-functional management process was introduced during
the year to drive continuous operational improvement and to ensure adoption
of best practice across the Group. This brought increased focus to a number
of areas, including: manufacturing efficiency; raw materials; product and
pack standardisation; and, optimisation of the Group-wide supply chain.
Gallaher continued to invest in state of the art technology. These
investments drove cost reductions, improved quality, increased capacity,
and enhanced flexibility - supporting volume growth and changes in brand
mix.
Production of high quality products and total consumer satisfaction are an
integral part of Gallaher's manufacturing strategy. The Group's Western
European factories have met the new requirements for continued
accreditation against the Quality Management System ISO9001 : 2000. Similar
best practice is being rolled out to other locations.
Gallaher continued its drive to deliver the highest standards of customer
service and flexibility across its Eurasian markets. This drive was
supported by supply chain simplification through devolving greater
responsibility to regional operations. In addition, Gallaher's strategic
demand planning capability was enhanced to ensure that Group capital
investment meets the changing needs of the business and that costs
continue to be optimised and reduced across Gallaher's growing operational
network.
- United Kingdom
Productivity at Gallaher's UK cigarette factory at Lisnafillan increased
8.8%. This improvement was driven by: increased use of ultra high speed
machinery; a major re-organisation of working practices, including job
reductions; and, in the latter part of the year, the transfer of volumes
from Dublin. Together with reduced leaf costs, this enhanced productivity
underpinned a 3.2% reduction in real term unit costs.
The ongoing success of the Amber Leaf flip top pack and reduced overall
volumes impacted productivity and unit costs at the Lisnafillan tobacco
factory. Productivity reduced 2.6% and real term unit costs increased 3.4%.
A programme of investment designed to increase the factory's efficiency and
flexibility was approved in early 2004.
Productivity at Gallaher's Cardiff cigar factory increased 6.6%, assisted
by increased use of higher speed equipment, greater efficiencies and a
re-organisation of working practices, including job reductions. Real term
unit costs fell 1.8%, driven by the increase in productivity and a
reduction in average leaf costs.
- Continental Europe
Productivity at Gallaher's Austrian factories increased 7.0%, assisted by
increased volumes and initial benefits associated with Gallaher's European
operational restructuring. This improvement underpinned a real term
reduction of 4.2% in cigarette unit costs.
Several projects were commenced to enhance efficiency during 2003. These
included: the standardisation of products; the creation of a new European
logistics department; and, the commencement of a project to manufacture
specialist filters for Gallaher's group-wide requirements in Austria.
Gallaher's Polish factory at Gostkow has steadily increased output since
the Group acquired KT Merkury in July. Investment in a new primary
processing line and high speed making and packing machines has increased
the factory's efficiency, capacity and flexibility. Gostkow now has the
ability to produce a range of Gallaher's Virginia and American blend brands
for the domestic market.
- Commonwealth of Independent States
The Group's manufacturing facilities in the CIS substantially increased
total output assisted by the optimal use of manufacturing assets across the
region.
Productivity in the CIS grew 9.0% as a result of higher efficiencies and
investment in new technology to meet the higher proportion of hard box,
filter cigarettes and premium brands. This change in mix contributed to a
0.9% real term rise in unit costs.
Output of filter cigarettes increased sharply at Gallaher's Moscow factory,
while production of oval cigarettes decreased - reflecting the growing
demand for the Group's higher priced brands in the Russian market.
Considerable steps were taken to maximise efficiency at the factory. These
included: the installation of new tobacco processing equipment to enable
cost reductions through onshore manufacture of all blends; material
standardisation and specification changes to optimise NTM costs; and, an
improvement in machine performance, resulting in reduced wastage.
Operational efficiency in Gallaher's Kazakhstan factory was enhanced as a
result of staff development and the installation of new equipment. This
included high speed cigarette making machinery and a second filter making
complex.
The installation of new lines in Ukraine facilitated a substantial increase
in volumes and the introduction of new brands. Overall factory efficiency
was enhanced by the installation of an automated stem processing line.
OUTLOOK
In 2003, Gallaher's leading positions in key mature markets underpinned volume
growth and market share gains in Continental Europe, the CIS, Central Asia and
Asia Pacific. The Group's strategy produced a strong overall performance,
although divisional results were impacted by foreign exchange translation, which
is expected to continue in 2004.
Current trading remains in line with expectations.
Gallaher Group Plc
Group Profit and Loss Account
YEAR ENDED 31 DECEMBER 2003
2003 2003 2002
US$m* £m £m
Turnover of the Group including
its share of joint ventures and
associate 16,196 9,048 8,422
Less share of turnover of joint
ventures and associate (1,888) (1,055) (962)
----------- ---------- ----------
Group turnover 14,308 7,993 7,460
Group operating profit before
exceptional charge 965 539 498
Exceptional charge (70) (39) -
----------- ---------- ----------
Group operating profit 895 500 498
Share of operating profits of
joint ventures and associate 9 5 7
----------- ---------- ----------
Total operating profit 904 505 505
Net interest and other financing charges (235) (131) (134)
Net retirement benefits financing income 9 5 7
----------- ---------- ----------
Total net interest and other
finance charges (226) (126) (127)
Profit on ordinary activities
before taxation 678 379 378
Tax on profit on ordinary activities (226) (126) (119)
----------- ---------- ----------
Profit on ordinary activities
after taxation 452 253 259
Equity minority interests (10) (6) (4)
----------- ---------- ----------
Profit for the financial year 442 247 255
Dividends (345) (193) (179)
----------- ---------- ----------
Retained profit for the financial year 97 54 76
----------- ---------- ----------
Earnings per ordinary share
- Adjusted (a) 99.3c 55.5p 51.2p
- Basic 68.0c 38.0p 39.3p
- Diluted 67.8c 37.9p 39.1p
Dividends per ordinary share
- Final proposed 36.1c 20.15p 18.75p
- Total for the year 52.9c 29.60p 27.55p
There is no difference between the profit on ordinary activities before taxation
and the retained profit for the financial year stated above and their historical
cost equivalents. Turnover and operating results relate to continuing
operations.
(a) Before intangible asset amortisation and exceptional charge.
* US dollar equivalents are provided for reader convenience at the 31 December
2003 exchange rate of £1:US$1.79.
Gallaher Group Plc
Group Balance Sheet
AT 31 DECEMBER 2003
2003 2003 2002
US$m* £m £m
Fixed assets
Intangible assets 2,504 1,399 1,375
Tangible assets 1,065 595 575
Investments:
- Investment in joint ventures 11 6 6
- Investment in associate 200 112 109
- Other investments 34 19 17
-------- -------- --------
245 137 132
-------- -------- --------
3,814 2,131 2,082
-------- -------- --------
Current assets
Stocks 902 504 466
Debtors 1,402 783 788
Non-liquid investments 2 1 1
Cash and liquid investments 208 116 95
-------- -------- --------
2,514 1,404 1,350
Creditors: amounts falling due within
one year
Borrowings (249) (139) (201)
Other (1,999) (1,117) (1,044)
-------- -------- --------
(2,248) (1,256) (1,245)
Net current assets 266 148 105
-------- -------- --------
Total assets less current liabilities 4,080 2,279 2,187
Creditors: amounts falling due after
one year
Borrowings (4,348) (2,429) (2,387)
Other (9) (5) (6)
-------- -------- --------
(4,357) (2,434) (2,393)
Provisions for liabilities and charges (95) (53) (49)
Net retirement benefits liability (122) (68) (82)
-------- -------- --------
Net liabilities (494) (276) (337)
-------- -------- --------
Capital and reserves
Called up share capital 116 65 65
Share premium account 224 125 117
Capital redemption reserve 14 8 8
Merger reserve 261 146 146
Other reserve (1,630) (911) (911)
Profit and loss account (including
retirement benefits reserve) 465 260 213
-------- -------- --------
Equity shareholders' deficit (550) (307) (362)
Equity minority interests 56 31 25
-------- -------- --------
(494) (276) (337)
-------- -------- --------
This summary financial statement was approved by the Board on 2 March 2004 and
signed on its behalf by Nigel Northridge and Mark Rolfe.
* US dollar equivalents are provided for reader convenience at the 31 December
2003 exchange rate of £1:US$1.79.
Gallaher Group Plc
Statement of Total Recognised Gains and Losses
YEAR ENDED 31 DECEMBER 2003
2003 2003 2002
US$m* £m £m
Profit for the financial year 442 247 255
Actuarial loss recognised on
retirement benefits (7) (4) (108)
Movement on deferred tax relating
to actuarial loss on retirement benefits 2 1 30
Exchange adjustments on foreign
currency net investments (7) (4) (22)
-------- -------- --------
Total recognised gains and losses
for the year 430 240 155
-------- -------- --------
Reconciliation of Movements in Equity Shareholders' Deficit
YEAR ENDED 31 DECEMBER 2003
2003 2003 2002
US$m * £m £m
Profit for the financial year 442 247 255
Dividends (345) (193) (179)
Actuarial loss recognised on
retirement benefits (7) (4) (108)
Movement on deferred tax relating
to actuarial loss on retirement benefits 2 1 30
Exchange adjustments on foreign
currency net investments (7) (4) (22)
Amounts deducted from profit and
loss reserve in respect of shares
issued to the Qualifying
Employee Ownership Trust - - (5)
Issue of ordinary shares 14 8 12
--------- --------- ----------
Net decrease/(increase) in equity
shareholders' deficit 99 55 (17)
Opening equity shareholders' deficit (649) (362) (345)
--------- --------- ----------
Closing equity shareholders' deficit (550) (307) (362)
--------- --------- ----------
* US dollar equivalents are provided for reader convenience at the 31 December
2003 exchange rate of £1:US$1.79.
Gallaher Group Plc
Group Cash Flow Statement
YEAR ENDED 31 DECEMBER 2003
2003 2003 2002
US$m* £m £m
Net cash inflow from operating activities 1,237 691 519
Dividends received from associate
and joint ventures 25 14 12
Returns on investments and
servicing of finance (234) (131) (135)
Taxation (177) (99) (101)
Capital expenditure (209) (117) (110)
Financial investment (2) (1) 1
Acquisitions and disposals (27) (15) (14)
Equity cash dividends paid (328) (183) (169)
---------- ---------- ----------
Net cash inflow before management
of liquid resources and financing 285 159 3
Management of liquid resources (4) (2) 1
Decrease in debt (202) (113) (7)
Issue of ordinary shares 5 3 4
---------- ---------- ----------
Financing (197) (110) (3)
---------- ---------- ----------
Increase in net cash in the year 84 47 1
---------- ---------- ----------
Reconciliation of Operating Profit to Net Cash Inflow from Operating Activities
YEAR ENDED 31 DECEMBER 2003
2003 2003 2002
US$m* £m £m
Group operating profit before exceptional
charge 965 539 498
Depreciation of tangible fixed assets 149 83 74
Amortisation of intangible fixed assets 138 77 72
Amortisation of other fixed assets 5 3 3
Loss/(profit) on sale of tangible fixed
assets 2 1 (1)
Decrease/(increase) in debtors 40 22 (127)
Increase in stocks (27) (15) (68)
Increase in creditors and provisions 30 17 71
Decrease in net retirement benefits
liability (27) (15) (3)
---------- ---------- ----------
Net cash inflow from operating activities
before exceptional charge 1,275 712 519
Cash outflow relating to exceptional
charge (38) (21) -
---------- ---------- ----------
Net cash inflow from operating activities 1,237 691 519
---------- ---------- ----------
* US dollar equivalents are provided for reader convenience at the 31 December
2003 exchange rate of £1:US$1.79.
Gallaher Group Plc
Reconciliation of Net Cash Flow to Movement in Net Debt
YEAR ENDED 31 DECEMBER 2003
2003 2003 2002
US$m* £m £m
Increase in net cash in the year 84 47 1
Increase/(decrease) in liquid resources 4 2 (1)
Decrease in debt 202 113 7
--------- --------- ---------
Change in net debt resulting from cash
flows 290 162 7
Exchange adjustments (217) (121) (74)
Loans acquired with subsidiary - - (1)
--------- --------- ---------
Movement in net debt in the year 73 41 (68)
Net debt at 1 January (4,462) (2,493) (2,425)
--------- --------- ---------
Net debt at 31 December (4,389) (2,452) (2,493)
--------- --------- ---------
Basis of Preparation
The preliminary announcement of results for the year ended 31 December 2003 is
an excerpt from the forthcoming annual report and financial statements and does
not constitute the statutory financial statements of the Group. The 2003 figures
are extracted from the audited financial statements that have not yet been
approved by the shareholders and have not yet been delivered to the Registrar.
The comparative figures are extracted from the latest published financial
statements that have been delivered to the Registrar. The Auditors' reports in
respect of both years were unqualified and do not contain a statement under
either Section 237(2) or Section 237(3) of the Companies Act 1985.
* US dollar equivalents are provided for reader convenience at the 31 December
2003 exchange rate of £1:US$1.79.
Gallaher Group Plc
Segmental Information (by Destination)
YEAR ENDED 31 DECEMBER 2003
2003 2003 2002
US$m* £m £m
Total Turnover
UK 6,464 3,611 3,720
Continental Europe 8,116 4,534 3,899
CIS 668 373 331
Rest of World 948 530 472
----------- ---------- ----------
16,196 9,048 8,422
----------- ---------- ----------
Duty
UK 5,429 3,033 3,127
Continental Europe 3,396 1,897 1,574
CIS 140 78 50
Rest of World 714 399 350
----------- ---------- ----------
9,679 5,407 5,101
----------- ---------- ----------
Total Operating profit
UK
- before amortisation of intangible
assets and exceptional charge 514 287 283
- amortisation of intangible assets (4) (2) (2)
- exceptional charge (32) (18) -
----------- ---------- ----------
478 267 281
Continental Europe
- before amortisation of intangible
assets and exceptional charge 435 243 213
- amortisation of intangible assets (127) (71) (65)
- exceptional charge (6) (3) -
----------- ---------- ----------
302 169 148
CIS
- before amortisation of
intangible assets 79 44 42
- amortisation of intangible assets (18) (10) (10)
----------- ---------- ----------
61 34 32
Rest of World
- before amortisation of intangible
assets and exceptional charge 95 53 44
- amortisation of intangible assets - - -
- exceptional charge (32) (18) -
----------- ---------- ----------
63 35 44
Total
- before amortisation of intangible
assets and exceptional charge 1,123 627 582
- amortisation of intangible assets (149) (83) (77)
- exceptional charge (70) (39) -
----------- ---------- ----------
904 505 505
----------- ---------- ----------
* US dollar equivalents are provided for reader convenience at the 31 December
2003 exchange rate of £1:US$1.79.
SUPPLEMENTARY FINANCIAL INFORMATION
International accounting standards
On 7 June 2002 the EU approved a Regulation on the use of International
Financial Reporting Standards ('IFRS') in the consolidated financial statements
of listed companies. This applies to financial years beginning on or after 1
January 2005.
The Regulation will require Gallaher to use IFRS as its reporting framework for
the financial year ending 31 December 2005. This will result in some changes in
the measurement and disclosure of certain accounting transactions in the Group's
financial statements.
The International Accounting Standards Board expects to issue several new or
improved standards during 2004. Furthermore, the approach to first time adoption
of existing and pending IFRS cannot yet be determined with certainty.
The Group has identified and procured the necessary resources required to ensure
that it is able to carry out the transition to IAS by 1 January 2005. To
facilitate this, the Group has formed a project team of senior finance
professionals to assess the impact of the change and to revise systems and
accounting policies in order to assure compliance. The project team provides the
Audit Committee with regular updates of its progress.
Weighted average cost of capital ('WACC')
Gallaher utilises project specific WACCs when evaluating investments, taking
into account the circumstances (including geographic location) of each potential
investment opportunity at the time. For general performance purposes, however,
management currently utilises a minimum hurdle rate of 7%.
Five year summary of shareholder returns
2003 2002 2001 2000(1) 1999(1)
Adjusted EPS (p) 55.5 51.2 46.9 41.0 36.9
Growth (%) 8.6 9.2 14.4 10.9
(1) Results not adjusted for changes in accounting policies in 2002 but
presented as previously reported.
Since 1999 dividends have increased at a cumulative average rate of 7.4% per
annum, reflecting Gallaher's dividend policy of consistently growing dividends,
while recognising the need to balance equity and debt holders interests.
Five year summary of key financial indicators
2003 2002 2001 2000(1) 1999(1)
EBITA interest cover(2)(3) 4.8 4.4 5.2 4.7 5.6
Net debt / EBITDA(2)(3) 3.4 3.8 4.5 2.9 1.9
Effective tax rate(4) 26.7% 26.2% 23.6% 26.0% 28.7%
Dividend cover(5) 1.88 1.86 1.84 1.72 1.66
Dividend yield(6) 4.9% 4.5% 5.4% 5.6% 8.6%
Net debt / market
capitalisation(6) 63% 62% 80% 54% 51%
Enterprise value /
EBITDA(2)(3)(6)(7) 9.0 10.0 10.2 8.4 5.8
(1) Results not adjusted for changes in accounting policies in 2002 but
presented as previously reported.
(2) Excludes exceptional charges.
(3) FRS 17 financing credit added back in 2003, 2002 and 2001.
(4) Excludes exceptional charges and amortisation charges.
(5) Calculated on adjusted earnings per share.
(6) Based on closing share price as at 31 December of each year.
(7) Excludes joint ventures and associates.
Treasury policies and financial risks
The Group has a centralised treasury function that is responsible for the
management of the Group's financial risks together with its liquidity and
financing requirements. The treasury function is not a profit centre and the
objective is to manage risk at optimum cost. Treasury operations are conducted
within a framework of policies and guidelines authorised by the Board, and are
monitored by a Treasury Committee. This framework provides flexibility for the
best execution of Board approved strategies. Summaries of treasury activities
and exposures are reported on a regular basis to the Board. The internal control
environment is also reviewed regularly.
The Group holds or issues financial instruments to finance its operations and to
manage the interest rate and foreign exchange risks arising from its operations
and from its sources of finance.
Financing and liquidity
The Group's principal sources of financing in 2003 have been bond issues, bank
borrowings and retained profits. It is the Group's policy to maintain sufficient
committed borrowing facilities, with a mix of long and short term debt, to
enable the Group to meet its business objectives.
At the year end, bond issues amounted to £1,977m, comprising: a £250m bond
maturing in February 2013; a £300m bond maturing in May 2009; a €375m bond
maturing in August 2008; a €750m bond maturing in October 2006; a €900m bond
maturing in January 2005; and, European medium term notes amounting to £128m. In
addition, at the year end, the Group's committed bank facilities comprised:
amortising term loans of €268m with a final repayment date in 2007; a syndicated
revolving facility of £650m, with £150m maturing in March 2004; and, £500m
maturing in March 2008.
The weighted average maturity of committed debt at the year end was 3.5 years
(2002: 3.5 years).
The Group's credit ratings are BBB (Stable Outlook) and Baa3 (Stable Outlook)
from Standard & Poor's, a Division of the McGraw-Hill Companies, and Moody's
Investors Service Limited respectively. These ratings allow the Group to access
the international capital markets and issue debt to a global investor base.
Certain of the Group's debt instruments contain covenants that if the Group's
credit rating is downgraded below BBB minus in the case of Standard & Poor's or
below Baa3 in the case of Moody's, additional interest accrues from the next
interest period at the rate of 1.25 percentage points, in the case of certain
bonds issued by the Group (€750m in October 2001, €900m in January/March 2002
and £250m in February 2003), and 1.0 percentage points in the case of the
Group's current committed syndicated bank facility. In the event that both
credit ratings are subsequently raised or reaffirmed to BBB minus and Baa3,
respectively, the additional interest no longer accrues from the next interest
period.
The only financial covenants applying to the Group's facilities relate to the
committed syndicated revolving bank facility. At the year end these require
Gallaher to maintain interest cover above 3.5 times based on pre-FRS 17 EBITDA,
and net debt below a multiple of pre-FRS 17 EBITDA of 3.75 times at 31 December
2003, falling to below 3.5 times by 31 December 2004. The Group continues to
comply with all borrowing obligations, and financial covenants have been
satisfied with an EBITDA interest cover at 5.5 times and a net debt multiple of
3.4 times at 31 December 2003.
Interest rate risk
The Group is exposed to fluctuations in interest rates on its net debt. In order
to manage the impact of adverse variations in interest rates on the Group's
profits, the Group borrows at fixed and floating rates of interest and uses
interest rate derivatives, where necessary, to maintain a target level of fixed
interest rate cover in the current and subsequent two years of between 40% and
80% of the level of core debt. At the year end, fixed interest rated debt
represented approximately 65% of total gross debt. All interest rate derivative
transactions have been accounted for as hedges.
Interest rate management improves the accuracy of the business planning process
and helps manage the level at which EBITA covers net interest expense, which the
Group currently aims to target at levels between 4.5 and 5.5 times.
Foreign currency risk
Due to the international nature of its operations, the Group is exposed to
exchange rate fluctuations on the translation of the results of overseas
subsidiaries into sterling and trading transactions in foreign currencies.
The Group makes limited use of derivative financial instruments to hedge balance
sheet translation exposures. On significant acquisitions of overseas companies,
borrowings are raised in the local currency to minimise the translation risk. It
remains the Group's policy not to hedge profit and loss account translation
exposures.
Transaction exposures are hedged where deemed appropriate and where they can be
reliably forecast with the use of forward exchange rate contracts.
Bank counter-party risk
The Group has cash and bank deposits and other financial instruments that give
rise to credit risks in the event of non-performance by counter-parties. Credit
risk is managed by limiting the aggregate amount of exposure to any one
counter-party and the Group's policy of only selecting major international
financial institutions with a strong investment grade credit rating.
LEGAL AND REGULATORY ENVIRONMENT
Gallaher has established and adheres to a number of policies and principles
governing the Group's conduct which underpin its relationship both to those
responsible for public health and those who choose to smoke. Gallaher believes
that it operates with a sense of responsibility and responsiveness to the issues
surrounding smoking and health, recognising the rights and responsibilities of
governments around the world to regulate the manufacture, distribution and
marketing of tobacco products. For its own part, the Group has an established
range of corporate and environmental policies consistent with its international
size and standing.
The global tobacco market has been subject to significant regulatory influence
in recent years, including: the levying of substantial tax and duty charges;
restrictions on advertising and marketing; the display of larger health warnings
and statements of tar, nicotine and carbon monoxide smoke yields on product
packaging; regulations on the smoke yields of cigarettes; the disclosure of
ingredients in tobacco products; the prohibition of certain descriptors such as
'light' and 'mild', and, increased restrictions such as the prohibition of
smoking in many public places and raising the ages at which cigarettes may be
purchased.
The Group has a long history of managing its business successfully within a
regulatory climate. In recent years, the Group has reduced its susceptibility to
regulatory changes in any single country by expanding its international
operations. However, it is possible that regulations in any of its key markets
could have an adverse effect on the Group's sales and operating performance.
Regulation
At a global level in 2003, the World Health Organisation adopted a Framework
Convention on Tobacco Control ('FCTC'). The tobacco control treaty includes
provisions governing, amongst other matters: advertising and sponsorship; tax
and price increases; labelling; illicit trade; and, environmental tobacco smoke.
The FCTC will come into force once 40 Member States have ratified it.
Within the EU, a Directive concerning the manufacture, presentation and sale of
tobacco products was adopted in 2001 and has been implemented into Member
States' national law. Its provisions include: matters relating to ingredients
disclosure; the prohibition of descriptors suggesting that a particular tobacco
product is less harmful than others; new and larger health warnings; rules
allowing for the use of colour photographs or other illustrations to depict and
explain the health consequences of smoking; tar, nicotine and carbon monoxide
ceilings; an assessment of the health effects of the smoke yield of other
substances; and, a proposal for a common list of ingredients. The EU Commission
is to report on the application of the Directive and indicate features that
should be reviewed or developed in light of developments in scientific or
technical knowledge by the end of 2004.
The EU Commission has adopted a Decision that establishes the Rules for the use
of colour photographs or other illustrations to depict and explain the health
consequences of smoking. It is for Member States to decide whether or not to
introduce such pictorial health warnings from October 2004.
In June 2003, an EU Directive relating to the advertising and sponsorship of
tobacco products was adopted. Its provisions include the prohibition of tobacco
advertising: in the press and other printed publications; in radio broadcasting;
in information society services; and, through tobacco related sponsorship,
including the free distribution of tobacco products. Member States shall comply
with this Directive by 31 July 2005 at the latest. The German Government and
others have commenced a legal challenge to the Directive in the European Court
of Justice.
The EU has indicated that it is to develop an initiative to ban smoking in the
workplace. Certain Member States have already enacted, or are considering,
legislation that restricts smoking in public places.
In May 2004, 10 additional European countries ('EU Accession Countries') will
join the EU. These countries are required to comply with the existing laws of
the EU at the time of joining except for certain transitional arrangements.
In the UK, the Tobacco Advertising and Promotion Act was adopted in 2002. The
Act prohibited the advertising and promotion of tobacco products including
billboards, press, and free distribution of samples from February 2003, and
in-pack promotion schemes from May 2003. The Act also banned sponsorship by
tobacco companies from July 2003, although transitional provisions allow an
exemption for 'exceptional global events' until July 2005. Draft Tobacco
Advertising and Promotion (Point-of-Sale) Regulations have also been published
that significantly restrict the size, format and content of tobacco
advertisements that may be published at point-of-sale and on tobacco vending
machines. Following correspondence, the Secretary of State has indicated a
commitment to resolve the outstanding issues.
In August 2003, the UK Office of Fair Trading notified Gallaher of an enquiry
into vertical agreements between manufacturers and retailers in the UK
cigarette, tobacco and tobacco related markets. Gallaher is co-operating with
the enquiry which is currently at the information gathering stage.
In the Republic of Ireland, the Public Health (Tobacco) (Amendment) Bill was
published in August 2003, purporting to give effect to two EU Directives and an
EU Recommendation relating to tobacco. The Bill includes provision for a
comprehensive ban on tobacco advertising, sponsorship and measures relating to
the manufacture, presentation and sale of tobacco products, and may be subject
to legal challenge. Also, in Ireland, the Tobacco Smoking (Prohibition)
(Amendment) Regulations 2003 (as subsequently amended), which allow for a
complete ban on smoking in all public places, with certain limited exceptions,
will come into force on 29 March 2004. Separately, Regulations were made in
September 2003, purportedly to give effect to the 2001 EU Directive on the
manufacture, presentation and sale of tobacco products.
In Germany, from 2007 cigarettes may only be bought from vending machines which
have youth protection technology installed, i.e., consumers will have to verify
their age, for instance, by using age encoded chip cards.
In France, the Government enacted a law in 2003 seeking to restrict tobacco
consumption among young people. The law includes the prohibition of packs of
less than 19 cigarettes.
In the Netherlands, the Government has introduced tobacco ingredient disclosure
regulations. In August 2003, Gallaher and Philip Morris International commenced
a joint legal challenge to the Dutch regulations, which, Gallaher believes, do
not provide adequate protection for brand recipes. Other tobacco companies
including British American Tobacco, Japan Tobacco International and Imperial
Tobacco have also commenced legal proceedings.
In Russia, a federal law on restrictions on the smoking of tobacco came into
force in 2002. The legislation prohibits: smoking in some public places; the
sale of cigarettes to those under 18 years of age; and, the sale of loose
cigarettes or packs containing fewer than 20 cigarettes. Furthermore, from
January 2003, the production and import of filter cigarettes with smoke yields
exceeding 14mg of tar and 1.2mg of nicotine was prohibited, and tobacco products
must display a general and rotational health warning and tar and nicotine smoke
yields.
In addition, draft Bills have been introduced to the Russian State Duma whose
provisions include: significantly larger rotational health warnings from January
2005; further reductions in maximum tar and nicotine smoke yields; a complete
ban on tobacco advertising, with certain limited exceptions, and at
point-of-sale, with effect from January 2006; one in every ten packs should have
a special leaflet inserted with health information on tobacco addiction; and, a
ban on the sale of tobacco products within 100 meters of educational
establishments.
In the Ukraine, the Parliament approved amendments to the Law on Advertising in
September 2003, restricting tobacco advertising in the printed media and
prohibiting it entirely on television and radio. Furthermore, a draft law is
being considered whose provisions include: prohibition of certain tobacco
advertising; prohibition of the sale of tobacco products to and by persons under
18 years of age; prohibition of the sale of cigarettes in packs of less than 20
sticks; further restrictions on smoking in public places; significantly larger
health warnings; and, reductions in maximum tar and nicotine smoke yields.
In Kazakhstan, the Parliament adopted the Law on Advertising in November 2003,
which limits tobacco advertising in the media. Outdoor tobacco advertising is
also to be prohibited from 1 October 2004, under the law on prevention and
restriction of tobacco smoking. Additionally, new health warning requirements
apply from April 2004.
Tobacco Taxation
In 2002, the EU adopted a Directive increasing the minimum excise rates on all
tobacco products. The provisions also include the introduction of a minimum
excise burden of €60 per thousand cigarettes on the most popular price category
of cigarettes, which will increase to €64 per thousand cigarettes in July 2006.
For certain Member States, transitional periods to comply with the new cigarette
rates are allowed by the Directive. Additionally, a number of Member States have
introduced a minimum excise duty, relating to the duty levied on cigarettes of
the most popular price category in each country.
*
EU Accession Countries will be required to implement significant duty increases
in order to comply with the minimum cigarette excise tax requirements. Many have
been allowed transitional periods - the longest until January 2010 - in which to
comply. The Austrian Government has issued regulations maintaining the
25-cigarette import limit for Austrian residents returning from four
neighbouring EU Accession Countries. Any relaxation of the current controls on
personal imports from Accession States into existing EU States could have a
significant negative impact on sales in neighbouring countries such as Austria
and Germany in the transitional periods.
In the UK, tobacco duty was raised in line with inflation in April 2003. The
impact of high taxation in the UK cigarette market, resulting in high prices,
has led to reduced annual industry volumes, greater price competition and
trading down by consumers to lower price cigarette brands. Gallaher believes
that the wide price differentials between the UK and Continental Western Europe
and other parts of the world have led to a smuggled market for legitimate and
counterfeit cigarettes and also an increase in legitimate cross-border
purchasing. HM Customs and Excise estimates that, for the year 2002-03,
approximately 27% of cigarettes and around 70% of handrolling tobacco smoked in
the UK market were not UK duty paid products.
The Group continues to support and endorse regulatory authorities' activities to
stop smuggling of tobacco products. Gallaher has a history of co-operation with
investigations into smuggling and readily exchanges relevant information with
the authorities on a regular basis.
In certain other important Continental European markets, excise duty increases
continue to have an impact on prices, sales and margins. These include, for
instance, large tax increases in Ireland, Germany, the Netherlands and France.
In Russia, the auditor of the Accounts Chamber is calling for the Government to
return to the specific excise system which could, if implemented, adversely
affect company sales.
Litigation
Certain companies in the Group are defendants in actions in the UK where the
plaintiffs are seeking damages for ailments claimed to have resulted from
tobacco use or exposure to tobacco smoke. There are no such claims in England
and Wales. As at 27 February 2004, Gallaher is involved as a defendant in three
dormant individual cases in Scotland where plaintiffs seek damages for ailments
claimed to have resulted from tobacco use. In the Republic of Ireland, the
number of individual claims against Group subsidiaries is currently 14. Of the
151 claims that have been dismissed or abandoned since 1997, 10 individual
plaintiffs have appealed against dismissal. The outcome of these appeals are
awaited. Of the remaining 14 claims, 12 Statements of Claim have been served
upon Group subsidiaries and other tobacco companies, making wide-ranging
allegations against such companies and against Ireland, the Attorney General and
the Minister for Health and Children, who are also named as defendants in some
of those cases. Gallaher has refused to accept service of four of the above
Statements of Claim due to the delays by the plaintiffs in prosecuting the
claims. Court applications by Gallaher are pending in relation to five of the
other Statements of Claim and, in relation to the remaining three, detailed
particulars of the claim are awaited from the plaintiffs. No defence will be
delivered by Gallaher pending the conclusion of all of these matters.
Gallaher is not a party to smoking related litigation anywhere else in the
world.
To date, there has been no recovery of damages against any Group company in any
action alleging that its tobacco products have resulted in human illnesses. It
is not possible to predict the outcome of the pending litigation. Gallaher
believes that there are meritorious defences to these actions and claims and
that the pending actions will not have a material adverse effect upon the
results of the operations, the cash flow or financial condition of the Group.
The pending actions and claims will be vigorously contested. There can, however,
be no assurance that favourable decisions will be achieved in the proceedings
pending against the Group, that additional proceedings will not be commenced in
the UK or elsewhere against Group companies, that those companies will not incur
damages, or that, if incurred, such damages will not have a material impact on
Gallaher's operating performance or financial condition. Regardless of the
outcome of the pending litigation, the costs of defending these actions and
claims could be substantial and will not be fully recoverable from the
plaintiffs, irrespective of whether or not they are successful.
Liggett-Ducat continues to be involved in court processes relating to payments
allegedly due for unpaid taxes, penalties and fines claimed by the Russian tax
authorities. As at 27 February 2004, the challenges that have been made to the
claims have been successful. Based upon the facts and matters currently known,
management considers that there are meritorious defences against these actions
and that they will be vigorously defended.
Gallaher Group Plc
Cautionary statement
This announcement includes 'forward-looking statements' within the meaning of
the US securities laws. All statements other than statements of historical fact
included in this announcement, including, without limitation, statements
regarding Gallaher's future financial position, strategy, dividend policy,
anticipated investments, projected sales, costs and results (including growth
prospects in particular regions), plans, projects to enhance efficiency, impact
of governmental regulations or actions, impact of new accounting standards,
litigation outcomes and timetables, the successful integration of acquisitions
and joint ventures into our Group, objectives of management for future
operations and effects of restructuring activities, may be deemed to be
forward-looking statements. Although Gallaher believes that the expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such expectations will prove to have been correct. We undertake
no obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise. Important
factors could cause actual results to differ materially from Gallaher's
expectations including, without limitation, changes in general economic,
political or commercial conditions, foreign exchange rate fluctuation, interest
rate fluctuations (including those from any potential credit rating decline),
competitive product and pricing pressures, the impact of excise tax increases,
regulatory developments, the uncertainties of litigation, difficulties in
integrating acquisitions and joint ventures, production or distribution
disruptions, difficulty in managing growth, declining demand for tobacco
products, increasing dependence on sales in the CIS, changes in the supply of
tobacco and non-payment of receivables by our distributors as well as other
uncertainties detailed from time to time in Gallaher's public filings and
announcements. The risks included here are not exhaustive. Moreover, we operate
in a very competitive and rapidly changing environment. New risk factors emerge
from time to time and it is not possible for us to predict all such risk factors
on our business or the extent to which any factor, or combination of factors,
may cause actual results to differ materially from those contained in any
forward-looking statements. Given these risks and uncertainties, investors
should not place undue reliance on forward-looking statements as a prediction of
actual results.
Definitions
The terms 'Gallaher' and 'Group' refer to Gallaher Group Plc and its
subsidiaries. The term 'Liggett-Ducat' refers to the Liggett-Ducat group of
companies. The term 'Austria Tabak' refers to the Gallaher Austria group of
companies. The term 'ATG' refers to Tobaccoland Automatengesellschaft mbH & Co
KG. The term Lekkerland-Tobaccoland refers to Lekkerland-Tobaccoland GmbH & Co
KG. The term 'TOBA' refers to Tobaccoland Austria (Tobaccoland Handels GmbH).
The term 'BAT' refers to British American Tobacco p.l.c. The term 'Philip
Morris' refers to Philip Morris International, Inc., a subsidiary of Altria
Group, Inc. The term 'Japan Tobacco' refers to Japan Tobacco Inc. and its
subsidiaries. The term 'RJ Reynolds' refers to R.J. Reynolds Tobacco Holdings,
Inc. The term 'Imperial Tobacco' refers to Imperial Tobacco Group PLC.
This information is provided by RNS
The company news service from the London Stock Exchange
