英美煙草 (BTI) 2002 Q4 法說會逐字稿

Good day, and welcome to the British American Tobacco year-end results 2002 conference call. During the presentation all participants will be in a listen-only mode. Afterwards, you will be invited to participate in a question and answer session. At that time, if you have a question, you will press star one on your touchtone phone to register. As a reminder, this conference is being record on Tuesday, February 25, 2003. I would now like to turn the program over to Mr. Robert Copudeo (ph) of Morgan Wall. Go ahead, please.

This is Robert Copudeo of SB Morgan Wall, representing British American Tobacco here in the US. I, along with my colleagues in London would like to welcome you to BAT's year-end 2002 results conference call. Today in London we have Chairman Martin Broughton, Managing Director Paul Adams, Financial Director Paul Rayner, and General Counsel, Neil Withington. Martin, please begin.

Thanks Robert. Good morning everyone, welcome to our 2002 preliminary results. I will kick off then I will pass to Paul Rayner, who will take you through the financials, and then Paul Adams will comment on some of the trading issues, before coming to questions.

There's no doubt that whatever business you're in, 2002 has been a difficult year, perhaps an exceptionally difficult year, with deteriorating economic conditions worldwide. With sterling being surprisingly strong, it's been tough, and with no improvement in sight.

The main feature of our 2002 results has been the impact of the weakening of a number of key currencies on the translation of the group's results into sterling. Now we're not making excuses here, it's a fact of life that we have to live with, but we will be showing the impact of exchange movements on our results, as it does help to understand what's really happening. In fact, at prior year's rates of exchange, operating profit would have grown by 3% rather than the published 3% fall to £2,681m at the average rates. A 3% rise in operating profit would have been broadly in line with the guidance we gave back in December 2001.

The absence of integration costs or any exceptionals, and lower interest costs results in pre-tax profit rising 2% to £2,113m. Volumes at £777b were nearly 4% lower than in 2001, mainly due to the planned action taken to restrict the supply of duty-free products. As a result of this action we believe we now have a more sustainable and higher quality business. If you recall, we did in fact forecast a 2% to 3% drop in volumes.

The lower interest costs and improved tax rate, and lower minority interests, has enabled adjusted, diluted earnings per share to grow 8%, to 66.5 pence, in line with market expectation of high single figure EPS growth. We recognize that there is a touch of serendipity here, there were some non-recurring interest and tax benefits helped offset the negative exchange effects. As you can see from this chart in front of you, adjusted EPS has grown consistently since British American Tobacco was listed was a standalone company in 1998.

Given the underlying strength of the business, and the Group's proven ability to generate cash, we are proposing a 9.9% uplift in the final dividend to 24.5 pence, making a 10% increase in dividends for the year. That represents 47% increase in annual dividends, from 24 pence to 35.2 pence over the past four years.

Now we've indicated for some time that our cash priority is acquisitions. Clearly, had there been an acquisition opportunity in 2002 we would have done it. At the same time we've also made it clear that our gross interest cover range is from five to nine times cover, and we're currently at 8.6 and moving towards 9. Accordingly, we feel the time is right to initiate a bond market share buyback program, which will obviously be earnings enhancing, but will not preclude us from taking advantage of industry consolidation should the opportunity arise.

Now we've been informed by our major shareholder, R&R Holdings, that is does not intend to participate in the buyback. We have a [Stanstead] agreement with them that prevents us from taking action that would push their shareholding above 29.9% they currently stand at 27.7%. Accordingly we would not anticipate acquiring more than 7.5% of the outstanding shares over the full length of the program.

The next two charts are dear to our hearts, as I'm sure they are to shareholders. Half of the executive long-term incentive payout relates to total shareholder return, against the FTSE 100 and against a peer group of companies. Strong cash generation, sustained earnings and dividend growth has enabled us to continue our out-performance in terms of shareholder return.

BAT was the second strongest performer in the FTSE 100 companies during the three years to 31 December 2002, with an annual return of 25.6%. Amongst our peer group of leading international fast moving consumer goods companies, we were ranked third out of the 28 companies on total shareholder return.

A feature of recent results meetings has been the low level of litigation news involving Brown & Williamson. The number of product liability cases pending has fallen by 200, to around 4,200 at the end of 2002. Approximately 4,100 individual cases are pending, almost 200 less than prior year. Two-thirds are [grow-in] follow-on cases, and another quarter are tied up in the West Virginia consolidated action. Even less than 7% of the cases filed by other individuals.

As you know in California there has recently been some positive verdicts for tobacco defendants, but Brown & Williamson has yet to defend an individual trial there. You're probably all aware that the Engle Appeal was heard in the fourth quarter of last year, and we expect a ruling to be handed down from the Third DCA some time in the next few months.

Now keen observers amongst you will have noticed that we've included in our contingent liabilities note, a reference to a US company called Flintkote. Now I don't want to get this out of proportion, it's not a big issue and doesn't concern us unduly. However, since we have added it into the contingent liability note, and knowing most of you won't have had the time to read that yet, we didn't want to ignore it and then have you think later that we'd tried to sneak it passed you unnoticed. So let me explain a bit about Flintkote.

Flintkote is a company that was acquired by Imasco (ph), our Canada operation in 1986, through Gemstar, whose principal subsidiary was Canada Trust. It became a Group subsidiary following the restructuring of Imasco (ph) in 2000. And Flintkote had net assets of £75m at the end of the year. Those of you who analyzed Imasco (ph) in the 90s may have seen reference to Flintkote in the Imasco (ph) contingent liability notes. Flintkote has been named, along with a large number of other defendants, in numerous personal injury claims alleging exposure to asbestos products. All claims relate to businesses which ceased active operations in the early 1970s, long before Flintkote became a subsidiary of Imasco (ph).

To date, substantially all the claims costs and legal expenses occurred in connection with these suits have been covered by insurance proceeds. But given the increased level of volatility of asbestos related actions in the US, and the sums being settled, we consider it prudent to point this out in our contingent liabilities notes. We do believe that all current claims and suits against Flintkote are sufficiently covered by insurance, and in a worst case scenario we believe the liabilities do not extend beyond the net assets of Flintkote.

Enough of that and turning to the results. Despite the difficult operating environment, 2002 was a year of real progress, as you will hear from Paul Rayner and Paul Adams during the presentation. The 10% increase in dividends and the share buyback program demonstrate the Board's commitment to look after shareholders, and reflects our faith in our medium-term prospects. As you know, historically we have not generally provided forecasts, leaving that to be the role of the analysts. Last year, when we announced a planned reduction in duty-free sales we made an exception. But this year we're reverting to our traditional view and not providing a forecast.

In any event, I think it would be a rash Chairman who would make a forecast for the current year, with so many extraneous factors unresolved. The Iraqi war and the economic and political aftermath of that, the state of the dollar and the state of the world economy to name but three. What I can promise you is that this management team is focused on shareholder value, and most importantly we enter the year from a consistently improving competitive position. The global dry brands will continue their great progress, indeed with the duty-free sales reduction behind us, we can expect some overall volume growth, and there are some great stories our there, like Korea, Russia, and Nigeria etc, to continue our organic growth.

With that I will pass over to Paul Rayner who will now take you through the financial results in more detail.

Thank you Martin, and good morning everyone. As Martin indicated, the results have been significantly impacted by weakening currencies, so we thought it may be helpful for your analysis if we gave you the regional net revenue and operating profit at both current and constant rates of exchange.

Total net revenue was down 5% at current exchange rates, to £11.4b. In percentage terms, the most significant declines were Latin America and Africa and Middle East. However, when we look at revenue at constant rates of exchange, we see a different picture. This chart shows the correlation between volumes in the blue bars and net revenue at constant rates, which are in the red bars.

America-Pacific saw a 1% increase in volume, with a 2% increase in revenue at constant rates, reflecting price increases in the US and Canada. You should note that the costs of discounting, which were higher in the US, are treated as an expense here. We are required to do this under UK GAAP, whereas under US GAAP the costs come off the revenue line.

Asia-Pacific and African and Middle East were the two regions most affected by the planned reduction in duty free sales. In Asia-Pacific the volume reduction of 6% can be attributed to duty free, which had a moderate impact on net revenue at constant rates. Similarly Africa and the Middle East had an 11% decline in volume, which in constant net revenue terms was more than compensated for by higher prices in South Africa and increased volumes in Nigeria.

As a result of substantial price increases, the Latin American net revenue at constant rates is down only 2%, despite a 6% fall in volumes. Adverse currency movements, however, turned this into a 13% reduction.

In Europe exchange rates did not have a material effect, but net revenue fell because of the loss of the UK partnership, the price war in Rumania, and the excise increase not fully passed on in Germany.

The impact of exchange on operating profit was £169m, pulling the reported figure down 6%. Thus the 3% increase in constant rates became a 3% decrease at current rates. Again, looking at operating profit on a constant rates basis, America-Pacific benefited from a 7% increase in profit in local currency in Canada, a significant increase in profit in Korea, and improved profit in Japan. While in the US, there was a good performance from Brown & Williamson, with dollar profit just 2% lower, despite the intense levels of discounting and free goods.

In Asia-Pacific margins improved, despite the reduction in duty-free sales. And in the Africa and Middle East, operating profit at constant rates actually rose, despite the 11% loss of volume. A word of explanation on the South African Rand. Although the Rand ended 2002 much stronger than the closing rate for 2001, the average rate for the year was 28% lower at 15.74 Rand to the Pound, compared to 12.33 in 2001.

Our businesses in Latin America performed remarkably well, given the exceptionally difficult circumstances and political uncertainty in many countries. In US dollar terms, there was profit growth in Brazil, and increased profit in Venezuela. We were delighted that Argentina also recorded a profit, which was a major achievement in itself.

Europe's 8% growth in operating profit, at both current and constant rates, was as a result of a strong performance in many markets, and was achieved despite the loss of the UK partnership, the price war in Rumania, referred to earlier, and the excise increase in Germany not fully recovered.

The 4% fall in volumes and 3% fall in operating profit, meant that margins improved slightly in sterling terms, when expressed in profit per 1000 cigarettes. This has been a major success story for BAT over the last four years. During 2002 profit per mil stood at £3.45, a 59% increase over the period shown on the chart.

If we have a quick look at the remainder of the profit and loss account, one can see that operating profit before goodwill amortization was £2,681m. There were no exceptional charges in 2002. The exceptional item for 2001 being integration costs of £82m, following the 1999 merger with Rothmans International.

Net interest costs were 28% lower at £190m, benefiting from the Group's cash flow, lower interest rates and interest received as a result of reassessment of net tax payments in the US. We would anticipate a slightly higher charge for the current year, in the absence of the one-off benefit we received in 2002 in the US. Obviously, the charge will rise further as the share buyback program is implemented. For those of you who may be interested, gross interest cover stands at 8.6 times.

Profit before tax was up 2%, to £2,113b. And for the record, EBITDA was 5% lower at £3.019b. There was an 8% improvement in the tax charge, at £818m representing a headline tax rate of 38.7%, down on the prior year's rate of 42.9%. If you exclude goodwill and exceptional items, as reflected in the adjusted EPS calculation, the underlying tax rate falls to 32.8% from 36.6% in 2001. This improvement reflects a change in the mix of profits and the resolution of certain outstanding tax issues. We would anticipate an ongoing tax rate of around 35% for 2003. The minority interest charge was lower at £143m, because of the buyout of the Australian minorities and the dissolution of the UK partnership in 2001.

Profit for the year, after tax and minorities rose 14%, to just over £1,152m. And, as Martin commented earlier, adjusted earnings per share, calculated on 2,299m shares, was 8% higher at 66.5 pence.

If we look at cash flow. Net operating cash flow was 10% lower, at £2,986m, reflecting a smaller reduction in working capital, following the significant reduction we had in working capital for 2001. Returns on investment and servicing of finance, which include preference dividends and minorities, as well as interest, improved by £181m to £405m, reflecting the lower net interest costs and they were coupled with some one-off payments in 2001. However, these were partly offset by increased tax outflows, due mainly to the timing of payments, as well as higher CAPEX and financial investment.

Acquisitions less disposals resulted in a net inflow of £25m, principally due the sale of a non-trading company in Malaysia. The £342m outflow in 2001, largely results from the buyout of the Australian minorities. Thus, the Group's net debt position improved by £0.5b, to £3.4b as a result of borrowings reducing by £0.8b to £5.3b, and cash reducing by £0.3b to £1.9b.

Before I hand over to Paul, a few words on FRS17, and retirement benefits.

As I am sure most of you know, the Accounting Standards Board here, decided last year to allow full implementation of FRS17 to be deferred until 2005, while the International Accounting Standards Board considers revisions to its standard on employee benefits. Therefore, we are continuing to report under SSAP24, and make use of the transitional arrangements under FRS17, which means that our reported income and shareholders equity are not affected by the new standard here. We will, of course, publish next month a detailed note of the effective FRS17 on reported income and shareholders equity, in our Directors Report and Accounts.

We believe the approach we use under current standard SSAP24 is relatively conservative. Therefore the impact on Group pre-tax profit of reporting under new standard FRS17, would not have a material effect on the 2002 pre-tax profit. Had we in fact reported under FRS17, the impact on the 2002 profit would have been negligible. In fact pre-tax profit would have increased by £4.0m, reflecting the conservativeness of our approach under the current standard.

FRS17 also requires that the balance sheet should include recognizable deficits and surpluses, reflecting the fair value of scheme assets and liabilities. Applying this criteria, shareholders funds would have been £561m lower, reflecting in the main, the decline in equity markets. This shareholders funds reduction, although significant, is not high when put into the context of the size of our Group and its cash flow generating ability. In view of this, the Group will continue to support the defined benefit schemes it has around the world.

A sensible way to deal with the deficit of course would be to amortize the deficit over the average service life of scheme members, which is 12 to 15 years. In fact we would expect under our existing accounting standards, the impact on operating profit to be in this range. Of course any estimates at this stage on the impact on 2003 are somewhat subjective.

I will now hand over to Paul, who will take you through some of the business issues.

Thank you Paul, and good morning everyone. As Martin said earlier, 2002 was another year of progress for the Group. A year in which our global dry brands grew 8%, making 19% over the last two years. This was particularly impressive when you bear in mind that international brands were hit harder by the planned reduction in our duty free sales. The dry brands now account for 14% of Group volume, as we continue to focus on the key international and premium priced segments of the market.

Looking at the brands in turn. Dunhill achieved a record volume of over 30b sticks, representing outstanding growth last year of 22%. Much of the growth can be attributed to the success of the brand in Korea, where volume has more than doubled. But Dunhill also recorded good performances in key markets, such as Malaysia and Australia. Lucky Strike volumes were down as a result of the planned reductions in duty free sales. A strong performance in key markets like Germany and Spain, led to an improvement in the second half of 2002, and we anticipate further improvements this year.

Kent's volumes rising 5% achieved another record year, with strong volume growth n Russia and Rumania, a market where Kent consolidated its position as the leading brand in the premium segment. Kent is now also the largest premium brand in Moscow and the 30 key cities in Russia. In Japan, Kent continues to make solid progress.

Pall Mall grew 16% last year, with notable successes in many countries, including Russia, Germany, Rumania, and is well positioned for future success in Italy. In the US, Pall Mall Box continued its outstanding success, growing 72% year-on-year, based on its unique longer-lasting product proposition, demonstrably offering real consumer value. It continues to increase its market share, by building higher distribution, awareness and trial, through a combination of both consumer and trade promotions. Pall Mall Box shipment share for 2002 grew by 0.4 share points to 1%, increasing Pall Mall's overall share to 1.4%. January 2003 share data confirms further growth.

As I have touched on the US market, I should comment further on a good performance from Brown & Williamson, in very difficult market conditions. Brown & Williamson's contribution from the US market was £353m, just 2% lower in US dollars, during a year when industry profit was substantially down. Of particular note is that during 2002, Kool grew more market share than any other premium brand.

Most of the analysts who cover the sector, have written extensively on the US market, and the issues faced by the major players. Quite simply, trading in the US has been reshaped, by higher state excise taxes, coupled with an escalation in price discounting and the use of promotional product. The impact of the state excise increases should not be underestimated. Although state taxes range from a few cents to over $1.50 per pack, the average tax burden, including federal excise tax, is forecast to double from 60 cents in 1998, to $1.20 by the end of 2003.

Let me put another perspective on this. In late 1998 the Master Settlement Agreement was reached with the State Attorney General, which resulted in a price increase of around 50 cents a pack. The Attorney General, as part of their propaganda, spoke of a $245b settlement. We thought of it as a litigated state excise tax. But here's the point, this additional 60 cents in five years, is the equivalent of another MSA.

On a shipment basis, although volumes were marginally lower, Brown & Williamson's market share grew in 2002, to 11.2% versus the 10.9% in 2001. The strategic brands, Kool, Pall Mall and Misty, continued to show positive share performances, offset by decrease in GPC and the smaller non-strategic brands. The strategic brands now represent almost 60% of Brown & Williamson's volume, up 8% on the prior year. This is an impressive performance, achieved with focus, brand repositioning and effective and efficient pricing and promotional programs. Certainly our concept of everyday low price seems to be catching on.

The outlook for the US remains uncertain, and will be shaped more by the actions of the competition, which are becoming increasingly difficult to predict. Furthermore, the financial results will be affected by the sterling/dollar exchange rate, which is also becoming harder to predict. However, we do believe that we have a high caliber, US management team in place, who have built a sustainable business model, and shown that they can construct and execute strategies that enable Brown & Williamson to compete in the US market. These efforts will continue.

North of the border, Imperial Tobacco Canada grew profits 7% in Canadian dollar terms. This result was only marginally ahead when translated into sterling, at £437m. The increase in profit was achieved through higher gross margins and operating efficiencies, partly offset by lower shipments, which were a result of [swinging] provincial and federal tax increases. These conditions have seen the growth of value-for-money brands, and contraband. The value-for-money manufacturers share of total cigarettes is up 5.3 points, and now stands at just under 9%. Imperial Tobacco Canada's share of the premium cigarette sector grew through the performance of du Maurier and Players. However, total Imperial volume money when you include roll-your-own, decreased 11%.

In Japan, both Kent and Kool increased volumes, despite industry volume decline, and contributed to the growth in overall market share.

In South Korea, Dunhill Lights continued its excellent performance, and its volume and market share growth, now up to 10.7%, which has more than doubled. There was a significant increase in profit.

As the announcement states, Asia-Pacific was destined, along with Africa and the Middle East, to suffer most from the planned reduction in duty-free sales. Although volume and profit were affected in both regions by this action, there were some good performance from markets such as Australia, where premium share increased, margins improved, and the benefit of savings in the supply chain came through.

Malaysia, improved its overall market share, as well as its share in the premium and ASU 30 segments. South Africa saw good profit growth in local currency, but the impact of the weak Rand through most of 2002 accounted for almost all of the regions reduction in sterling profit, as Paul explained earlier. The investment in Nigeria continues to progress well, and volume and profit grew strongly.

Profit in the Europe region was up £42m, to £547m, despite a number of adverse variances such as the dissolution of the UK partnership, lower margins in Germany following the excise increase in January last year, and the price war that has broken out in Rumania. On the credit side, there have been many solid market performances. Notably Russia, where record sales of Kent, Pall Mall and Vogue led to a 7% increase in volumes, despite the drop in volumes during the first quarter, following the reorganization of the secondary supply chain.

Germany continued to grow its market share, and importantly its ASU 30 share behind Lucky Strike and Pall Mall. In Hungary we saw strong share growth, following the success of the implementation of direct store distribution. Ukraine, where we have seen margin improvement and strong volume growth, and France, where last year's price increase resulted in a substantial increase in profit, despite a small decline in market share.

The Latin American region performed remarkably well, with profit at £393m, down just £35m despite the significant weakening of all major currencies. Volumes fell 6% due to adverse economic conditions, fierce competition, higher prices, and consumer down-trading, often to contraband.

Martin referred to 2002 as a year of progress, it was. Global dry brands grew impressively. The investments we have made in markets such as Korea, Nigeria and Turkey are laying the foundations for organic growth.

Alongside revenue growth, the other major component of profit growth is cost control. Recent trends are positive. Product costs per mil have reduced, and we have achieved an improvement of 5% last year, in terms of the cigarettes produced per man-hour, and almost 13% over the last two years. Pleasing as these figures are, we are committed to finding further significant improvements.

Our strategy is to unlock the trapped value throughout the entire supply chain, by managing it as an integrated process. Increased use of e-business and commonality of systems and processes will drive this. As a result, we will improve product availability and customer service, to drive revenue growth. We will reduce inventories to release cash, and reduce supply chain costs to improve earnings.

We also aim to reduce overheads and indirect costs, to achieve real annual savings of £200m per annum by the end of the next five years. To deliver these savings we do recognize the need to improve the way we currently operate, but we do not want to jeopardize our business effectiveness, with cuts made just for short-term effect. The target has therefore deliberately been set over a five-year period, to ensure that we design and execute sustainable programs.

Looking forward, the quality of our underlying business has improved on both a geographic and brand basis. We've improved our ASU 30 performances in key markets, such as the US, Germany, Russia, Italy, South Korea, Malaysia and Switzerland. We continue to successfully implement our core strategies, and have grown a management team across the world of unrivaled depth.

While pricing and currency issues remain, we are confident in playing the hand we have dealt ourselves.

Thank you. We will now hand over to the operator to take your questions.

Do you want to explain the Q&A please.

Yes. If you would like to ask a question, please press star one now on your touch-tone telephone. To withdraw yourself from the queue press the pound key. Once again to ask a question press star one now. We'll take our first question from the site of David Adelman of Morgan Stanley go ahead please.

Good afternoon, Martin and Paul, Paul and Neil.

Hi David.

Paul could you characterize sort of on the margin, what types of changes you're seeing in the US competitive environment very recently? And is the business stabilizing or is the industry dynamics stabilizing at a low level of profitability? Or, are you seeing consistent incremental weakness in the profitability in the market?

Well I think it's fair to say that we foresee industry profitability declining quite significantly in 2003. We've yet to see the full impact of Philip Morris's off-invoice buy-down, which is currently running in February/March, and I think it's been announced that it's continuing into April. So we've yet to see the other side of that and how long that will run, and RJR's reaction. But my assessment is that we've yet to see the full impact of that in terms of industry profitability. But I think it's going to be pretty bloody. I suppose in an optimistic mood, one can say that we're reaching some kind of equilibrium - but I think this is in an optimistic mode - in that if we're reaching an acceptable price gap between premium brands - principally those of our competition - and the discount brands, if we see further legislation by the states in terms of forcing the NPM's into paying into ESCROW, which may put prices up a little, you might say that we're on the verge of equilibrium, but I think that's optimistic.

And Paul, within the scope of the issues in the US market, how significant on a relative basis is non-MSA or non-ESCROW compliance in your view?

Difficult to say. Difficult to say. I think it will have some significance, I'm not sure that it's a silver bullet.

And then in the Canadian market, have you had a response there as of yet to the rapid growth of the deep discounts brands in that market? Have you done anything?

No we haven't done anything as yet. RBH, as you may know are about to launch a brand called Number Seven, which is I think the first launch of a brand to compete, or at a price point that will compete with the discount brands. It's not a brand that's been launched before in tailor-made form. It is a brand that's been in the roll-your-own and stick market there. So we will see how that tracks. It could be nothing, but as was described to me in Canada, that could be the equivalent of Archduke Ferdinand being shot.

Okay and then lastly on the share repurchase intent, could you review -- I think it's in mid '04 that there's a change in R&R's ownership, whether there's a put option. If that's exercised, how would that alter the maximum availability of share repurchases? Could you review that issue, please?

In mid '04 the convertible redeemable preference share, are either redeemed or converted. And if they are converted that will actually increase the ability for us to do a share buyback. As we stand now, if we start the share buyback, we could effectively buy something like 7.5% of the stock. And with R&R not participating, once we've bought 7.5% of the stock they reach the limit under the [Stansel] agreement of 29.9%. It stays at that figure unless the convertible redeemable shares are converted. If they're converted then there's the capacity for us to buy more shares in the marketplace and keep them under 30%. So I think June 2004 is an interesting date from that perspective, because we won't know until we get to that date the capacity for us to buy shares over and above the 7.5%.

Okay, thank you all very much.

Thank you, David.

We'll take our next question from the site of Mr. Martin Feldman of Merrill Lynch.

The first question I have relates to the US market as well. Paul, we saw in the fourth quarter, we saw [B&W] clearly deliver a fairly robust performance. We saw the same from [Laurelard]. So clearly the USA's profits were down over 70%, and [Ardreas] down over 50%. What do you think is characterizing what has become a very divergent performance in the US? You're all subject to the same excise tax environment, you're all subject to the same pricing pressures. Can you comment on how much you think the specific brands are having an issue, and are playing a part in how much the costs within the business? And anything else you think is relevant?

That's a big question, Martin. I think that -- and this will be no surprise to you, Martin, we've discussed this on a number of occasions -- but I think brand equity plays a role. I think pricing certainly plays a role. And I think penetration of low price plays a role. That is why we went with everyday low price. I believe that is why Philip Morris has moved to the off-invoice buy-down, to expand the penetration of low prices into those stores where the non big four are bigger. And I think it's a smart move on their part.

Having congratulated them on the smart move, I'd also -- I'm duty bound to say, it's about time. So I think we've got some things to play out, and I read the same reports that you read. I rather suspect the competition are feeling their way forward. They've got some strategies which are logical, but they want to see how they play. We have seen, certainly in the fourth quarter, a significant slowdown in the growth of the non big four, which points back to my earlier comment of potentially reaching some kind of equilibrium. But I think we've got to see how it plays, and I think it's a brave or rash man that will make a call on it right now.

Paul, obviously forecasts for the whole of '03 is, as you say, one needs to be brave or rash or perhaps just silly to do it. But if we were to look at just the first quarter, or perhaps at a stretch the first half, do you think the pattern of the profitability by the four businesses - and most especially Brown & Williamson having remained pretty stable - is likely to continue for the next few months?

No I think industry profitability is going to be bloody. Certainly very bloody in the first quarter, pretty bloody in the second.

So the strong performance we saw from [B&W] in the fourth quarter, we shouldn't necessarily assume can be repeated in the first and second quarters?

I don't think you should assume that, no.

Okay, Martin, a question for you. Could you perhaps say, philosophically, what made you come round to the idea of a buyback? I thought in the conversations we've had in the past that it had really been an option that you thought was perhaps the least attractive of virtually all of them in terms of what you can do with your cash?

Well I think it's fair to say it's not my preferred option. And I think we've said, you know, the preferred option is acquisitions and remains acquisitions. But we've also been clear that we operate within a five to nine times gross interest cover, and we're getting close to that. So I'm comfortable going ahead with an on-market buyback. Which obviously, if the appropriate acquisition opportunity comes along, we can always suspend for a period of time, depending on what the debt equity position, what the gross interest cover position really goes to.

So yes, my preference hasn't changed. I'd rather be doing an acquisition, a significant acquisition, but we've made the point before, we're not sitting here with a feeling that the money is burning a hole in our pocket and we need to do an acquisition at any price. We need to do acquisitions which are strategically attractive, financially attractive, and preferably with the acquisition competition really hurdled, condition issues involved in any of the -- any possible major acquisition. I mean it's really on a willing buyer/willing seller basis. So we haven't written off the possibility of an acquisition, but it hasn't been possible so far.

You've commented to me in the past that perhaps the major impediment has been the blessing from the various competition authorities, rather than tobacco sector valuations. One, does that still remain the price. Secondly, were there any deals that you thought were interesting of a reasonable size that in the end were not consummated during 2002, while perhaps at some point you thought there might have been?

Well let me say on the first one, I think it's all three. It is financial and competition issues. It's a collection of the three things I said, strategic, financial and competition issues. Let me simply say, on the other side, that I didn't see any acquisitions done in the market that we wish we'd done instead.

Okay, and were there any that you tried to get done?

You wouldn't expect me to answer that now, would you?

No, but you'd expect me ask the question. Okay, finally just a question for Paul Rayner. Paul, I was interested in the chart you showed on the profit per 1000 and how it's risen over the five years that you demonstrated, with just slight growth in '02 as a result of the currencies diluting the operating profit. Have you done the exercise of looking at that same chart on a constant currency basis?

Yes. It would have gone up to 367 on a constant currency basis. About 6.8% increase.

6.8% increase. I see. Okay, thank you very much.

Our next question comes from the site of Bonnie Hertzog of Salomon Smith Barney.

Good afternoon everyone. I had a question, again, I guess on your everyday low price program that seems to have helped you quite a bit as you suggested. Can you give us some idea, with that program does that allow you to get distribution or shelf space, maybe specifically in the fourth quarter? And then how have you seen the retailers react during this first quarter, the last few months as Philip Morris's new pricing strategy again related to your program? Has there been a negative impact on your program? I'm just curious to hear, in your opinion, what's been going on the last month or two.

Bonny, I think we're please with our everyday low price. That gives us good penetration where we want it, and gives us adequate retail presence. Brown & Williamson got off to a good start in January. There was share growth overall for Brown & Williamson, certainly in terms of retail off-take in January, and also on strategic brands. So we did okay in January, which give us renewed confidence that we can compete.

So now that Philip Morris has their program in place, you haven't seen that have too much of a negative impact on your business? I mean you would read the comments, that of course it allowed Philip Morris to get their lower price into so many more distribution channels?

Well they've only been running it since the February 1, Bonnie, you'll have to give us a few more weeks to read that.

Fair enough. The net question I have is on China, and the opportunities in that market. If you can talk about that as you see them, and maybe give us a status on your business in that market, please?

Nothing really to say on that, Bonnie. I think we've said before that we're in discussions with the Chinese government. We’ve also said that we've agreed with the Chinese government we won't say anything other than what they've approved with us to date. I'll go one stage beyond that and say, progress has been a little disappointing so far. We would have liked to have got further in the discussion than we have. But we remain in discussion.

Okay, well that's helpful. And then my last question is on a reduced risk cigarette. Can you talk about your plans for one, if any? And then what you think the opportunities are with this type of product?

Okay, big question, Bonnie. As you know we have Advance in test market in the US. We are looking at other technologies, a possible launch in other markets, to add to the portfolio of potentially reduced exposure products. I don't want to go too further with that, there are other people than your good selves listening at this conference call. So yes, it's a very important part of our research program. We're committed to it, we're going to do it, and we'll see about the commercial success. One of the -- there are two major issues with preps, one is to work with regulators, and to get their reaction. As you can imagine it's a bit of a long haul. And the second is, consumer communications, getting the balance right so that you can responsibly market that product to consumers.

So I think we feel pretty comfortable we've got some good technologies, it's the down stream end of how you use those technologies, which will take the time, and will present the uncertainty.

Okay. And you won't necessarily wait for any type of regulation in this space then, to put some parameters around what you're discussing? Would you just -- you know, if you're ready with technology, would you move forward?

Well we have done so, with Advance, unless I'm missing your question. So yes, we'll go when we've got it.

Okay, in a bigger way. Alright. Actually one final question if I may. Regarding the profitability benefit with the MSA. You've obviously mentioned that it's going to be pretty bloody, low profits in '03. And if I remember right, there is -- if the industry's profits get to a certain point there is a benefit for you. Is that going to be achieved in '03, can you talk about that? Isn't it if the industry's profits get below the base here there's a credit under the MSA?

It's quite a long time, I think we'd have to go back and have a close look at that. There was certainly a credit if any particular company lost share, and the non-MSA members gained share. That was one aspect, but the overall profit level, I'd have to go back and look at it.

Okay. I'm just wondering if we're getting to that point. Alright, thank you so much.

Thank you, Bonnie.

Once again, if you'd like to ask a question, please press star one now on your touch tone telephone. We'll take our next question from Ann Gurkin, Davenport.

Hello.

Hi, Ann.

I was just wondering if we could have a general discussion on how you all approach managing price gaps in your international markets? Are there any areas that may be out of line right now?

Well that's another big question. Global context. I suppose amber lights would be flashing in Canada, as I've mentioned, but that's about it. I mean obviously you're aware of the Latin American situation. We occasionally have a skirmish in Eastern Europe. We had one in Poland a couple of years ago and we had one in Rumania last year. But these aren't really price gaps, this is sort of competitive action. Bearing in mind of course the two absolute truisms of price wars, that everybody hates them and nobody admits to starting them. I suppose price gaps, no new news on managing the price gap in Germany, you will be close to that. I guess the only other area where an amber light may be flashing is France, with the increase in prices in France and [Altardis] reducing the prices of their local brands there. We've yet to see some clarity on that.

I think it's fair to say that in quite a lot of developing markets the price gap is huge anyway. You quite often get a multiple of as much as 10 between the most expensive price and the cheapest price. There are very, very big gaps in lots of markets, and the market is quite comfortable living with that.

Okay, and then just focusing on Argentina, would you comment on your strategy to grow volumes in that market, or maybe to reverse the market share decline?

We've launched Viceroy in Argentina, at a value-for-money price, which is doing well. Obviously with the dynamics in Argentina at the moment, value-for-money is a component which is important to the consumer. So the thing to do is to try and have a portfolio there which will reach a broad range of consumers and their disposable income. But frankly, Ann, the thing to do in Argentina is to hold on by your fingernails and hope for the best.

Great. Thank you very much.

There are no further questions at this time. I would like to turn the program to Mr. Broughton for any concluding remarks.

Thanks very much. Well I think just to conclude, I think 2002 was a year of real progress. Think you've heard where that's been. I think we're particularly pleased with the global dry brand progress, given particularly that we planned the cutback in duty-free sales, which was obviously going to affect those four brands more than most. So I think that's the upbeat note I'd like to leave it on. Thanks very much for listening.

Thank you. This does conclude our conference call for today. You may now disconnect your lines. Thank you for participating.