Driving growth, delivering value

Transcription

1 Imperial Tobacco Group PLC Annual Report and Accounts 2008 Driving growth, delivering value

2 About Us Imperial Tobacco is a leading international tobacco company which manufactures, markets, distributes and sells a comprehensive range of cigarettes, tobaccos, cigars, rolling papers and tubes. We continue to build on our long track record of creating sustainable shareholder value. See overleaf for an overview of our business today Information key p35 Cross reference within report for more information For more information visit The Annual Report contains certain forward-looking statements with respect to the operations, performance and financial condition of the Company and the Group as a whole. By their nature, these statements involve uncertainties since future events and circumstances can cause actual results to differ materially from those anticipated. The forward-looking statements reflect knowledge and information available at the date of preparation of this Annual Report and the Company undertakes no obligation to update these forward-looking statements. Nothing in this Annual Report should be construed as a profit forecast.

3 Our Business Today Logistics Tobacco Our brands Our manufacturing sites Cigarette factories Other tobacco product factories Tobacco processing factories Rolling papers and tubes factories With established operations across the Southern European countries of Spain, France, Italy and Portugal, and recent entry into Central Europe with the opening of our operations in Poland, we are one of the largest logistics companies in Europe. 33 Cigarette factories 14 Other tobacco product factories 8Tobacco processing factories 3Rolling papers and tubes factories

4 For more information visit Performance highlights United Kingdom p26 Germany p27 Spain p28 Rest of EU p29 Americas p30 Rest of the World p31 > Our leading cigarette market share is at 45.9 per cent > We have the UK s two best-selling cigarette brands in Lambert & Butler and Richmond > We are the clear market leader in fine cut tobacco and rolling papers > Our cigarette market share grew to 27.4 per cent > JPS is now Germany s second best-selling cigarette brand with 7.8 per cent share > Our market share in Other Tobacco Products increased to 20 per cent > We are the number one across all tobacco categories in Spain > Our cigarette market share is 37.1 per cent with brands including Fortuna, Ducados Rubio and Nobel > Our fine cut tobacco and cigar shares are 49.1 and 36.8 per cent respectively > We increased our cigarette market share in many countries in the region > JPS grew cigarette market share in a number of markets and Gauloises Blondes also performed strongly > We have a leading fine cut tobacco position across the region > Our share of the overall cigarette market in the USA increased to 4.3 per cent > Our USA market share in fine cut tobacco grew to 8 per cent in September > We expanded our portfolio with the launch of Davidoff and Fortuna cigarettes and Premier fine cut tobacco > We have grown our cigarette volumes and delivered market share gains across the region > We had excellent growth in Africa, the Middle East and Eastern Europe > With our versatile portfolio we see significant opportunities for future growth Net revenue 869m 664m 411m 1,250m 542m 1,502m Adjusted profit from operations 584m 309m 150m 494m 166m 404m Logistics p33 > A good performance in tobacco logistics reflected a number of factors, including stable volumes in Spain > In other products, our traditional wholesale business performed well in a difficult environment Distribution fees Adjusted profit from operations 607m 121m

5 Contents Overview 2 Financial Highlights 3 Chairman s Statement Directors Report: Business Review Strategic and Financial Review 6 Chief Executive s Review 8 Financial Review 12 Where We Operate 14 Focus on the Future 15 World Tobacco Market 16 Our Strategy 17 Key Performance Indicators 18 Case Study: United States of America 20 Case Study: Africa and the Middle East 22 Principal Risks and Operating Environment Our new logistics operations p33 Case Study: Africa and the Middle East p20 Operating Review 26 United Kingdom 27 Germany 28 Spain 29 Rest of EU 30 Americas 31 Rest of the World 32 Manufacturing 33 Logistics 35 Corporate Responsibility Directors Report: Governance 38 Board of Directors 40 Chief Executive s Committee 41 Report of the Directors 44 Corporate Governance Report 55 Directors Remuneration Report Case Study: USA p18 Financial Statements 72 Independent Auditors Report to the Members of Imperial Tobacco Group PLC 74 Consolidated Income Statement 75 Consolidated Balance Sheet 76 Consolidated Statement of Recognised Income and Expense 76 Consolidated Cash Flow Statement 77 Accounting Policies 83 Critical Accounting Estimates and Judgements 85 Notes to the Financial Statements 127 Independent Auditors Report to the Members of Imperial Tobacco Group PLC 128 Imperial Tobacco Group PLC Balance Sheet 129 Notes to the Imperial Tobacco Group PLC Balance Sheet Supplementary Information 131 Principal Subsidiaries 133 Shareholder Information 135 Index 136 Glossary 1

6 OVERVIEW Financial Highlights Volumes 2008 Change 2007 Cigarettes (billion) % Cigars (million) 2,452 >100% 316 Fine cut tobacco (tonnes) 25,150 +3% 24,450 In s million 2008 Change 2007 Revenue 20, % 12,344 Profit from operations 1,157-18% 1,418 Adjusted profit from operations 2, % 1,475 Profit before tax % 1,237 Adjusted profit before tax 1, % 1,238 Attributable earnings % 905 Adjusted attributable earnings 1, % 921 Distribution to shareholders % 467 In pence 2008 Change 2007 Basic earnings per share % Adjusted earnings per share % Diluted earnings per share % Dividend per share % 60.4 Results include the contribution from Altadis since completion of the acquisition on 25 January 2008 and the 2007 per share figures have been restated to reflect the bonus element of the related rights issue. Profit from operations, profit before tax, attributable earnings, basic and diluted earnings per share are impacted, where applicable, by amortisation of acquired intangibles, restructuring costs, certain fair value gains and losses on derivative financial instruments, an exceptional gain on brand divestments, charges for one-off acquisition accounting adjustments, retirement benefit net financing income and related taxation effects. Further detail of these items is included in the Financial Review. Earnings per share amounts are calculated using the weighted average shares in issue of million (2007: million). Dividend per share has been determined using the current shares eligible for the final dividend of 1,011.3 million (2007: million), applying our policy of distributing around 50 per cent of adjusted attributable earnings. Management believes that reporting adjusted measures provides a useful comparison of business performance and reflects the way in which the business is controlled. Accordingly, as outlined in our accounting policy note, adjusted measures of profit from operations, net finance costs, profit before tax, attributable earnings, taxation and earnings per share exclude, where applicable, amortisation of acquired intangibles, restructuring costs, retirement benefits net financing income, fair value gains and losses on derivative financial instruments in respect of commercially effective hedges, one-off acquisition accounting adjustments, brand divestment gains and related taxation effects. Reconciliations between adjusted and reported profit from operations are included within note 1 to the financial statements, adjusted and reported finance costs in note 5, adjusted and reported taxation in note 6, and adjusted and reported earnings per share in note 8. The adjusted measures in this report are not defined terms under International Financial Reporting Standards and may not be comparable with similarly titled measures reported by other companies. 2 Imperial Tobacco Group PLC 2008

7 OVERVIEW Chairman s Statement The past year has again demonstrated the success of our strategy with positive progress across the enlarged Group. Iain Napier, Chairman Delivering value across the Group In what was a year of significant achievement for Imperial Tobacco we delivered another good operational and financial performance. Earnings and Dividends Our adjusted earnings per share have risen by 15 per cent to pence. Basic earnings per share were 50.6 pence (2007: pence, adjusted for the bonus element of the rights issue in June 2008), primarily impacted by restructuring costs, fair value movements on derivatives, amortisation of acquired intangibles and one-off acquisition accounting adjustments, partially offset by brand divestment gains. Adjusted attributable earnings grew by 26 per cent to a little under 1.2 billion. In line with our policy, the Board is proposing to pay out half of this as ordinary dividends. The Board recommends a final dividend of 42.2 pence per share, bringing the total for the year to 63.1 pence (2007: 60.4 pence, adjusted for the bonus element of the rights issue in June 2008). 1 Altadis On 25 January 2008 we completed the acquisition of Altadis, significantly enhancing our business profile. We have a strong track record in acquisitions and a reputation for integrating new businesses efficiently. 1 If approved by shareholders the dividend will be paid on 20 February 2009 to those shareholders on the register at the close of business on 23 January With our enhanced geographic and brand profile we look to the future with confidence. The enlarged Group has around 40,000 employees, 58 manufacturing sites, an extended geographic reach and a more versatile brand and product portfolio, including international strength in cigarette and world leadership in fine cut tobacco, cigars and rolling papers. We now also have a leading logistics platform in Europe. As part of the integration process we announced a number of European restructuring projects in June which will enable us to strengthen our competitive position and deliver the previously announced annual operating efficiencies of approximately 300 million by the end of the financial year ending 30 September 2010, rising to approximately 400 million by the end of the financial year ending 30 September The estimated one-off cash cost of achieving these efficiencies is approximately 600 million. Regrettably, these projects are impacting our workforce and we are committed to providing a comprehensive range of support measures to assist affected employees. Driving Operational Performance Altadis and integration have been key priorities during the year but we have also remained focused on driving the operational performance of the enlarged business, which included an eight month contribution from 3

8 OVERVIEW Chairman s Statement continued Altadis and the first full year contribution from Commonwealth Brands. Whilst building on our strong profit base in mature markets we pursue growth in emerging markets and this year we made excellent progress in Eastern Europe, Africa and the Middle East. The USA is another important growth market and one where our cigarette and fine cut tobacco shares further increased in the year. These positive operational developments are underpinned by our ongoing focus on reducing costs and effectively managing our cash. The Rights Issue From the outset, we said that the acquisition of Altadis would be part funded by a rights issue. At our half-yearly results in May we announced a 1 for 2 rights issue at a share price of 1475 pence per share to raise 4.9 billion. The rights issue was sized at the minimum level required to maintain our investment grade credit rating, to which we remain committed. Given the uncertainties affecting the capital markets this year, it was gratifying to see that the take-up rate was 97.2 per cent and the remainder of the shares were successfully sold in the market. Following the success of the rights issue and two bond issues in September, we are comfortable with our current financing position. Corporate Governance As a major international company we seek to act in a fair and responsible manner towards all stakeholders. It is the Board s duty to review and approve our Company s policies in this regard. We have in place processes which enable us to meet the high standards of conduct expected of our Company. In September, we delisted from the New York Stock Exchange as part of our ongoing programme of business simplification. This will not compromise the integrity of our Corporate Governance and internal control procedures and we will continue to communicate regularly with our investors based in the USA. Board Changes David Cresswell, Manufacturing Director and Anthony Alexander, Vice Chairman, retired during the year and I would like to express my sincere thanks to them for their contribution to the Company. There have been several new additions to the Imperial Tobacco Board during the year. We were delighted to welcome Jean- Dominique Comolli, former Chairman of Altadis, to the role of Non-Executive Deputy Chairman. We also welcomed Bruno Bich and Berge Setrakian, both former board members of Altadis, to our Board as Non-Executive Directors. All have a tremendous wealth of international business experience and their knowledge of the tobacco industry will be invaluable in ensuring that we maximise the significant opportunities the enlarged Group offers. In conclusion, I would like to thank our employees for their contribution to another successful year. Imperial Tobacco and Altadis employees have developed strong working relationships and their combined skills and expertise will enable us to create further sustainable value for our shareholders. The turbulent economic conditions are unlikely to change in the short term but we are resilient and highly cash generative. With our enhanced geographic and brand profile, and strong business fundamentals, we can look to the future with confidence. Iain Napier Chairman Total Shareholder Return Over the past five years our total shareholder return was 151 per cent and we have outperformed the FTSE All-Share Index by 106 per cent Sep 03 Sep 04 Sep 05 Sep 06 Sep 07 Sep 08 Imperial Tobacco FTSE All-Share Index 4 Imperial Tobacco Group PLC 2008

9 In this section: Chief Executive s Review 6 Financial Review 8 Where We Operate 12 Focus on the Future 14 World Tobacco Market 15 Our Strategy 16 Key Performance Indicators 17 Case Study: United States of America 18 Case Study: Africa and the Middle East 20 Principal Risks and Operating Environment 22 Strategic and Financial Review

10 DIRECTORS REPORT: BUSINESS REVIEW: STRATEGIC AND FINANCIAL REVIEW Chief Executive s Review We have improved our position in mature and emerging markets and, in Altadis, completed an acquisition that has substantially strengthened our business. Gareth Davis, Chief Executive Significant potential for further growth Performance Overview The acquisition of Altadis has been the highlight of an eventful year for Imperial Tobacco. Our overall cigarette volumes were up 46 per cent to 292 billion cigarettes, including contributions from Altadis and Commonwealth Brands. Our cigarette portfolio is complemented by our world leadership in fine cut tobacco and cigars. Overall, fine cut tobacco volumes were up to 25,150 tonnes, while cigar volumes were 2.5 billion. The enlarged Group has an enhanced geographic profile and multi-product portfolio and during the year we increased our cigarette and fine cut tobacco shares and volumes across many territories. Our international cigarette brands, Davidoff and Gauloises Blondes, performed very well, complemented by further growth from a number of regional brands including Gitanes and JPS. Our strategy is to drive sales growth by developing our brands and products through investment and innovation, supported by excellent trade marketing skills and strong sales forces. Our versatile portfolio is characterised by great brands and products across all price segments, which provides considerable growth opportunities given the large and diverse number of markets in which we operate. Whilst we have an excellent portfolio of premium brands, we also have particular strength in the value segment enabling us to capitalise on consumer downtrading in mature markets, a trend that is likely to continue in the current economic climate. Our continued success in the contrasting markets of the USA, Eastern Europe, Africa and the Middle East was particularly pleasing and demonstrates our ability to successfully develop our business in both mature and emerging markets. Integration The integration of Imperial Tobacco and Altadis has been a key focus during the year. Whilst pursuing the growth opportunities presented by our combined portfolio and enhanced geographic footprint, we have been managing the consultation process related to our European integration projects. These projects affect sales and marketing, manufacturing and central support functions in a number of markets and will improve our competitiveness by reducing over-capacity and improving efficiencies. We concluded the European consultation process in September and have made very good progress on the national consultations and implementation of our projects in many markets. We have completed the mergers of the Imperial Tobacco and Altadis sales teams in Russia, Ukraine, Poland, Austria, Belgium and Italy, and closed our cigar and fine cut tobacco factory in Slovakia. The consultation process in France and the UK has been completed, enabling us to begin implementing our projects in these markets in early 2009, while in Spain and Germany the consultations are ongoing. We continue to offer comprehensive support to all employees affected by our integration projects. Regulation We continue to effectively manage the increasing levels of regulation affecting our industry. We support sound and proportionate regulation that respects adult freedom of choice and recognises that tobacco products are enjoyed by millions of people worldwide. We have a long history of co-operation with authorities in the markets in which we operate and remain committed to continuing to work constructively with individual governments and other regulatory bodies. Corporate Responsibility Our ongoing commitment to manage our business responsibly is fundamental to our long-term success. As a global tobacco company we recognise the importance of manufacturing, marketing and selling our products responsibly. 6 Imperial Tobacco Group PLC 2008

11 Over the years we have taken an increasingly strategic approach to promoting responsible behaviour through defined governance structures, group principles and policies. We have also established robust risk management procedures, progressed our non-financial performance reporting processes and further developed our Five-for-Five corporate responsibility initiative which was launched last year. Further information on our progress is outlined on page 35 of this report and our detailed Corporate Responsibility Review will be published in December. Our People The development of our employees is critical if we are to continue delivering sustainable shareholder value and I am proud of the success of the leadership programmes we have in place. We seek to support and develop people in all functions and at all levels, from senior managers to employees who are at an early stage of their career. Our programmes are run on an international basis and participants are often tasked with managing business projects on behalf of the Chief Executive s Committee. I have been extremely impressed with the results, which have highlighted the significant and growing talent pool we have within the business. Outlook The integration of Altadis will remain a priority going forward. We have an excellent track record of integrating new businesses into the Group and remain on course to successfully deliver our targeted cost savings. Leveraging our enhanced operating platform and stronger, more diversified brand and product portfolio will be key to driving future growth and I am confident that we will realise the potential of the many opportunities that lie ahead. Combined with our ongoing focus on cost and effectively managing our cash, we remain well placed to continue to create sustainable value for our shareholders. Gareth Davis Chief Executive Altadis related events in 2008 On 25 January 2008 we completed the acquisition of Altadis, strengthening our position as one of the world s leading international tobacco companies. The transaction was the catalyst for a series of further related events, which are highlighted in the table below. 26 Feb 2008 Offer for Logista Altadis held a 59.6 per cent share in Logista, the largest distributor of tobacco and other products in Southern Europe. Under Spanish takeover law we were required to make a tender offer for the outstanding shares or reduce the shareholding to below 30 per cent. We launched an unconditional offer for the outstanding shares held by minority shareholders at a price of per share. This offer closed on 6 May 2008 with acceptances taking our overall holding to 96.9 per cent, and enabling a squeeze-out of the remaining 3.1 per cent, which was completed in June The additional cost of this transaction was 925 million and Logista s shares were subsequently delisted. 14 Apr 2008 Aldeasa disposal We completed the disposal of the per cent shareholding in Aldeasa, a Spanish-based airport duty free retailer, that we acquired with Altadis. The sale, for a consideration of 355 million, was to Autogrill Espana, the other partner in the joint venture. 23 Apr 2008 Divestiture of tobacco brands The divestment of a small number of brands in certain European markets was a condition of the European Commission s approval of the Group s acquisition of Altadis and we therefore agreed the sale of certain fine cut and pipe tobacco brands to Philip Morris International for a total consideration of 254 million. The divestment was completed on 30 June 2008 and will not materially affect the operational and financial performance of Imperial Tobacco. The gain realised on the divestment was 174 million. 20 May 2008 Launched rights issue We announced the launch of a fully underwritten rights issue to raise 4.9 billion to repay part of the debt facilities put in place to fund the cash consideration paid for the acquisition of Altadis. The basis of the rights issue was 1 new share for every 2 existing shares held on 15 May 2008 at a subscription price of 1475 pence per share. At the close of the rights issue on 11 June 2008 valid acceptances had been received in respect of 97.2 per cent of the total number of new shares offered. This was an excellent response considering the financial climate and the remainder of the shares were successfully sold by the underwriters on 12 June Jun 2008 Integration announcement We announced a number of European restructuring projects that we propose to implement progressively over the next three years as part of the integration of Imperial Tobacco and Altadis. We believe that the Group will be able to generate annual operating efficiencies from these restructuring projects of around 300 million by the end of the financial year ending 30 September 2010, rising to around 400 million by the end of the financial year ended 30 September We estimate that the one-off cash cost of achieving these efficiencies will be around 600 million. For more information visit 7

12 DIRECTORS REPORT: BUSINESS REVIEW: STRATEGIC AND FINANCIAL REVIEW Financial Review Our good financial performance and working capital improvements enabled us to generate free cash flow of 1 billion. Robert Dyrbus, Finance Director Strong cash generation Segmental Reporting Prior to the acquisition of Altadis on 25 January 2008, the Group undertook a single principal activity which was the manufacturing, marketing and sale of tobacco and tobacco-related products. Following the acquisition of Altadis the enlarged Group has two main business activities, Tobacco and Logistics, which have been used as the basis of the segmental reporting in this report. The Tobacco segment comprises the manufacturing, marketing and sale of tobacco and tobacco-related products including sales to, but not by, the Logistics segment. The Logistics segment comprises the distribution of tobacco products for major tobacco manufacturers, including Imperial Tobacco, as well as a wide range of other products and services. New Geographic Analysis Following the acquisition we will be reporting Tobacco results for the enlarged Group using a new geographic analysis reflecting the way we manage our business. Further information can be found in our Preliminary Results presentation on our corporate website at To aid understanding of our 2008 results, we have also provided details of the contribution of the standalone Imperial Tobacco and Altadis businesses, as well as a geographic breakdown of the existing Imperial Tobacco business and a divisional breakdown for Altadis. Enlarged Group Performance Profit from Adjusted profit Revenue operations from operations In s million Tobacco 15,650 12,344 1,531 1,418 2,107 1,475 Logistics 5, Eliminations (683) (83) 2 Fair value movements on derivatives (314) Group Total 20,528 12,344 1,157 1,418 2,230 1,475 Enlarged Group Performance Results have benefited from a full year s contribution from Commonwealth Brands in the USA and the consolidation of Altadis from 25 January These financial results also reflect good performances in a number of regions across the enlarged Imperial Tobacco Group and foreign exchange gains which were partially offset by the impact of specific events in Europe and Asia. New Geographic Analysis of Tobacco 2008 Adjusted profit from In s million Net revenue operations UK Germany Spain Rest of EU 1, Americas Rest of the World 1, Total 5,238 2,107 8 Imperial Tobacco Group PLC 2008

13 Tobacco In s million Revenue 15,650 12,344 Net revenue 5,238 3,280 Profit from operations 1,531 1,418 Adjusted profit from operations 2,107 1,475 Adjusted operating margin % 40.2% 45.0% Logistics In s million Revenue 5,561 Distribution fees 607 Profit from operations 23 Adjusted profit from operations 121 Adjusted distribution margin % 19.9% Profit from Operations In s million Adjusted profit from operations 2,230 1,475 Acquisition accounting adjustments (161) Amortisation of acquired intangibles (309) (23) Brand divestment gains 174 Fair value movements on derivatives (314) (34) Restructuring costs (463) Profit from operations 1,157 1,418 Profit from Operations Acquisition Accounting Adjustments There are a number of acquisition accounting adjustments required under IFRS which have affected reported profit from operations. The most significant of these are one-off adjustments related to the fair value of stocks held by Altadis at the date of the acquisition, which reduced our reported profit from operations for the year by 118 million. Prior to the acquisition of Altadis, Imperial Tobacco sold products to Altadis, principally to the logistics business for distribution in France, Spain, Italy and Portugal, and recognised profit at the time of sale to Altadis. Following the acquisition we now recognise these profits when the products are sold out of the enlarged Group. There are similar, although smaller, effects where Imperial Tobacco distributed goods on behalf of Altadis prior to acquisition. Together they have affected reported profit from operations recognised in the year to 30 September 2008 by a further 43 million. Acquired Intangibles Amortisation Reported profit from operations for the year included acquired intangible amortisation costs of 309 million related mainly to the Altadis and Commonwealth Brands acquisitions. Brand Divestment Gains Reported profit from operations includes a profit of 174 million on the sale of a number of fine cut and pipe tobacco brands to Philip Morris International. The divestments will result in a full year reduction of around 20 million in our profit from operations. Derivative Financial Instruments Fair value losses of 314 million on derivative financial instruments used to hedge our net investment in overseas operations are included in profit from operations. These losses are offset by gains on the underlying foreign currency assets which have been recognised in the exchange translation reserve. Restructuring and Synergies In June we announced a number of restructuring projects in Europe as part of the integration of Imperial Tobacco and Altadis. The total restructuring charge in the year was 463 million, with 442 million relating to these integration projects. The expected cash element of these restructuring costs is 412 million and mainly relates to redundancies and social plan costs. There was also 30 million in respect of asset write downs. These figures reflect where we were in the consultation process at the end of September 2008, and we still expect the total cash costs in respect of the European restructuring projects to be in the region of 600 million. In addition, we have announced some smaller restructuring projects, including the integration of Lignum 2, our recent USA acquisition, the closure of our cigar factory in Selma, Alabama, USA, and the streamlining of our Logistics operations in France. These projects have resulted in additional restructuring charges of 21 million. Included within profit from operations is 43 million of synergies generated from the Altadis acquisition. These were primarily reflected in the Altadis results. Production and purchasing accounted for around 40 per cent of the savings with the balance being split evenly between sales and marketing and corporate overheads. 9

14 DIRECTORS REPORT: BUSINESS REVIEW: STRATEGIC AND FINANCIAL REVIEW Financial Review continued Enlarged Group Adjusted Profit from Operations Adjusted profit from operations In s million Imperial 1,578 1,475 Altadis 641 Eliminations 11 Group Total 2,230 1,475 Imperial Tobacco Regional Results (excluding Altadis) In s million Net Adjusted profit Cigarette Fine cut tobacco (unless otherwise stated) revenue from operations volumes (bn) volumes (tonnes) UK ,350 2,200 Germany ,150 4,700 Rest of W. Europe ,800 14,900 USA Rest of the World 1,314 1, ,300 2,550 Total 3,654 3,280 1,578 1, ,150 24,450 In the UK, despite the initial impact of public smoking bans on volumes, profits were up, benefiting from price increases and reduced costs. In Germany, results were up, benefiting from the strengthening euro exchange rate. Share gains in both cigarette and fine cut tobacco alongside selective price increases were offset by market volume declines, in part impacted by the introduction of public smoking restrictions, as well as ongoing downtrading. In the Rest of Western Europe we delivered cigarette share growth in many markets and benefited by 37 million as a result of the strengthening euro exchange rate. However, following the Altadis acquisition, we have reassessed and reduced the levels of stock of Imperial Tobacco brands in Spain. This impacted Imperial Tobacco standalone operations but not the Group results as the offsetting amount is reflected within eliminations. Our performance was also impacted by the divestment of Interval in Europe and by travel retail declines in Western Europe. Taking these operational factors into account, we estimate that profit from operations in this region was reduced by around 50 million in the year ended 30 September Therefore, excluding foreign exchange, underlying growth was around 6 per cent. In the USA our results were enhanced by a full year s contribution from Commonwealth Brands. The results also reflect market share gains in both cigarette and fine cut tobacco and price increases which more than offset cigarette market volume declines and additional investment on advertising and promotion to support our brand launches. In the Rest of the World, we delivered strong performances in many markets across the region, particularly in Eastern Europe, Africa and the Middle East and we have made further significant investment in the region with a view to continuing this momentum. This region also benefited from a foreign exchange benefit of 26 million, which helped offset the impact of the planned destocking in Taiwan and Russia. We also absorbed duty to maintain market share and our competitive position in some Central European countries as the accession states move towards the end of their derogation periods. We estimate that the overall impact of these events was a reduction in profit from operations of around 50 million and, excluding foreign exchange gains, that our underlying profit growth was around 8 per cent. After increasing our marketing investment by around 10 per cent, particularly focusing on the USA, Turkey and Ukraine, we delivered underlying growth in total profit from operations of 4 per cent. Altadis Divisional Results from 25 January 2008 Fine cut Adjusted Adjusted In s million Cigarette and tobacco Net distribution profit from (unless otherwise stated) cigar volumes volumes revenue fees operations Cigarette 84.7bn 2,000t 1, Cigar 2,162m Logistics Other Eliminations (10) Total 641 (37) Altadis Divisional Results In cigarette, we delivered a strong performance reflecting market share gains and improved profitability particularly in Spain, France and North Africa. Within cigar, we performed well in the natural wrapper segments in the USA, with Habanos in the emerging markets of Eastern Europe, Latin America and Asia Pacific, and in Spain with mini cigars. Overall, the division was impacted by increasing smoking restrictions and the economic slowdown. In Logistics, results were in line with our expectations with a good performance in Tobacco offsetting ongoing weakness in publications and transport. Other costs relate to Altadis central overheads and support function costs. 10 Imperial Tobacco Group PLC 2008

15 Cash and Debt Our business is highly cash generative and we aim to convert around 100 per cent of our profit from operating activities after net capital expenditure into cash. We have performed a review of all aspects of capital employed to enable us to deliver further sustainable improvements in our working capital. At the end of September 2008 we had committed financing facilities in place of around 14 billion. Around 66 per cent was bank facilities with the balance raised through capital market bond issues. Our closing adjusted net debt was 11.5 billion which was denominated in the following currencies: 62 per cent euros, 25 per cent US dollars and the remaining 13 per cent mainly sterling. Our all-in cost of debt was stable at 5.5 per cent. We had a successful dual-tranche bond issuance in September 2008 where the 1.2 billion raised has fulfilled our short-term financing needs. In the short term, we will utilise the high level of cash we generate to reduce debt and to continue to create additional value for our shareholders. Other Financial Information Net Finance Costs Adjusted net finance costs were 623 million (2007: 237 million). On an adjusted basis, our interest cover was 3.6 times (2007: 6.2 times). Our interest cover for banking covenant purposes was higher as this excluded some matters, including the interest paid on the equity bridge. Reported net finance costs of 536 million (2007: 181 million) include retirement benefit net finance income of 45 million (2007: 54 million) and fair value gains on interest rate derivatives of 42 million (2007: 2 million). Reported and adjusted net finance costs include 289 million related to the acquisition of Altadis. Profit Before Tax Adjusted profit before tax was 1,607 million (2007: 1,238 million). Reported profit before tax was 621 million (2007: 1,237 million). Taxation The adjusted tax charge for the year was 426 million (2007: 310 million) representing an adjusted effective tax rate of 26.5 per cent (2007: 25.0 per cent). The increase in the adjusted effective tax rate is due to the higher rates of tax applying to Altadis. The reported tax charge was 180 million (2007: 325 million). Earnings per Share and Dividends Adjusted earnings per share increased by 15 per cent to pence. Basic earnings per share were 50.6 pence (2007: pence), primarily impacted by restructuring costs, fair value movements on derivatives, amortisation of acquired intangibles and one-off acquisition accounting adjustments, partially offset by brand divestment gains. The total amount of dividends payable in respect of 2008 is 588 million, an increase of 26 per cent on last year, which reflects growth in our adjusted attributable earnings to a little under 1.2 billion and maintains our payout ratio at around 50 per cent, in line with previous years. We have proposed a final dividend of 42.2 pence per share such that the total dividend for the year is 63.1 pence. Following approval by shareholders this dividend will be paid on 20 February 2009 to those shareholders on the register at close of business on 23 January Net Debt and Cash At 30 September 2008, our reported net debt had increased to 11.7 billion (2007: 4.9 billion). Eliminating accrued interest, the fair value of interest rate derivatives and finance lease liabilities, our adjusted net debt was 11.5 billion (2007: 4.8 billion). Additional borrowings to finance the Altadis acquisition have been partially offset by the proceeds of 4.9 billion from the rights issue. Our cash conversion was 86 per cent (2007: 81 per cent). This level was achieved despite the lower than usual level of Altadis net debt at the date of acquisition which normalised in February, resulting in a cash outflow of approximately 400 million. Excluding this impact, our cash conversion was 103 per cent, slightly ahead of our target. Foreign Exchange Net revenue was increased by 257 million mainly as a result of the stronger euro exchange rate. Adjusted profit from operations was increased by 93 million and this was partially offset by an adverse impact on adjusted net finance costs of 19 million. Acquisitions and Non-Core-Asset Disposals On 25 January 2008, we completed the acquisition of Altadis for a total cash consideration of 50 per share representing an enterprise value for Altadis of 15.2 billion ( 11.3 billion as of 25 January 2008), taking into account Altadis net debt and the interests of minority shareholders at that date. Our tender for the per cent Logista minority which we did not acquire through the Altadis acquisition ended on 6 May 2008, with 37.3 per cent accepting our offer. We subsequently used the squeezeout mechanism to compulsorily acquire all of the remaining Logista shares for a total cash consideration of 925 million. On 14 April 2008 we completed the disposal of Altadis per cent shareholding in Aldeasa S.A. to Autogrill S.A. for a total cash consideration of 275 million and a number of fine cut and pipe tobacco brands were sold to Philip Morris International for 254 million on 30 June Continuing the programme of non-core asset disposals of 650 million originally announced by Altadis in April 2007, 380 million had been realised as at 30 September This includes the sale of Logista s stake in Iberia for 220 million prior to our acquisition of Altadis. Since completion of the Altadis acquisition 34 million has been realised. Rights Issue In June we completed a 1 for 2 rights issue at a subscription price of 1475 pence which raised 4.9 billion and we used the proceeds to repay the equity bridge facility put in place to part fund the Altadis acquisition. Robert Dyrbus Finance Director 11

16 DIRECTORS REPORT: BUSINESS REVIEW: STRATEGIC AND FINANCIAL REVIEW Where We Operate The acquisition of Altadis has increased our geographic reach and portfolio of brands in both cigarette and other tobacco products. A stronger international portfolio We have pursued a consistent strategy of expanding our international footprint and developing our multi-product portfolio to create sustainable value for our shareholders. This has resulted in a diversified tobacco company, with a strong presence within the developed markets of the European Union and an increasing share of the emerging markets of the world. Some 60 per cent of our cigarette volumes now come from the growing emerging markets. Cigarette We combine a strong and growing cigarette presence in the mature markets of Europe, the USA and Australasia with expanding market shares across the emerging markets in Eastern Europe, Africa, the Middle East and Asia. Our focus is on creating comprehensive coverage of key price segments within individual markets through our portfolio of local, regional and international brands. Due to the addition of Altadis cigarette business, we now have a broader portfolio of brands with which we can enhance our position in both new and existing markets. Imperial Tobacco Cigarette Volumes % Developed markets Emerging markets Other Tobacco Products Through brands including Golden Virginia and Drum, we are the global leader in fine cut tobacco with the largest market shares in several countries within the European Union. Our acquisition of Lignum 2 during the year added the Rave brand to our portfolio and doubled our fine cut tobacco market share in the USA. Fine cut tobacco is growing in response to the demand from cigarette consumers downtrading to value for money options. It is primarily a developed market product but we see opportunities for introductions into new markets and have achieved significant growth in the Central European markets of Hungary and the Czech Republic this year. Cigar With the acquisition of Altadis we became the global leader in cigar, with sales in more than 120 countries worldwide. We hold around a quarter share of the global market and have leadership in the high value premium cigar sector. We are the market leader in France and Spain and are the number one in the large cigar segment in the USA in value terms. Our joint venture, Corporación Habanos, is an exclusive exporter and marketer of Cuban cigars, and offers further opportunities for the Group to develop its interests in this segment. The largest cigar markets are predominantly in North America and Western Europe. However, we are seeing impressive growth rates in the emerging markets of Asia, Eastern Europe and the Middle East. 12 Imperial Tobacco Group PLC 2008

17 We are a diversified tobacco company with strong international positions across our key product categories. CIGARETTE FINE CUT TOBACCO CIGAR We have leading cigarette positions in markets across Europe, Asia, Africa and the Middle East. Our portfolio of brands has given us global leadership in the growing fine cut tobacco segment. We are the world leader in cigar with particular strength in the high value premium sector. 13

18 DIRECTORS REPORT: BUSINESS REVIEW: STRATEGIC AND FINANCIAL REVIEW Focus on the Future Our Corporate Development team is focused on the strategic direction and sustainable growth of the business. Alison Cooper, Corporate Development Director Corporate Development was established to focus on the long-term strategy and sustainable growth of Imperial Tobacco. It brings together various activities within the Group, including Business Development, Corporate Affairs, and Strategy and Foresight, with the task of examining how the business and the industry are developing and identifying future growth opportunities. Corporate Development is also responsible for Corporate Communications and managing the integration of Imperial Tobacco and Altadis. Business Development We have a long and successful track record of acquisitions and although further significant consolidation within the industry may be more limited, there remain numerous opportunities for further market or product specific acquisitions. The Business Development team continually evaluates these opportunities against Imperial Tobacco s financial and strategic acquisition criteria. The team is also responsible for assessing potential strategic alliances and joint ventures that will further develop our business and create value for our shareholders. This year there has been considerable focus on activities related to the acquisition of Altadis. Scope of role > Planning for the long-term development of the Group. > Assessing acquisitions and developing strategic alliances and joint ventures. > Engaging externally on issues affecting our company and the industry. These have included the disposal of our stake in the duty-free retailer, Aldeasa, the divestment of certain fine cut and pipe tobacco brands as required by the European Commission and the buy-out of the minority shareholding in the logistics business, Logista. Elsewhere, Business Development has led negotiations in the successful buy-out of the outstanding shares in the Scandinavian snus company, Skruf, and the USA cigar business, JR Cigars. Corporate Affairs We support sound and proportionate regulation and continually seek opportunities for active engagement on a range of issues affecting our industry, including public smoking restrictions, packaging regulation, ingredients disclosure, excise duties, illicit trade and the display of tobacco products at the point of sale. This requires expertise across all Corporate Affairs disciplines and we constantly review our structure to ensure that we have sufficient skills and resources in place to inform on strategy and effectively manage these issues. Strategy and Foresight In Strategy and Foresight we focus on longer-term planning issues, anticipating changes to our operating environment and how these might impact our business. Strategy and Foresight s core objective is to ensure that the enlarged Group is well placed to maximise the potential of its combined portfolio and enhanced operating platform. This requires a diligent approach to monitoring and responding to external events. The team continually reviews evolving market dynamics and the potential effect they may have on consumers and the demand for our products. Understanding these issues and developing appropriate responses are fundamental to the strategic direction of Imperial Tobacco. Integration Integration is managed by a dedicated Integration Team in conjunction with functional senior managers, and reports into the Chief Executive s Committee via the Corporate Development Director. The team is particularly focused on managing the specific European integration projects which will improve operational efficiencies and deliver substantial cost savings. This involves managing a wide range of activities throughout the consultation and implementation phases, ensuring that all employees affected by the projects are treated responsibly and provided with a comprehensive range of support measures. Outlook Critical to the success of our business has been our ability to anticipate and respond to changing market dynamics and consumer preferences. We achieve this by encouraging all functions to work together to optimise our growth potential. This cross-functional approach is vital and we are currently implementing a number of structural changes that will strengthen cross-functional collaboration and ensure that it is fully embedded across the enlarged Group. Regional Forums and a Group Planning Forum, with representatives from all functions and strong links to the Chief Executive s Committee, are established and have the remit to identify and maximise the many opportunities that lie ahead. 14 Imperial Tobacco Group PLC 2008 For more information visit

19 World Tobacco Market The world tobacco market is stable with over five trillion cigarettes consumed each year. Industry Overview The past year has seen significant change among the largest tobacco companies, with Imperial Tobacco s acquisition of Altadis, formerly the fifth largest company in the industry, and Altria retaining its operations in the USA and spinning off its international tobacco operations to form Philip Morris International. Excluding China, which accounts for a third of total global cigarette consumption, the five largest tobacco companies are Philip Morris International, British American Tobacco, Japan Tobacco, Imperial Tobacco and Altria. The respective cigarette market shares are 24 per cent, 19 per cent, 17 per cent, 9 per cent and 5 per cent. Together, they account for 74 per cent of the total cigarette market. Stability in the world tobacco market is a function of offsetting trends in the developed and emerging markets. In the developed markets, such as those in Western Europe, smoking incidence is expected to continue to decline, with the percentages of smokers within total populations reducing. However, the number of adults in the world is expected to grow, especially in emerging market regions, such as Africa and Asia, and as a result we expect that overall annual global consumption will remain broadly unchanged in the medium term. Tobacco regulation and legislation have increased in recent years, including restrictions on smoking in public places, advertising and promotional restrictions and pictorial health warnings. Excise duties have also increased, especially in the developed markets, leading consumers to downtrade to value brands and products. The level of excise also tends to facilitate a positive pricing environment for the industry. Summary > The developed markets are experiencing a move towards lower priced tobacco products. > In the emerging markets volumes are growing and consumers are uptrading to international brands. > Diversification across tobacco products is an increasingly common strategy. Global market shares % Other Philip Morris International Altria British American Tobacco Japan Tobacco Imperial Tobacco Group Other tobacco products, particularly fine cut tobacco, have experienced growth as a result of this trend, and this is expected to continue. Conversely, in emerging markets, premium brands have been growing as consumers are increasingly trading up. The global market for cigars has been stable in recent years with growth being experienced in smaller, mass market oriented products. The market is concentrated in the developed markets of Western Europe and the USA, although growth is being seen in the emerging markets of Asia, the Middle East and Eastern Europe. Industry Outlook While the tobacco markets of the EU, North America and Australasia are mature we believe there are still many opportunities to grow profits. We expect that our organic growth will continue to be derived from volume trends across the emerging markets and product categories, enhanced by market share gains from other manufacturers resulting from entry into new markets, new brand launches and the introduction of innovative brand variations. Cost management will also contribute to organic profit growth. Diversification into the full array of tobacco products by broadening their portfolios beyond cigarette, is a common thread of the strategic objectives being pursued by the major tobacco companies, as is the development of international cigarette brands. Further consolidation within the tobacco industry may be limited, but still remains a strategic opportunity, with more focus on market or product specific acquisitions and strategic alliances. 15

20 DIRECTORS REPORT: BUSINESS REVIEW: STRATEGIC AND FINANCIAL REVIEW Our Strategy We are delivering on our global strategy by actively pursuing three primary strategic objectives. To create sustainable shareholder value by growing our operations organically and through acquisitions. Sales development Cost focus Cash management The enlarged Group has sales in over 160 countries. In the developed markets we have strong positions in the European Union and a growing presence in the USA. In these markets volumes are in gradual decline but we have benefited from a combination of the pricing environment and our ability to respond to trends, such as downtrading, by positioning our portfolio to meet consumer demand. This is balanced with extensive exposure to the emerging markets of the rest of the world, including Eastern Europe, Africa, the Middle East and Asia. These are markets where volumes have been growing, and account for 60 per cent of our overall cigarette business. In these regions, there are considerable opportunities to develop our international, regional and local brands in new and existing markets. We have a versatile brand and product portfolio that has been enhanced significantly with the acquisition of Altadis. We have strong local, regional and international brands across all tobacco categories and comprehensive coverage of the key price segments within individual markets. Our strategy is to drive sales growth by developing our brands and products through investment and innovation, supported by excellent trade marketing skills and strong sales forces. Managing costs and improving the efficiency of our operations are core objectives. Our challenge each year is to find new ways of optimising our manufacturing capacity and performance. These improvements have to be achieved without undermining our approach to best practice or our focus on quality and innovation. Standardisation across the manufacturing portfolio has become a central theme of our success. We are already addressing many issues relating to cost management and efficiency resulting from the ongoing integration of the enlarged Group. We believe there are many opportunities to deliver cost improvements through better resource allocation, simplification of processes and infrastructure, and the economies of scale available from our combined purchasing power. The Group s business is highly cash generative and our focus is on managing capital expenditure and working capital, tax and interest costs to ensure cash flows are optimised. As a result of the increased debt arising from the acquisition of Altadis, a reduction in our overall debt level is a key objective for cash management going forward. Our objective is to ensure that the cash we generate is used efficiently, and as well as paying down debt we will invest in the future growth of the business, including acquisitions, and return cash to shareholders through dividends and, when appropriate, share buybacks. Since our listing on the London Stock Exchange in 1996, we have invested over 17 billion in acquisitions. We are committed to continuing to expand our business through both acquisitions and organic investment opportunities. Over 3.7 billion has been returned to shareholders through a combination of dividends and our share buyback programme. Our dividend policy is to increase dividends broadly in line with underlying earnings growth, with a payout ratio of around 50 per cent, and this has led to increases in the dividend each year since our listing. p18-21 See our case studies on the USA and Africa and the Middle East demonstrating our strategy in action 16 Imperial Tobacco Group PLC 2008

21 Key Performance Indicators Key Performance Indicators are the principal measures used by the Board to assess performance against our strategy. Adjusted Earnings Per Share 2008 performance 2007 performance p 118.8p Total Shareholder Return 2 Imperial Tobacco FTSE All-Share Index Adjusted Operating Margin Adjusted Distribution Margin 30% 12% Cash Conversion Rate 81% Cigarette Market Share 3 Volumes -5% -22% 40.2% Tobacco 19.9% Logistics 86% 45.9% UK 27.4% Germany 37.1% Spain 291.8bn Cigarettes 25,150t Fine Cut Tobacco 2,452m Cigars +5% Productivity 4 +7% 1 Imperial Tobacco standalone figures. 2 In 2008 Imperial Tobacco achieved a total shareholder return 17 per cent greater than that of the FTSE All-Share Index (2007: 18 per cent greater). 3 Imperial Tobacco estimates. 4 Excluding Altadis. 45.0% 46.4% 21.3% 5.9% 200.3bn 24,450t 316m 17

22 DIRECTORS REPORT: BUSINESS REVIEW: STRATEGIC AND FINANCIAL REVIEW Case Study: United States of America Our expansion into the USA demonstrates our ability to continue to create value in mature markets. Graham Blashill, Group Sales & Marketing Director Implementing our strategy in the USA Our recent rapid expansion into the USA is a good example of our ability to create value through targeted investment. We have sold rolling papers and tubes in the USA since our acquisition of the Rizla business in 1997 but made a strategic decision not to enter the tobacco market due to the uncertain litigation environment. Over the years, however, this has eased considerably reflecting the fact that the vast majority of individual and class action claims in the USA have been decided in favour of the tobacco industry. These improvements prompted us to re-evaluate our strategy. We originally intended to enter the USA tobacco market organically but in 2007 had the opportunity to acquire Commonwealth Brands, the fourth largest tobacco company in the USA. The company, based in Bowling Green, Kentucky, had a 3.7 per cent cigarette market share from a portfolio of discount brands, a sizeable sales force, and a modern factory in Reidsville, North Carolina. The company was also the exclusive distributor of the Bali Shag and McClintock fine cut tobacco brands. Commonwealth Brands was one of the first tobacco companies to voluntarily sign the Master Settlement Agreement (MSA) and, like Imperial Tobacco, has never lost or settled any product liability claim. The MSA is an agreement between tobacco manufacturers and the National Association of Attorneys General. In return for annual payments based on market share and compliance with restrictions on advertising and marketing, each MSA member is protected from State healthcare cost actions. 18 Imperial Tobacco Group PLC 2008

23 USA: Cigarette market share % Imperial Tobacco Group Lorillard Reynolds American Other Altria Membership of the MSA is important in managing litigation risk in the USA and was always a pre-requisite for our entry into the tobacco market. The acquisition of Commonwealth Brands provided a strong platform for growth which we have optimised through a number of initiatives. Imperial Tobacco secured MSA membership in November 2007 in order to be able to sell our own tobacco brands in the USA. We have subsequently launched Davidoff in key cities across the USA and Fortuna in both Florida and Texas. We also focused on driving the growth of Commonwealth Brands portfolio of discount brands, which include USA Gold and Sonoma, and our cigarette share has now increased to 4.3 per cent. Fine cut tobacco is a growth area in the USA and as world leader in this sector we were quick to capitalise on this opportunity, acquiring the Bali Shag and McClintock brands in the USA, and launching our own brand, Premier. We further enhanced our fine cut tobacco portfolio with the Rave brand following the acquisition of the company, Lignum 2, in May These initiatives have significantly developed our fine cut tobacco share which had grown to around 8 per cent in September 2008 compared to 1 per cent in the previous year. Completing our multi-product portfolio is our market-leading position in cigars, in terms of net sales, which we inherited through the Altadis acquisition. We offer the broadest range of cigar products in the USA, from premium to mass market. Although our cigar sales have been generally affected by smoking restrictions and the economic downturn, particularly in the premium category, this is being offset by the good performance of our brands in the natural wrapper segment and growth in cigarillos. Altadis had a 51 per cent stake in JR Cigars, a nationwide retailer of cigars and related products, and in October 2008 we purchased the remaining shares to further strengthen our position in the market. Outlook In a relatively short period of time we have developed a strong and growing presence in the USA tobacco market and remain very well positioned to continue to improve our market shares and profitability. Through our strong portfolio we have a presence in cigarette, fine cut tobacco, cigar and rolling papers and tubes. This broad representation provides significant potential for future growth. Sales excellence is key to our success and we are currently in the process of expanding our sales force. This will improve our national distribution capabilities and ensure that we continue to maximise the opportunities that our versatile multi-product portfolio offers. In a relatively short period of time we have developed a diverse portfolio of brands across cigarette, fine cut tobacco and cigars. 19

24 DIRECTORS REPORT: BUSINESS REVIEW: STRATEGIC AND FINANCIAL REVIEW Case Study: Africa and the Middle East The acquisition of Altadis has significantly enhanced our presence and future growth potential in Africa and the Middle East. Developing opportunities in emerging markets Our presence in Africa and the Middle East has grown steadily over the past decade. We estimate that the region accounts for almost 500 billion cigarettes annually. We have very strong positions in established markets and see numerous opportunities for expansion through the introduction of our brands across existing markets, and by entry into new markets. We have 13 manufacturing plants in the region with a capacity of around 50 billion cigarettes, including facilities in Morocco, West Africa and Turkey. Increases in tobacco regulation and taxation are a feature of the African and Middle Eastern markets. As in all our markets we remain focused on effectively managing the implications of regulation on our business. The evolving political dynamics can at times lead to instability in some countries but our committed and experienced employees have continually demonstrated their ability to overcome these challenges. Africa In 2001, we significantly enhanced our position in Sub-Saharan Africa with the acquisition of a majority stake in Tobaccor, a major cigarette manufacturer and distributor with strong market shares in a number of African countries and an expanding business in Vietnam. The acquisition transformed our presence in Africa and provided a springboard for growth in South East Asia. In 2008, with the acquisition of Altadis we have again strengthened our position, more than doubling our volumes in the region with the addition of an Altadis footprint that was complementary to our own, and bringing us into new markets. We are the market leader in the majority of our markets in Africa and have consistently achieved market share gains in many areas including the Ivory Coast, Burkina Faso and Senegal. Our footprint in Africa is by no means complete, and there is substantial scope for us to expand further into new markets. Through Altadis we gained entry into Morocco and are now the number one player with our leading cigarette brand Marquise. We have also launched our premium brand Davidoff with encouraging early results. Our other key brands in Africa include Fine, Gauloises Blondes, Excellence, Mustang and Good Look. Mustang, a mid-priced brand in Burkina Faso, has grown market share to almost 46 per cent, while Fine, a mid-priced brand sold in key markets such as the Ivory Coast, Chad 20 Imperial Tobacco Group PLC 2008

25 and Congo, has seen consistent volume growth. Excellence, a value brand also sold in the Ivory Coast, Senegal and Burkina Faso, has performed similarly well, as have Gauloises Blondes in Algeria and Good Look in Madagascar. Whilst focusing on developing our business we remain committed to supporting the tobacco growing industry in Africa. We believe that we have a responsibility to help address key issues affecting tobacco farmers. We strive to prevent the exploitation of children through our membership of the Eliminating Child Labour in Tobacco Foundation and help tobacco growers develop sustainable agricultural practices as part of the Social Responsibility in Tobacco Production programme. Our ongoing community investment initiatives have also provided wide ranging support to local communities, including improved education and healthcare facilities. Middle East Whereas in Africa a major acquisition provided us with strong established market shares, which we have continued to develop, our progress in the Middle East has been based on an import strategy that seeks to build share through the development of our international brands. The acquisition of Altadis has enhanced our geographic profile in the region and has also considerably strengthened our cigarette portfolio. Gauloises Blondes is now our leading cigarette brand in the Middle East, complemented by Gitanes and Davidoff. These prestigious brands are supported by a number of regional and local brands, including Superkings and Golden Gate. Davidoff has been a real success story in the region, recording compound annual growth of 44 per cent over the last five years. Davidoff s best selling market is Saudi Arabia, where its share now stands at over 9 per cent. Our expanding operations in Turkey are also included in this region. We entered the Turkish market in 2003 with the construction of a new cigarette factory which became fully operational a year later. We have since captured a 3.2 per cent market share with our brands Klasik, West and Davidoff, and are strengthening our position with increased marketing investment. Outlook Africa and the Middle East have been key growth regions for both Imperial Tobacco and Altadis, and we see further significant opportunities given our combined portfolio and geographic reach. Our international cigarette brands are performing well in the Middle East and through our portfolio of local brands in Africa we are focused on enhancing our strong market shares. We also have ambitions to further grow our international brand presence in the African region. With the acquisition of Altadis we doubled our volumes in a region estimated to account for almost 500 billion cigarettes annually. 21

26 DIRECTORS REPORT: BUSINESS REVIEW: STRATEGIC AND FINANCIAL REVIEW Principal Risks and Operating Environment A detailed assessment of strategic risks within our operating environment is undertaken by management and is embedded into our corporate planning process. Each area of the business is required to formally review its principal areas of risk and uncertainty so that major risks are reviewed at all levels across the Group. This is an ongoing process, ensuring there are clear and consistent procedures for monitoring, updating and implementing appropriate controls to manage the identified risks. The Board has responsibility for the Group s systems of internal control. We are subject to the same general risks and uncertainties as any other business; for example, the political stability in the countries in which we operate and source our raw materials, the impact of natural disasters and changes in general economic conditions including currency and interest rate fluctuations, changes in taxation legislation and the impact of competition. Outlined below is a description of the principal risks and uncertainties that are specific to and may impact our business. Not all these factors are within the Group s control. There may be other risks and uncertainties which are unknown to the Group or which may not be material now but could be material in the future. A more detailed description of risks relating to the Group is set out in Part II of our rights issue prospectus dated 20 May 2008, available on our website: Regulation The tobacco industry is subject to substantial and increasingly restrictive regulatory practices. In many of the markets in which we operate, there are regulatory restrictions affecting the development, manufacture, sale, distribution, marketing and advertising of tobacco products. Any future increases in regulation of the tobacco industry could have an adverse effect on the demand for our products or increase the costs related to compliance. Key regulatory developments in 2008 are outlined below. 1) WHO Framework Convention on Tobacco Control The World Health Organization s (WHO) Framework Convention on Tobacco Control (FCTC), ratified by 160 countries, provides all ratifying countries with a framework within which national authorities may decide on the most appropriate tobacco control regulation for their national circumstances. The FCTC contains wide-ranging provisions, including those on advertising, ingredients, product testing, taxation and illicit trade. Our View We respect the WHO s overall objective of the attainment by all peoples of the highest possible level of health and agree with some principles of the Convention, most notably the need to prevent youth smoking and combat illicit trade in tobacco products. However, it is our belief that the WHO should not attempt to regulate areas that fall outside its mandate or competence, as many FCTC provisions seek to go beyond reasonable objectives and impose a supranational regulatory regime covering a wide range of areas better addressed by national regulators, who are familiar with local conditions. Moreover, it gives the WHO authority to establish rules in areas outside its core competence areas that fall under the jurisdiction of other bodies such as the World Trade Organization or the International Organization for Standardization Update New work has been agreed by the parties to the FCTC, including the development of guidelines on advertising and sponsorship, packaging and labelling, smoking cessation, and education. The development work for a further protocol that would focus solely on crossborder advertising has been suspended following the decision to develop a comprehensive guideline on advertising, sponsorship and promotion. Little progress has been made regarding the development of the protocol on illicit trade which addresses issues such as licensing, tracking and tracing, duty free, supply chain, anti-money laundering provisions and internet sales. As a consequence, adoption of the protocol is likely to be moved back from 2010 to ) UK Consultation on the Future of Tobacco Control In May 2008 the UK Department of Health issued a consultation document on the future of tobacco control which covered many areas including proposals to ban product display, vending sales and 10 packs. We submitted a detailed response rigorously opposing these proposals, and this document is available via our corporate website: Our View We agree with reasonable regulation and remain committed to working constructively with governments and other regulatory bodies around the world. However, legislation must meet the principles of good regulation by being proportionate, supported by compelling evidence and fit for purpose. In our view the proposals outlined in the Department of Health s consultation document do not meet these criteria. The Department of Health is expected to publish a summary of all the responses received, before 8 December ) Smoking in Public Places Authorities have introduced tighter regulations on smoking in public places in many of the markets in which we operate. Our View We support sensible regulation but believe that bans on smoking in public places are disproportionate and unnecessary. Our experience in markets where smoking restrictions or total bans are in place supports our view on the impact of this legislation; while there may be an initial dip in cigarette consumption, this tends to diminish over time. However, we are concerned that these unnecessary restrictions have an adverse effect on smokers and on the venues which may wish to allow smoking. We believe that concerns about smoking in public places can be resolved through common sense and courtesy and by introducing practical solutions such as well-ventilated smoking and no-smoking areas into work places, restaurants and other public places Update A proposal for a directive banning smoking in all enclosed work places, including catering establishments, within the EU is expected to be announced by the EU Commission through the Director General Employment and Social Affairs by the end of This requires consultation with the social partners: trade unions and employers (or their representative organisations). The previous consultation in 2004 led to the conclusion that social partners were not in favour of an EU-wide workplace smoking ban. If such a directive was approved by the Council and Parliament, it would override national legislation that allows for exemptions in hospitality venues. Comprehensive smoking bans in hospitality venues are in place in a number of markets including Ireland, the UK, Norway and New Zealand, as well as in several Canadian provinces and USA states. In France, a smoking ban in hospitality venues took effect in January In Germany, there is a national ban on smoking in public places; however, the regulation of smoking in hospitality venues is determined individually by 16 Federal states, resulting in varying degrees of restrictions, ranging from full bans to exemptions for small venues. 4) Pictorial Health Warnings There is a general trend towards introducing pictorial health warnings. Countries such as Canada, Brazil, Australia, Thailand and Singapore have had pictorial health warnings on cigarettes and other tobacco products for several years, while others have passed legislation which will become effective in the near future. Our View We do not believe that pictorial health warnings are necessary, as such warnings are designed 22 Imperial Tobacco Group PLC 2008

27 solely to shock and stigmatise smokers, and we disagree with their use. We believe that pictorial health warnings make no overall contribution to the public awareness of the risks associated with smoking, which are already well known. We support the principle of adult choice and believe that we are entitled to use our packaging to enable our consumers to distinguish our products from those of our competitors Update A number of markets in which we operate already have, or will implement, pictorial health warnings in the near future. New Zealand introduced pictorial health warnings earlier this year while the UK Government required them from October 2008 on all tobacco product packs. 5) Product Display Bans at Point of Sale Product display bans have been in place in parts of Canada for a number of years now. In Europe, Iceland is currently the only country with a product display ban in place. Our View Imperial Tobacco encourages governments to respect the principles of adult choice and freedom of competition when regulating tobacco products. We are opposed to regulation that restricts or prohibits retailers from displaying tobacco products at the point of sale. We are concerned that smokers are unreasonably and unjustifiably denied the opportunity to view the range of tobacco products available from their chosen retailer. The display of products is an important aspect of the consumer purchasing process; it provides consumers with the information to make a genuine selection from the wide range of tobacco products, brands and prices that are available in retail outlets, whilst contributing to fair and undistorted competition between tobacco manufacturers and retailers. We are also concerned that prohibiting or restricting the display of tobacco products is likely to further fuel the illicit trade in tobacco products Update The Republic of Ireland is set to introduce a product display ban in July Norway is also expected to announce new regulations in In September, we submitted our response to the UK Government s consultation on future tobacco control measures in England, Wales and Northern Ireland, which among other issues, sought views on proposals to ban or restrict product display or to retain the status quo. For further information our submission is available via our corporate website: Similar proposals are currently under consideration in Scotland and in the Australian state of New South Wales. 6) Lower Ignition Propensity Products (LIPPs) Canada and a number of states in the USA have introduced regulations that all cigarettes sold in the market must comply with lower ignition propensity standards. Our View Both regulators and the industry must take care with the terms used in any regulations and promotion of products. The term fire-safe, which was adopted widely by USA media, is in our view unhelpful and dangerously misleading. We prefer the term lower ignition propensity. We believe that the most effective way to reduce fires is through a range of measures including public education, fire protection and prevention programmes Update A standard for LIPPs is being developed in the EU, and could be implemented in A final safety assessment was approved by the European Commission in November 2007 and a mandate has now been passed to the European Committee for Standardization to establish a standard. The Australian Government has published a national LIPPs standard and is discussing the safety assessment process that is required before its implementation. Excise Duty Tobacco products are subject to excise duty which, in many of the markets in which we operate, represents a substantial percentage of the retail price and has been steadily increasing in recent years. Increasing levels of excise duty are likely to encourage consumers in affected markets to switch from premium-priced cigarettes to lowerpriced cigarettes and fine cut tobacco, or to turn to the black market. Substantial increases in excise duty and any significantly unfavourable change in the tax treatment of fine cut tobacco, if widely adopted, may have an adverse effect on the size of individual duty paid markets for our products. Excise duty increases encourage both legal and illegal cross-border trade from countries with lower levels of duty and the production of counterfeit tobacco products. Within such an environment there is a risk that we and/or our employees may be subject to investigation by customs or other authorities. Although we have implemented procedures to detect and control illegal trading of our products, such procedures can provide only reasonable and not absolute assurance of detecting non-compliance by managing rather than eliminating risk. Our View We remain totally opposed to the illicit trade in both smuggled genuine and counterfeit tobacco products. We are committed to working with government authorities and international organisations around the world and we continue to invest considerable resources in working to counter the illicit trade in tobacco products Update In general, levels of excise duty have been steadily increasing in recent years in a number of markets in which we operate and this trend continued in EU Member States in All the Member States that joined the EU in May 2004 and January 2007 have continued to implement excise duty increases as they move towards the EU excise tax minima. In the EU, the Tobacco Excise Tax Directive contains a provision for its evaluation every four years. A technical consultation document was published in March 2007 seeking overall excise duty simplification and a narrowing of differentials between fine cut tobacco and cigarette excise duty. A formal report, published in July 2008, contained firm proposals to amend the structure and minimum levels of excise duty relating to tobacco products as well as product definitions. Discussions in the Member States, European Parliament and European Council are now in progress. The new EU Tobacco Excise Tax Directive is expected to be adopted in 2009, with implementation from Considerable negotiation over the proposals in consultation with the 27 Member States is expected. Further increased levels are proposed from We continue to work with customs authorities around the world to counter the illicit trade in tobacco products. We have now signed formal Memoranda of Understanding (MoU) in 13 countries including the UK, Ireland, Turkey and China, with similar industry-wide co-operation agreements in Australia and the Ukraine. Further information regarding certain investigations initiated in January 2003 in relation to alleged foreign trading and related violations by a number of people, including former Reemtsma employees, during a period prior to our 2002 acquisition of Reemtsma, is included in the Corporate Governance Report. Key Market Dependency The continued organic growth of the business is underpinned by our key markets. Any material decline in the performance of these markets may impact our future profit development Update Our business profile and brand and product portfolio have been considerably strengthened following the Altadis acquisition. Our extended international footprint provides a more balanced exposure to mature and emerging markets, while our enlarged portfolio includes international strength in cigarette and world leadership in fine cut tobacco, cigars, rolling papers and tubes. We now also have a leading logistics platform in Europe. This provides us with enhanced growth opportunities and has resulted in individual key markets contributing a lower percentage of the Group s adjusted profit from operations. Competition Law We have significant market positions in certain countries. As a result, we may be subject to enhanced regulatory scrutiny as to competition law in these countries, which could result in adverse regulatory action by relevant authorities, including the potential for monetary fines, and negative publicity Update Along with a number of other companies we supplied information to the UK Office of Fair Trading (OFT) in October 2003 and April 2005 in relation to an enquiry into the operations of the UK tobacco supply chain. On 25 April 2008 the OFT issued 23

28 DIRECTORS REPORT: BUSINESS REVIEW: STRATEGIC AND FINANCIAL REVIEW Principal Risks and Operating Environment continued a Statement of Objections (SO) to a number of retailers and two tobacco manufacturers, including Imperial Tobacco, alleging those parties had engaged in unlawful practices in relation to retail prices for tobacco products in the UK. On 11 July 2008, the OFT announced that six companies had reached early resolution agreements and had agreed to pay individual penalties with a combined maximum value of million. Imperial Tobacco was not one of those companies. We take compliance with competition law very seriously and reject any suggestion that we have acted in any way contrary to the interests of consumers. Imperial Tobacco has co-operated fully with the OFT throughout and continues to do so. We provided our submission to the OFT responding to the allegations in August In the event that the OFT decides that a company has infringed UK competition law, it may impose a fine which could be material and have adverse effects on the company s profitability. In the event that such a fine is imposed on the Company we would be able to appeal the decision to the Competition Appeal Tribunal and, ultimately, on a point of law to the Court of Appeal. Further information is available in the Corporate Governance Report. Tobacco-Related Litigation We may incur substantial costs in connection with health-related litigation. Various tobacco litigation claims are pending against the Group. To date, no tobacco litigation claim brought against Imperial Tobacco has been successful and/or resulted in the recovery of damages. However, if any individual claim were to be successful, it may result in a significant liability for damages, and may lead to further claims against us. Regardless of the outcome of pending litigation, the costs of defending such claims can be substantial and may not be fully recoverable Overview We are not facing any active tobacco-related litigation in the UK. In the Republic of Ireland, the number of tobacco-related claims has fallen from 307 in 1997, to 11. Ten of these claims are subject to dismissal motions. The other claim is inactive. The dismissal motion in respect of one claimant was heard by the Dublin High Court in In April 2007, the court ruled that this claim should be dismissed. This decision has been appealed and the dismissal motions in respect of the nine other active claims have been stayed pending the appeal. No date has been set for the appeal hearing. Following our acquisition of Altadis in January 2008, we are currently facing two claims in Spain. A claim on behalf of an individual has been dismissed pending appeal to the Spanish Supreme Court. A claim on behalf of the Regional Government of Andalucia has also been dismissed and subsequently appealed to the Spanish Supreme Court. The Regional Government is attempting to restart this claim, although no statement of claim has been served upon us. We are not facing any claims in France. Following our acquisition of Logista in May 2008, we are currently facing a claim in Italy which is at an initial stage. In Poland, we faced a claim filed by three prisoners in April 2008, in response to which we filed a defence. The statement of claim was subsequently withdrawn in September 2008, and the court has discontinued the proceedings. We understand that a claim was filed against us (and other tobacco companies) in Bulgaria in March 2008 but we have not yet been formally served with any court documents. Despite threats to do so, no proceedings have been commenced against us in The Netherlands. Following our acquisition of Commonwealth Brands in April 2007, we are currently facing three claims brought by individuals in the United States. Two of these claims are brought by prisoners and were served on Commonwealth Brands in January In the first prisoner claim the court has dismissed the case. That dismissal has been appealed, but Commonwealth Brands believes the appeal was not filed in time. In the second prisoner claim the court has also dismissed the case, but that judgment could still be appealed. The other case is inactive and has been for some time. Commonwealth Brands has applied to dismiss the case. That application remains pending. Two further claims against Commonwealth Brands have been dismissed. These dismissals are consistent with the considerable improvements we have seen in the USA litigation environment. We also understand from media reports that the Saudi Ministry of Health has issued legal proceedings against a number of international tobacco companies and their agents to recover the costs of providing medical care to individuals. It is reported that Imperial Tobacco is one of these defendants, however, we have not been served with any court documents to date. To date, no judgment has been entered against Imperial Tobacco and no action has been settled in favour of a claimant in any tobacco-related litigation involving Imperial Tobacco or any of its subsidiaries. Imperial Tobacco has been advised by its lawyers that it has meritorious defences to the legal proceedings in which damages are sought for alleged tobacco-related health effects. We will continue to vigorously contest all such litigation against us. The Acquisition of Altadis Altadis was acquired by way of a public tender offer and we did not have access to perform significant due diligence prior to the completion of the acquisition. In the event that liabilities or other problems concerning Altadis arise, the Group has no warranty or indemnity protection. While we believe that we have a proven track record of integrating acquisitions, their success is dependent on our ability to integrate without significant disruption to either business. The integration of Altadis may involve particular challenges and require management attention that would otherwise be devoted to running our business. We can offer no assurance that we will be able to realise the potential benefits of the acquisition to the extent envisaged and within the timeframe contemplated. If we are unable to successfully integrate Altadis, this could have a negative impact on the revenue, profit and financial condition of the enlarged Imperial Tobacco Group Update In June 2008 we announced a number of restructuring projects in Europe which we propose to implement progressively over the coming years as part of the integration of Imperial Tobacco and Altadis. The projects affect sales and marketing, manufacturing and central support functions in a number of markets, and will strengthen the enlarged Group s competitive position by addressing over-capacity and improving efficiencies. Consultations have been concluded in several markets, enabling the implementation of projects to begin. Elsewhere, consultations are ongoing and are being conducted in a constructive and productive manner. Financing The Group has significant borrowings which may impair operational and financial flexibility and performance. The Group s indebtedness could potentially cause Imperial Tobacco to dedicate a substantial portion of cash flow from operations to payments to service debt, depending on the level of borrowings, prevailing interest rates and exchange rate fluctuations, which would reduce the funds available to the Group for working capital, capital expenditure, acquisitions, dividends, and other general corporate purposes. It could also limit the Group s ability to borrow additional funds for these purposes and limit flexibility in planning for, or reacting to, changes in technology, customer demand, competitive pressures and the industry in which the Group operates. This could place the Group at a competitive disadvantage compared to its competitors that are less leveraged, and increase our vulnerability to both general and industryspecific adverse economic conditions. Our credit ratings may be adversely affected by various factors if this happens and/or if conditions in credit markets are unfavourable at a time when we are looking to refinance our current sources of financing, we may not be able to obtain new sources of financing or only at higher costs Update Following the completion of a rights issue, our reported net debt was 11.7 billion, as at 30 September In September we had issued new capital market debt equating to 8 per cent of our committed financing at a rate above our overall cost of debt, which remained stable at 5.5 per cent. 24 Imperial Tobacco Group PLC 2008

29 In this section: United Kingdom 26 Germany 27 Spain 28 Rest of EU 29 Americas 30 Rest of the World 31 Manufacturing 32 Logistics 33 Corporate Responsibility 35 Operating Review

30 DIRECTORS REPORT: BUSINESS REVIEW: OPERATING REVIEW United Kingdom UK: Tobacco Adjusted profit from operations % 28 UK Rest of Tobacco Market Dynamics We estimate that the duty paid cigarette market declined by 5 per cent to 45.5 billion cigarettes in the year (2007: 47.9 billion). We estimate that 2-3 per cent of the decline was attributable to the smoking bans introduced in England, Wales and Northern Ireland in 2007, with the balance due to normal long-term decline. In contrast, market volumes of duty paid fine cut tobacco rose by an estimated 7 per cent to 3,750 tonnes during the year (2007: 3,500 tonnes). From 1 October 2008, all tobacco products manufactured for sale in the UK must have a pictorial health warning on the reverse of the pack, although there is a sell-through period for products without these warnings of 12 months for cigarettes and 24 months for fine cut tobacco. Our Performance In the UK, net revenue was 869 million, with adjusted profit from operations of 584 million. We lead the UK market in cigarette, fine cut tobacco and rolling papers. We have a 45.9 per cent cigarette market share, led by Lambert & Butler at 16.2 per cent (2007: 16.6 per cent) and Richmond at 16.1 per cent (2007: 15.7 per cent), the two best-selling cigarette brands in the country. Our value offering, Windsor Blue, had another successful year, increasing its market share to 3 per cent (2007: 2.6 per cent). Value brands and products are growing in many mature markets, particularly those with high taxation as consumers continue to downtrade in search of value, and the UK is no exception. Downtrading is likely to continue in the current economic climate and to capitalise on this we launched the JPS Silver range in the economy sector in November Our fine cut tobacco market share declined to 61.6 per cent (2007: 63.6 per cent), with our market leading premium brand, Golden Virginia, declining due to downtrading. However, we continued to improve the share of our value brand, Gold Leaf, which is now up to 2.6 per cent. Performance Highlights Net Revenue 869m Cigarette Volumes 21.4bn Market Size No.1 in the UK Rizla, the world s leading rolling paper brand and number one in the UK, delivered another strong performance in the year. Outlook The UK is an important market and one where we remain focused on strengthening our leadership position. We expect a more normal rate of decline in duty paid cigarette volumes in the coming year and further growth in duty paid fine cut tobacco volumes. The portfolio initiatives we have taken in recent years have continued to build our position at the value end of both cigarette and fine cut tobacco, leaving us well placed to capitalise on the downtrading trend. Regulation continues to increase but we are very experienced at successfully managing the impact on our business. In our response to the Department of Health consultation document on the future of tobacco control, we took the Adjusted Profit from Operations 584m Fine Cut Tobacco Volumes 2,350t No.1 in the UK Cigarette bn 47.9bn Fine cut tobacco 1 3,750t 3,500t Market Share Cigarette % 46.4% Fine cut tobacco % 63.6% 1 Imperial Tobacco estimates. opportunity to reiterate our support for initiatives to reduce youth smoking and illicit trade. We robustly opposed a number of proposals which we consider to be unnecessary and disproportionate, including proposals to ban product display, vending sales and 10 packs. The Department of Health is expected to publish a summary of all the responses received by 8 December Further information is available on our website: 26 Imperial Tobacco Group PLC 2008

31 Germany Germany: Tobacco Adjusted profit from operations % 15 Germany Rest of Tobacco Market Dynamics In Germany, duty paid cigarette volumes have declined by an estimated 3 per cent to just under 88 billion cigarettes (2007: 91 billion). This was largely influenced by the introduction of public smoking restrictions in all states. These restrictions have recently eased in some states following a court ruling that some aspects of the legislation were unconstitutional. Downtrading remains a key dynamic, with the value price sector share now up to 24 per cent of factory made cigarettes (2007: 19 per cent). Private label s cigarette share continues to fall, now down to 11.3 per cent (2007: 12.5 per cent). The level of both legal and illegal crossborder flows reduced slightly to an estimated 20 per cent during the year but still remains a significant problem. Other tobacco product volumes fell by an estimated 5 per cent to 34 billion cigarette equivalents (2007: 36 billion). This was largely due to a 24 per cent decline in eco-cigarillos as a result of legal changes to the product specifications coming into effect from January Our Performance In Germany, net revenue was 664 million, with adjusted profit from operations up to 309 million. Against a challenging market environment we delivered a number of good performances in Germany, including increasing our cigarette share to 27.4 per cent. In recent years JPS has achieved significant success and continued to build on its impressive growth record in JPS now accounts for 7.8 per cent of the market (2007: 6.4 per cent) and has become the second best-selling cigarette brand in Germany. Our mid-priced brand West continues to be impacted by downtrading but our premium brand Gauloises Blondes was resilient in maintaining its share at 5.6 per cent. Performance Highlights Net Revenue 664m Cigarette Volumes 22.9bn Market Size No.2 in Germany Our market share of other tobacco products was up to 20 per cent. Both JPS and Route 66 made market share gains to 8.4 and 2.5 per cent respectively and performed particularly well in the make your own sector. We continue to manufacture eco-cigarillos and during the year we improved our share of this segment to 15.1 per cent. Outlook We remain focused on improving our competitive position in Germany and further developing our strong market shares. We have a broad portfolio which we will continue to leverage in order to capitalise on growth opportunities. Our strength in value brands and products means we are Adjusted Profit from Operations 309m Other Tobacco Products (as cigarette equivalents) 6.9bn No.1 in Germany Cigarette 1 88bn 91bn Other tobacco products bn 36bn Market Share Enlarged Group Altadis Imperial Tobacco Imperial Tobacco Cigarette % 5.8% 21.6% 21.3% Other tobacco products % 0.6% 19.4% 19.1% 1 Imperial Tobacco estimates. 2 As cigarette equivalents. well placed to benefit from downtrading, both within cigarette and from cigarette into other tobacco products, whilst continuing to support our key brands, such as West and Gauloises Blondes. The market environment is evolving and we will continue to monitor cross-border inflows and participate in the ongoing debate regarding restrictions on smoking in public places. 27

32 DIRECTORS REPORT: BUSINESS REVIEW: OPERATING REVIEW Spain Spain: Tobacco Adjusted profit from operations % 7 Spain Rest of Tobacco Market Dynamics Spain is a key market for the enlarged Group. Tobacco sales are through two distinct channels tobacconists, who account for two thirds of volumes, and vending machines which account for the balance. During the year market volumes of duty paid cigarettes remained stable at an estimated 90 billion, while volumes of fine cut tobacco have seen significant growth to approximately 3,600 tonnes (2007: 2,800 tonnes). The cigar market was up 5 per cent to around 1.1 billion units. Volumes of large and medium-sized cigars have declined following the introduction of smoking restrictions, although this has been more than offset by the growth in volumes of small cigars. Our Performance In Spain, net revenue was 411 million and adjusted profit from operations was 150 million. Our position in Spain has been significantly enhanced following the acquisition of Altadis, and we now have a market leading position across all tobacco categories. Our cigarette market share was 37.1 per cent (2007: 5.9 per cent) with Fortuna, a mid-price offering and the second bestselling cigarette brand in Spain, broadly maintaining its share at 12.1 per cent. Nobel, also in the mid-price sector, and our value brand Ducados Rubio performed well in the year, growing their shares to 6.1 and 4.9 per cent respectively. Our fine cut tobacco market share has declined to 49.1 per cent as a result of competition and downtrading, which we have taken steps to address with the price repositioning of Golden Virginia and Drum during the year. Our cigar market share, including Habanos brands, is at 36.8 per cent, mainly driven by three brands: Farias, Vegafina and Dux. All three brand families are building on a broad and loyal consumer base and are represented across all the different sub-segments. Performance Highlights Net Revenue 411m Cigarette Volumes 22.9bn Market Size No.1 in Spain With Farias we are number one in both large and miniature cigars, whilst Vegafina is the leading non-habanos premium brand and Dux is number two in the medium-sized segment. Outlook Our broad brand and product portfolio gives us the opportunity to enhance our market leading positions, which we will support by improving our sales and trade focus. As part of the integration of Altadis and Imperial Tobacco, we plan to improve our sales effectiveness and customer service by combining the three sales forces of Imperial Tobacco and Altadis cigarettes and Altadis cigars into one unified team. We will also optimise the visibility of our brands and point of sale activities at tobacconists and increase our presence in the vending channel. Adjusted Profit from Operations 150m Fine Cut Tobacco Volumes 1,550t No.1 in Spain Cigarette 1 90bn 90bn Fine cut tobacco 1 3,600t 2,800t Market Share Enlarged Group Altadis Imperial Tobacco Imperial Tobacco Cigarette % 31.9% 5.2% 5.9% Fine cut tobacco % 2.2% 46.9% 53.2% 1 Imperial Tobacco estimates. Full Year 2007 figures adjusted for divestments. We launched a new Fortuna pack design in the year which was well received by consumers and we are focused on developing further innovative packaging initiatives for our products. We will also seek to build on our leading cigar position, particularly in the growing miniature cigars segment. 28 Imperial Tobacco Group PLC 2008

33 Rest of EU Rest of EU: Tobacco Adjusted profit from operations % 23 Rest of EU Rest of Tobacco Market Dynamics We have replaced our Rest of Western Europe region with the Rest of EU, which for our purposes includes some non-eu countries which we have incorporated on the grounds of geographic proximity. In the region as a whole, we estimate that cigarette market volumes declined by 3 per cent to 382 billion cigarettes. Regional fine cut tobacco volumes grew by 1 per cent to an estimated 34,000 tonnes. Our Performance In the Rest of EU, net revenue was 1,250 million and adjusted profit from operations was 494 million. France is a key market for us in this region and one where the Altadis acquisition has significantly increased our cigarette share, now up to 29.3 per cent with gains from JPS, Gauloises Blondes, News and Fortuna. We are the leader in the French cigar market with a 23.5 per cent share. We delivered a good performance in Poland, growing Route 66 and West, while JPS and Fortuna improved our position in Belgium. JPS also helped to increase our share in The Netherlands and we achieved further strong growth from Davidoff in Greece, where our cigarette share is now up to 10.9 per cent. The regional fine cut tobacco market remains extremely competitive. In The Netherlands, by far the largest regional market, our share was at 50.7 per cent with both our value brands, Zilver and Evergreen, making gains. In Hungary, we have captured 40.6 per cent of the rapidly growing fine cut tobacco market and our share in the Czech Republic increased significantly to 51.8 per cent, driven by strong growth in our Paramount brand. Outlook We expect further modest declines in regional cigarette market volumes and continued growth in fine cut tobacco market volumes. Our versatile portfolio provides a number of growth opportunities. We remain focused on further improving our cigarette position, delivering growth across the pricing spectrum, and see considerable scope for building on our growing fine cut tobacco market shares in a number of accession countries. Performance Highlights Net Revenue 1,250m Cigarette Volumes 56.8bn Market Size Adjusted Profit from Operations 494m Fine Cut Tobacco Volumes 14,300t Cigarette 1 382bn 391bn Fine cut tobacco 1 34,000t 33,650t Enlarged Group Altadis Imperial Tobacco Imperial Tobacco Belgium 16.5% 6.1% 10.4% 10.6% Czech Republic 12.2% 0.3% 11.9% 12.0% France 29.3% 24.8% 4.5% 4.0% Greece 10.9% 0.6% 10.3% 9.7% Hungary 12.6% 0.3% 12.3% 13.2% Ireland 26.6% 0.0% 26.6% 26.4% Italy 2.7% 1.5% 1.2% 1.3% Netherlands 13.5% 2.1% 11.4% 10.6% Poland 25.1% 7.6% 17.5% 16.9% Fine Cut Tobacco Market Shares Enlarged Group Altadis Imperial Tobacco Imperial Tobacco Belgium 11.9% 3.1% 8.8% 8.8% Czech Republic 51.8% 0.0% 51.8% 27.7% France 24.4% 13.2% 11.2% 11.4% Greece 41.9% 0.0% 41.9% 43.8% Hungary 40.6% 0.0% 40.6% 28.7% Ireland 64.0% 0.0% 64.0% 65.6% Italy 46.7% 3.2% 43.5% 47.7% Netherlands 50.7% 0.2% 50.5% 50.6% Poland 2.0% 0.0% 2.0% 2.1% 1 Imperial Tobacco estimates. Full Year 2007 figures adjusted for divestments. 29

34 DIRECTORS REPORT: BUSINESS REVIEW: OPERATING REVIEW Americas Americas: Tobacco Adjusted profit from operations % 8 Americas Rest of Tobacco Market Dynamics The Americas is a major growth area for us as we continue to focus on building our geographic footprint in these profitable markets. Currently, the main focus of our operations is the USA where we estimate that the overall cigarette market declined by 4 per cent to 351 billion cigarettes during the year. The discount segment remained broadly stable and accounts for around 27 per cent of the total cigarette market. In fine cut tobacco, we estimate market volumes grew by 5 per cent to 9,100 tonnes as a result of further downtrading from cigarettes. Sales of cigars have been generally affected by the economic slowdown and public smoking restrictions, particularly in the premium segment, although this is being offset by positive trends in the smaller sizes. In the USA, further tobacco tax increases are expected in 2009 and we continue to monitor the ongoing debate around the potential for the Food & Drug Administration to assume responsibility for tobacco regulation. Our growing Americas profile also includes a small presence in Mexico and Canada, where we launched Davidoff in 2007, and Argentina, where we gained our position through the Altadis acquisition. Our Performance Net revenue in the year was 542 million, with adjusted profit from operations of 166 million. Our USA cigarette volumes were 14.2 billion, with our cigarette share up to 4.3 per cent of the total market and 14.2 per cent of the discount segment. Both our key discount brands, USA Gold at 2.6 per cent and Sonoma at 1.6 per cent, grew share. Having established a secure footing in the value end of the cigarette market, we have taken steps to expand our portfolio, launching Davidoff, initially in ten cities, and Fortuna in Florida and Texas, with encouraging early results. Our fine cut tobacco volumes continue to grow and were up to 600 tonnes in the year. During the year we launched our own fine cut tobacco brand, Premier. The Performance Highlights Net Revenue 542m Cigarette Volumes 15.2bn Market Size No.4 in the USA acquisition of Lignum 2 added the Rave brand to our growing portfolio and doubled our market share, which was around 8 per cent in September. In acquiring Altadis, we gained market leadership, in value terms, in the large cigar segment with a strong presence in all the cigar categories in the USA. In challenging market conditions, our natural wrapper brands of Backwoods and Dutch Masters performed well following the introduction of new flavoured variants and two price increases. In October 2008, we took up the option to acquire the remaining 49 per cent of JR Cigars not previously owned by Altadis as another step towards consolidating our market position. The company is a nationwide distributor of cigars and related products. Outlook We have made considerable progress in the short time we have been present in the USA tobacco market and see attractive opportunities for expanding our profile. Adjusted Profit from Operations 166m Fine Cut Tobacco Volumes 600t No.3 in the USA Cigarette USA 1 351bn 367bn Fine cut tobacco USA 1 2 9,100t 8,700t Market Share Cigarette USA % 4.0% Fine cut tobacco USA 1 5.8% 1.0% 1 Imperial Tobacco estimates. 2 USA fine cut tobacco volumes have been restated to exclude pipe tobacco. 3 Our USA cigarette market share estimate in 2007 has been restated to reflect a changed basis of calculation. Our multi-product portfolio means we are well placed to respond swiftly and efficiently to changing market dynamics. We also remain focused on improving our national distribution capabilities in the USA and are currently in the process of expanding our cigarette sales force. Our ambition is to continue to enhance our cigarette presence and build on the excellent progress we have made in fine cut tobacco, whilst consolidating our position in cigar. 30 Imperial Tobacco Group PLC 2008

35 Rest of the World RoW: Tobacco Adjusted profit from operations % 19 RoW Rest of Tobacco Our Rest of the World region contains a diverse array of markets which offer considerable opportunities for growth. Our Performance In the Rest of the World, net revenue grew to 1,502 million, with adjusted profit from operations up to 404 million. We had an excellent year in Africa, increasing our volumes and market share in many countries. The acquisition of Altadis has enhanced our position in this important growth region, giving us a market leading position in Morocco, with our key brand Marquise. Our volumes have also grown strongly in Algeria with Gauloises Blondes. Our performance in the Middle East has been equally strong, with further volume and share growth. Gauloises Blondes is now our largest cigarette brand in the region, complemented by Gitanes and Davidoff. Eastern Europe generates 54 per cent of our Rest of the World cigarette volumes, predominantly in Russia and the Ukraine. In Russia, sales were affected by destocking, both at the distributor and wholesale levels, following the merger of the two largest tobacco distributors. In the Ukraine we increased volumes of our value brand Classic by 55 per cent, while in Azerbaijan we further built on our track record of growth with gains from West and Davidoff. In Asia, our Taiwan share declined as a result of increased competition and downtrading. However, our new cigarette factory will generate substantial cost savings and improve our competitiveness in this important market. In Vietnam, we have strengthened our position with a new production and sales joint venture, and in Laos our A brand generated further share growth. Our presence in Asia has been strengthened as a result of the Altadis acquisition and we now have a strong position in Cambodia. Australia remains extremely competitive, particularly in the low price cigarette sector, resulting in a slight fall in our market share, although we continue to lead the fine cut tobacco market with a 61.1 per cent share. Performance Highlights Net Revenue 1,502m Cigarette Volumes 152.6bn Outlook Our primary objective is to build on our enhanced footprint by leveraging our brand and product portfolios. There are many opportunities for us to develop our business in this region and we will particularly focus on maintaining our growth momentum in Africa, the Middle East, Eastern Europe and Asia. In Africa our strong portfolio of local brands will continue to drive our volume and share growth, with growing support from our international brands. In the Middle East we will continue to enhance market share through the development of our international brands. Adjusted Profit from Operations 404m Fine Cut Tobacco Volumes 2,050t Enlarged Group Altadis Imperial Tobacco Imperial Tobacco Australia 17.2% 0.0% 17.2% 17.5% Azerbaijan 39.4% 0.0% 39.4% 36.6% Cambodia 25.6% 25.6% 0.0% 0.0% Ivory Coast 84.8% 0.1% 84.7% 84.7% Lebanon 21.1% 17.4% 3.7% 3.3% Morocco 87.3% 87.3% 0.0% 0.0% Russia 11.0% 5.5% 5.5% 5.5% Saudi Arabia 9.7% 0.5% 9.2% 7.0% Taiwan 9.7% 0.0% 9.7% 11.7% Turkey 3.2% 0.0% 3.2% 2.5% Ukraine 21.8% 0.1% 21.7% 20.6% 1 Imperial Tobacco estimates. Our cigarette volumes are growing in Eastern Europe and we remain focused on building on our success. Our extended geographic reach presents a platform to expand the distribution of Habanos cigar brands, such as Cohiba and Montecristo, into new markets and we see particular growth opportunities in Eastern Europe and Asia. 31

36 DIRECTORS REPORT: BUSINESS REVIEW: OPERATING REVIEW Manufacturing The acquisition of Altadis has substantially increased our international manufacturing footprint. Gary Aldridge, Manufacturing Director Our manufacturing capabilities now extend across North America, Europe, Africa, the Middle East and Australasia, where we produce a broad range of high quality cigarettes, tobaccos, cigars, rolling papers and tubes. The Altadis acquisition increased our manufacturing sites from 31 factories to 58. In combining two such large footprints, there will inevitably be a degree of overcapacity, and as part of our integration strategy we proposed closing six sites and restructuring a number of others in order to address this and improve operational efficiencies. We have so far completed the closure of our cigar and fine cut tobacco factory in Slovakia and remain committed to supporting employees affected by integration. Our Performance We have maintained our focus on simplification and standardisation while managing integration, and have delivered further operational improvements within the Imperial Tobacco portfolio. Productivity improved by 5 per cent and we reduced overall cigarette unit costs by 3 per cent. In addition, the number of blends and ingredients we use have decreased by a further 9 and 6 per cent respectively. Like Imperial Tobacco, Altadis has continually reviewed its manufacturing operations in recent years and has delivered a steady progression of efficiency enhancements which we will seek to build on. A key area of focus this year has been integrating the Altadis supply chain processes with our own in order to benefit from ongoing synergies. In October 2008 we obtained the manufacturing licence for our new factory in Taiwan and are currently in the final phase of test production. The factory is a state-of-the-art facility with the most modern technologies available and we expect it to be fully operational in January The factory will enable us to respond more swiftly to changing market dynamics and provides a strong platform for further expansion in the Asia-Pacific region. It is inevitable that rising costs will present a challenge to our business and in order to mitigate their impact we continue to focus on deriving efficiencies from our cost base. We are constantly looking at the processes for controlling and improving our environmental performance and ISO14001 is an international standard applied to our manufacturing bases. This year, we increased the number of Imperial Tobacco factories with ISO14001 accreditation to 74 per cent (2007: 68 per cent). This standard is also in place in 12 Altadis factories and in all the main distribution centres of our Logistics business. Outlook Our long-term strategy of simplification, standardisation and supply chain optimisation, whilst maintaining quality, remains central to the success of our manufacturing operations. Our focus on cost optimisation and efficiency improvements is being extended across our enlarged manufacturing portfolio. The tobacco industry is evolving and flexibility is therefore key to our success. We will ensure that we respond quickly to changing market dynamics and consumer preferences, and will continue to deliver the quality of product necessary to build upon our strong presence in the international tobacco markets. Our ongoing programme of simplification and standardisation is being applied to the Group s enlarged manufacturing portfolio. 32 Imperial Tobacco Group PLC 2008

37 Logistics We are one of the largest distributors of tobacco and other products in Europe. Performance Highlights Distribution Fees 607m Adjusted Profit from Operations 121m Adjusted Distribution Margin 19.9% Overview The logistics operations acquired with Altadis comprised a wholly owned company in France and a majority stake in Logista, a publicly traded company focused on the Spanish, Portuguese and Italian markets. Both companies owe their roots to the traditional distribution activities of previously state-owned tobacco manufacturers that became a part of Altadis. Following the acquisition of Altadis, Spanish takeover law required that we either reduced our majority shareholding in Logista to below 30 per cent or made an offer for those shares not already held by the Group. We reviewed the overall logistics business and decided to launch an offer for the remaining shares, which was completed at a cost of 925 million in June The business has a strategy of expansion through both organic growth and acquisitions. In the last decade logistics has diversified from tobacco distribution within France and Spain into new markets and a range of new and related product groups. As a result, our operations are split into two distinct areas: tobacco and other products. Our tobacco logistics business is the largest of its kind in Europe and has in excess of 90 per cent market share in the distribution of tobacco within Spain, France and Italy. Tobacco logistics delivers products for international manufacturers, including Imperial Tobacco, to tobacconists and other sales outlets across Southern Europe. The business is run on an operationally neutral basis, providing bespoke solutions based on our technology, and ensuring that all customers are treated equally. Through our other products activities, we manage the full logistics value chain of a diverse range of products for clients including those from the pharmaceutical, publishing, transportation and telecommunications industries. These range from telephone cards, stamps, magazines and books, to promotional items and industrial courier services. Today, our Logistics division distributes to around 200,000 outlets across Europe. These span convenience stores, tobacconists, bakeries, kiosks, pharmacies, grocery stores, service stations and stationers. Market Dynamics In tobacco logistics, the continued gradual decline in the volumes of cigarettes consumed across Western Europe requires distributors to focus on offering additional services while 33

38 DIRECTORS REPORT: BUSINESS REVIEW: OPERATING REVIEW Logistics continued improving operating efficiencies. Expansion into additional territories is a strategy our Logistics business has pursued successfully in Portugal, Italy and, more recently, Poland. Through the scale and efficiency of our distribution activities we are providing customers with a range of services they would find difficult to replicate elsewhere. The other products logistics business has proven successful in identifying areas where the growth dynamics are favourable, such as pharmaceuticals, books and transportation. In transportation, we are one of the largest business-to-business courier and industrial parcel delivery operators in Spain, offering long distance services across Europe. This has seen attractive growth over the last five years, with opportunities for further growth through diversification into related areas within and beyond Spain. Our Performance Distribution fees in the eight months to September were 607 million, with adjusted profits from operations of 121 million. Our overall performance was in line with our expectations. The good performance of tobacco logistics reflected a cigarette price increase in Italy and stable tobacco volumes in Spain, which offset a decline in French volumes following the extension of the public smoking bans in January In other products logistics, our traditional wholesale business performed well in a difficult environment. However, our overall business was affected by continued weakness in publications and the impact of the economic downturn on the transport business. Outlook The current economic conditions present challenges for our other products logistics business but we anticipate a stable tobacco performance going forward, with the benefit of cigarette price increases by tobacco manufacturers compensating for slight cigarette volume declines. The Logistics business has grown rapidly and we see further opportunities both within the regulated markets of Western Europe and the unregulated markets of Central and Eastern Europe, where industry consolidation is likely. Logistics is a profitable and highly cash generative part of the Group, and our long-term strategy is one of continuing to enhance service levels to existing customers whilst looking for opportunities to extend our logistics footprint into additional countries and related other products. Our logistics business is run on an operationally neutral basis, ensuring that all customers are treated equally. 34 Imperial Tobacco Group PLC 2008

39 Corporate Responsibility We remain committed to building a sustainable and profitable business while behaving responsibly. The principles of corporate responsibility are integrated within the Group s management practices and processes. Responsibly managing our business Highlights Lost time accident rates reduction in % Energy consumption reduction in % CO 2 emissions reduction in % compared with 2006 (excluding Altadis). 2 Absolute values for financial year 2007 compared with 2001 base year (excluding Altadis). Conducting our business responsibly is fundamental to our future success and the sustainability of our business, from managing social and environmental and economic risks and opportunities, to responding to external developments and stakeholder issues. Our Strategy The way we approach Corporate Responsibility (CR) and how it supports our commercial strategy has developed over the years. Following a strategic review of international trends in CR, we identified five key areas of focus with the purpose of enhancing our performance over a five year horizon, supported by increasing local participation in managing these issues. Our Performance Progress has been made for each of our Five-for-Five priorities and across a range of financial and non-financial performance metrics. Five-For-Five Priorities Carbon Management: we are committed to further improvements in carbon management through energy conservation, the application of lower carbon technologies and carbon offsetting. Progress Report: we have identified the most significant risks and opportunities for improvement in our business operations relating to climate change. Consultation has commenced with key stakeholders to consider the potential impact on our business and assist in the definition of appropriate energy and carbon dioxide emission reduction targets. We are participating in the Carbon Disclosure Project s Supply Chain Leadership Study, to assess climate change risks and to assist our suppliers in managing carbon. Our 2008 submission to the project resulted in a score of 87 per cent for our climate change strategy (sector average 67 per cent). Portfolio Balance: we are committed to further improvements in how we manage our product portfolio to achieve an appropriate balance between product stewardship, regulatory demand and the needs and preferences of our consumers. Progress Report: we completed the first phase of this work by identifying a crossfunctional decision-making mechanism to optimise our product portfolio. As a result, information system projects are underway to enable us to better understand how ingredients link to products, their market destinations and regulatory requirements within the enlarged Group. Supplier Standards: we will continue to work with our suppliers to improve their economic, social and environmental standards. 35

40 DIRECTORS REPORT: BUSINESS REVIEW: OPERATING REVIEW Corporate Responsibility continued Progress Report: the aim of our supplier engagement and assessment programmes is to safeguard future supplies by managing the social, environmental and economic aspects of our supply chain. Preliminary analysis has been undertaken to deepen understanding of reputational risk and the appropriate standards which need to be promoted in the supply chain. We continue to use the Social Responsibility in Tobacco Production programme, in conjunction with our suppliers. An improvement in overall performance and a good level of risk management is generally evident. We continue to engage with our leaf suppliers, and have underlined our commitment to finding solutions to child labour by increasing our funding to the Elimination of Child Labour in Tobacco Foundation. We continue to include CR-related factors in the qualification of non-tobacco material suppliers engaged in business with the Group. Local Accountability: we will aim for accountability through the provision of training and expertise to ensure a more effective local response to CR issues. Progress Report: a suite of educational materials is being developed to raise awareness of accountability for CR throughout the enlarged Group and at all levels. This year we have been able to link CR and Group policies to different elements of job roles within the business to enhance this understanding. Policy Evidence: we are aiming to increase transparency that our policies and standards are routinely and universally observed. Progress Report: we have created a single reference point on our corporate intranet to communicate the requirements of our policies to employees. We have also taken steps to support the alignment of policies with working practice, and completed a project to help improve the clarity of purpose of our corporate documents and how they are interconnected. Non-Financial Objectives In the phased implementation of projects related to our key strategic objectives we continue our work in the social and environmental areas important to our business. Benchmarks Ranking in Business in the Community CR Index 2007 Gold Class distinction in Sustainability Asset Management Sustainability Yearbook 2008 Bronze SAM Research for Dow Jones Sustainability Index 2008 (sector average 69%) 74% Product Stewardship: we have invested further in better understanding our products, assessing materials for suitability, evaluating scientific developments in tobacco and health, and complying with all voluntary agreements, legal and regulatory requirements. Sales and Marketing: we remain committed to promoting and selling our tobacco and paper products responsibly, applying our International Marketing Standards (IMS) as the minimum and directing our products only to adult consumers. The IMS has undergone extensive review to ensure it continues to be fit for purpose for the enlarged Group. Employment Practices: our Business Principles and employment policies set out a framework of practices to ensure our people are treated with fairness, dignity and respect, in line with universally accepted standards for human rights. We continue to invest in our people through our international career management, leadership and development programmes, as well as through ongoing local training and development initiatives within our markets and factories. Occupational Health and Safety (OHS): the safety and well-being of our employees and those who work with us remain a high priority. The Board has reiterated its commitment to continuous improvement by leading an initiative to reinvigorate OHS to coincide with organisational changes within the enlarged Group. Environmental Management: we remain committed to minimising the adverse impact of our activities on the natural environment. Our environmental performance shows a downward movement in energy consumption and carbon dioxide emissions. Since 2004, we have reduced waste from our factories and main offices by 9 per cent and we send 62 per cent less waste to landfills. Water use by our factories and main offices has decreased by 8 per cent since Community Investment: we have invested 2.4 million in our community activities, through international and local partnership projects, charitable giving and matching employee fundraising. We were delighted to receive the Charity Aid Foundation Community Investment Award 2007 in recognition of our commitment to sustainable funding of charities. Integration Imperial Tobacco and Altadis have taken similar approaches to CR. This close alignment has enabled us to swiftly and effectively plan implementation of our systems across the enlarged Group, including various social and environmental due diligence activities, our non-financial reporting system, the Social Responsibility in Tobacco Production programme, and community investment activities. Following the announcement of proposed integration projects in June 2008, we have been actively consulting with our employees, trade unions, work councils and other organisations. We remain focused on providing those affected by integration with a comprehensive range of support measures. Further detailed information on our performance can be found in our Corporate Responsibility Review which is published in December and which includes an independent verifier s statement provided by SGS United Kingdom Limited on the accuracy and reliability of our corporate responsibility performance reporting. 36 Imperial Tobacco Group PLC 2008

41 In this section: Board of Directors 38 Chief Executive s Committee 40 Report of the Directors 41 Corporate Governance Report 44 Directors Remuneration Report 55 Governance

42 DIRECTORS REPORT: GOVERNANCE Board of Directors Name Title & age Appointment Committee membership Skills and experience 1. Iain Napier, FCMA Chairman, 59 Appointed Chairman in January Non-Executive Director from March Chairman of Nominations Committee and Member of the Remuneration Committee. Iain was formerly main Board Director of Bass PLC, Chief Executive of Bass Leisure and then of Bass Brewers and Bass International Brewers. He was then Vice President UK and Ireland for Interbrew SA until August He was Chief Executive of Taylor Woodrow International Housing and Development from 2001 to 2005, and was previously Director of Tomkins PLC until December Graham Blashill, BSC Group Sales and Marketing Director, 61 Appointed to the Board in October Chief Executive s Committee. Graham is responsible for global sales and marketing activities. With over 40 years experience with the Group he has held a number of senior sales and marketing positions, including Managing Director UK and Regional Director for Western Europe. External appointments Name Title & age Appointment Committee membership Skills and experience Non-Executive Chairman of McBride PLC and a Non- Executive Director of Collins Stewart PLC, and was appointed to the Boards of Molson Coors Brewing Company and John Menzies plc during the year. 2. Gareth Davis, BA Chief Executive, 58 Appointed Chief Executive on demerger in Chief Executive s Committee. Gareth led the successful demerger from Hanson and subsequent listings on the London and New York Stock Exchanges. With 36 years experience across all aspects of the Company, he has played a key role in the development and execution of the Group s strategy and its development into one of the world s leading multinational tobacco businesses. No external Director appointments. 5. Alison Cooper, BSC, ACA Corporate Development Director, 42 Appointed to the Board in July Chief Executive s Committee. Alison has responsibility for strategic planning and business development, Corporate Affairs and, currently, the process of integration of the Altadis business into the enlarged Imperial Tobacco Group. Alison joined the Group in 1999 and has held a number of senior roles including Director of Finance and Planning and Regional Director, Western Europe. Previously she was with PricewaterhouseCoopers. External appointments Name Title & age Appointment Committee membership Non-Executive Director, Wolseley plc since Senior Independent Director, Wolseley plc since Robert Dyrbus, BSC, FCA Finance Director, 56 Appointed Finance Director on demerger in Chief Executive s Committee. No external Director appointments. 6. Jean-Dominique Comolli Non-Executive Deputy Chairman, 60 Appointed Non-Executive Deputy Chairman in July Nominations Committee. Skills and experience External appointments Robert was Finance Director of Imperial Tobacco Limited from November 1989 and one of the three-man Hanson team involved in the strategic reorganisation of the Group. Since then he has played an integral part in shaping the strategic direction of the Group. No external Director appointments. Jean-Dominique has held a number of senior positions in the French Civil Service including Assistant Principal Private Secretary to the Minister of the Economy and Principal Private Secretary to the Budget Minister, before his appointment as Director General of Customs at the Budget Ministry in In 1993 he was appointed Chairman and Chief Executive of SEITA and in 1999 appointed as Co-Chairman of the Altadis Group, a position he held until 2005, when he was appointed Chairman of Altadis. Non-Executive Director of Pernod-Ricard, Non- Executive Director of Calyon and Non-Executive Director of Public Establishment of Opéra Comique. 38 Imperial Tobacco Group PLC 2008

43 Pierre Jungels, CBE (HON), C ENG, PHD Senior Independent Non-Executive Director, 64 Appointed Non-Executive Director in August Chairman of the Remuneration Committee and Member of the Nominations Committee and the Audit Committee. Pierre has held numerous senior international positions within the oil industry with Shell International, Petrofina SA and British Gas PLC. He became CEO of Enterprise Oil in 1996, leading the business to substantial geographic and financial growth until retirement in November Chairman of Oxford Catalyst Group PLC, Director of Baker Hughes Inc., Chairman of Rockhopper Exploration PLC and a Non-Executive Director of Woodside Petroleum Ltd. 8. Bruno Bich Non-Executive Director, 62 Appointed Non-Executive Director in April Nominations Committee. Bruno is Non-Executive Chairman of the BIC Group, having been appointed as Chairman and Chief Executive Officer in June Prior to his appointment as BIC Group Chairman, Bruno held a number of key corporate positions including Chairman and Chief Executive Officer of BIC Corporation, Vice President of Sales and Marketing and National Sales Manager. Bruno was a Non- Executive Director of Altadis, S.A. having been appointed in November Non-Executive Chairman of Société Bic. 10. Michael Herlihy, MA, (Oxon), Solicitor Non-Executive Director, 55 Appointed Non-Executive Director in July Nominations Committee, Audit Committee and Remuneration Committee. Michael was formerly General Counsel and Head of Mergers and Acquisitions for ICI PLC with overall responsibility for corporate acquisitions and divestments and has extensive experience of both private and public market transactions. Serves on the Board of Compass Partners International LLP. 11. Charles Knott, FCMA Non-Executive Director, 53 Appointed Non-Executive Director in April Nominations Committee, Audit Committee and Remuneration Committee. Charles was a Director of ICI plc from 2004 to 2007, Chairman and Chief Executive of Quest International, ICI s flavours and fragrances business. Previously fulfilled a variety of international assignments as a long-term executive at National Starch, a Unilever company until Currently, Chief Executive Officer of Flint Group. No external Director appointments. 13. Berge Setrakian Non-Executive Director, 59 Appointed Non-Executive Director in June Nominations Committee. Berge is a senior partner in the law firm Dewey & LeBoeuf LLP and has extensive expertise in international transactions. He was a Non-Executive Director of Altadis, S.A. having been appointed in May 2004 and was a Non-Executive Director of Investcom, a telecommunications company which was acquired in 2006 by MTN, a Johannesburg-based company. Berge is currently the Executive Chairman and CEO of AGBU, the largest philanthropic Armenian organisation in the world. He also serves as a Non-Executive Director on various not-for-profit organisations. Non-Executive Director of Interaudi Bank of New York, Executive Chairman and CEO of AGBU, Non-Executive Director of The Morganti Group, Inc. 14. Mark Williamson, CA (SA) Non-Executive Director, 50 Appointed Non-Executive Director in July Chairman of Audit Committee; Member of the Nominations Committee and Remuneration Committee. Mark has considerable international financial and general management experience. He joined International Power in 2000 as Group Financial Controller and was appointed to the Board as Chief Financial Officer in Previously, he was Group Financial Controller and Group Chief Accountant at Simon Group, the engineering and bulk chemicals storage group. Serves on the Board of International Power plc. 9. Ken Burnett, MA, MBA, PHD Non-Executive Director, 56 Appointed Non-Executive Director in April Nominations Committee. Ken was President, Asia Pacific of Allied Domecq from 1996 until its acquisition by Pernod Ricard in Prior to joining Allied Domecq, he held senior management positions in the Asia Pacific region with Seagram, Interbrew and International Distillers & Vintners Ltd (now part of Diageo plc). 12. Susan Murray Non-Executive Director, 51 Appointed Non-Executive Director in December Nominations Committee, Audit Committee and Remuneration Committee. Susan was a Board member at Littlewoods Limited from October 1998 until January 2004, latterly as Chief Executive of Littlewoods Stores Limited. Prior to this she was worldwide President and Chief Executive of The Pierre Smirnoff Company, a part of Diageo plc. Susan is also a former Non-Executive Director of SSL International plc and of Aberdeen Asset Management PLC. 15. Matthew Phillips, LLB Company Secretary, 38 Appointed Company Secretary in October Chairman of the Disclosure Committee, Secretary to and Member of the Chief Executive s Committee; Secretary to the Audit, Nominations and Remuneration Committees. Matthew joined Imperial Tobacco s legal department in 2000 and was closely involved in the acquisitions of Reemtsma and Altadis. Previously he worked for law firms Linklaters and Burges Salmon. No external Director appointments. Non-Executive Director of Enterprise Inns Plc, Wm Morrison Supermarkets plc and Compass Group PLC. Also fellow of the Royal Society of Arts and council member of the Advertising Standards Authority. No external Director appointments. 39

44 DIRECTORS REPORT: GOVERNANCE Chief Executive s Committee Name Title & age Appointment Committee membership Skills and experience External appointments 1. Gary Aldridge, MBA Manufacturing Director, 55 Appointed Manufacturing Director in January Chief Executive s Committee. Gary was Regional Operations Director Far East, Eastern Europe, Africa and Middle East. Previously, he was Director of Operations, Central and Eastern Europe. He held a number of senior manufacturing roles in RJ Reynolds International before joining Reemtsma in No external Director appointments. 3. Kathryn Turner Group Human Resources Director, 53 Appointed Group Human Resources Director in Chief Executive s Committee. Kathryn is responsible for all aspects of human resource management across the Group. She joined in 2002 from Somerfield PLC, where she was a member of the PLC Board. She has also held a number of senior operational consulting roles in change management in the FMCG sector. No external Director appointments. Name Title & age Appointment Committee membership Skills and experience External appointments 2. Fernando Domínguez, IE Chief Operating Officer Cigar Business Unit, 49 Appointed Chief Operating Officer Cigar Business Unit in June Chief Executive s Committee. Fernando is Chief Operating Officer Cigar, responsible for the Cigar Business of the Imperial Tobacco Group. With an industrial engineering background he joined Tabacalera in Fernando has held numerous senior positions within both Tabacalera and the Altadis Group, mainly in the Cigar Division. He was Co-chairman at Corporación Habanos, S.A. before his appointment as Chief Operating Officer Cigar Business Unit in May No external Director appointments. 40 Imperial Tobacco Group PLC 2008

45 DIRECTORS REPORT: GOVERNANCE Report of the Directors The Directors submit their report together with the audited consolidated financial statements of the Group and the accounts of the Company for the year to 30 September Business Review Following the acquisition of Altadis, the enlarged Group now has two main business activities: Tobacco and Logistics. The tobacco segment comprises the manufacture, marketing and sale of tobacco and tobacco-related products. The logistics segment comprises the distribution of tobacco products for major tobacco manufacturers, including Imperial Tobacco, as well as a wide range of non-tobacco products and services. A review of the Group s activities and future developments is included in the Business Review section on pages 5 to 36. This review fulfils the requirements of the Business Review contained in section 417 of the Companies Act 2006, including the financial performance during the year on pages 8 to 11, key performance indicators on page 17 and a description of the principal risks and uncertainties facing the Group on pages 22 to 24. The purpose of the Annual Report is to provide information to the shareholders of Imperial Tobacco Group PLC. The Company, its Directors, employees, agents and advisers do not accept or assume responsibility to any other person to whom this document is shown or into whose hands it may come and any such responsibility or liability is expressly disclaimed. The Annual Report contains certain forward-looking statements with respect to the operations, performance and financial condition of the Company and the Imperial Tobacco group as a whole. By their nature, these statements involve uncertainties since future events and circumstances can cause actual results to differ materially from those anticipated and no reliance should be placed on them. The forward-looking statements reflect knowledge and information available at the date of preparation of this Annual Report and the Company undertakes no obligation to update these forward-looking statements. Nothing in this Annual Report should be construed as a profit forecast. The principal operating subsidiaries within the Group are shown on pages 131 and 132. Financial Results and Dividends The profit attributable to equity holders of the Company for the financial year was 428 million as shown in the consolidated income statement set out on page 74. Note 1 to the financial statements gives an analysis of revenue, duty and similar items, profit from operations and net assets. The Directors have declared dividends as follows: In s million Ordinary Shares Interim paid, 20.9p 1 per share (2007: 18.2p 1 ) Proposed final, 42.2p per share (2007: 42.2p 1 ) Total ordinary dividends, 63.1p p er share (2007: 60.4p 1 ) Comparatives reflect the bonus element of the Rights Issue in June The interim dividend per share for 2008 has been similarly adjusted. The full year dividend distribution of 588 million represents an increase of 26 per cent on 2007 and a payment ratio of 50.7 per cent of the Company s adjusted attributable profit of 1,159 million for the year. The final dividend, if approved, will be paid on 20 February 2009 to shareholders whose names are on the Register of Members at the close of business on 23 January The associated ex-dividend date is 21 January The interim dividend was paid on 8 August 2008 to shareholders on the register at the close of business on 6 June Share Capital Details of the Company s share capital are shown in note 20 to the financial statements. All shares are freely transferrable and rank pari passu for voting and dividend rights. At the Company s Annual General Meeting (AGM) on 29 January 2008 shareholder authority for the buyback of up to 72,900,000 ordinary shares of 10 pence each was renewed. The Company holds 51,717,000 ordinary shares of 10 pence each in Imperial Tobacco Group PLC, representing 4.84 per cent of issued share capital with an aggregate nominal value of 5,171,700. These shares have not been cancelled but are held in a treasury shares reserve within the profit and loss account reserve and represent a deduction from equity shareholders funds. These treasury shares do not carry any voting rights or rights to dividends. The share buyback programme was suspended on 8 February At an Extraordinary General Meeting (EGM) on 13 August 2007, the Company s authorised share capital was increased from 1,000,000,000 to 56,040,000,000 by the creation of an additional 55,040,000,000 ordinary shares of 10 pence each. As a result of the Rights Issue in June 2008 the Company issued an additional 338,741,960 shares at a price of 1475 pence per share. At 26 November 2008 the Company had been notified that the following persons had interests in 3 per cent or more of the Company s issued share capital. Number of ordinary shares millions Percentage of issued share capital Invesco Limited Legal & General Investment Management Limited Barrow, Hanley, Mewhinney & Strauss Inc Franklin Resources Inc Morgan Stanley Investment Management Limited Barclays PLC The Company has not received notification that any other person holds 3 per cent or more of the Company s issued share capital. The share interests of the Directors, their families and any connected persons are shown on page 61. Statement on Corporate Governance The required disclosures are contained within the Corporate Governance Report on pages 44 to 54. Following recommendation by the Nominations Committee, Directors are appointed by the Board. They must, however, submit themselves for election by shareholders at the AGM following their appointment. The powers of the Directors are contained in the Company s Articles of Association, changes to which require approval of the shareholders at a general meeting. Contracts with Employees or Directors Other than disclosed on page 69 there are no agreements between the Company and its Directors or employees providing for compensation for loss of office or employment due to a takeover. 41

46 DIRECTORS REPORT: GOVERNANCE Report of the Directors continued Significant Agreements That Take Effect, Alter or Terminate on Change of Control The following agreements are those agreements which the Company considers to be significant to the Group as a whole and which contain provisions giving the other party a specific right to terminate them if the Company is subject to a change of control following a takeover bid. Certain members of the Group entered into a credit facilities agreement on 18 July 2007 under which certain banks and financial institutions made available to Imperial Tobacco Finance PLC and Imperial Tobacco Enterprise Finance Limited committed and uncommitted credit facilities. The credit facilities agreement provides that, unless the lenders thereunder otherwise agree, in the event of any person or group of associated persons acquiring the right to exercise more than 50 per cent of the votes exercisable at a general meeting of the Company, Imperial Tobacco Finance PLC and Imperial Tobacco Enterprise Finance Limited must repay each advance utilised by it under the credit facilities agreement and the total commitments under the credit facilities agreement will be immediately cancelled. Certain members of the Group entered into a letter of credit facility agreement dated 12 December 2007 under which certain banks and financial institutions made available to Imperial Tobacco Limited a letter of credit facility. The letter of credit facility agreement provides that, unless the lenders thereunder otherwise agree, in the event of any person or group of associated persons acquiring the right to exercise more than 50 per cent of the votes exercisable at a general meeting of the Company, Imperial Tobacco Limited must repay each credit utilised by it under the letter of credit facility agreement and the total commitments under the letter of credit facility agreement will be immediately cancelled. Imperial Tobacco Finance PLC issued on 15 September ,000, per cent guaranteed notes due 2024 under the 10,000,000,000 Debt Issuance Programme. The Company acted as guarantor. The applicable final terms of this series of notes contains change of control provisions pursuant to which the holder of each note will, subject to any earlier exercise by the issuer of a tax call, have the option to require the issuer to redeem or, at the issuer s option, purchase (or procure the purchase of) that note at its nominal value if: (a) any person (or, subject to customary exceptions, any persons acting in concert or any person or persons acting on behalf of any such person(s)) becomes interested in: (i) more than 50 per cent of the issued or allotted ordinary share capital of the Company; or (ii) such number of shares in the capital of the Company carrying more than 50 per cent of the voting rights normally exercisable at a general meeting of the Company; and (b) as a result (in whole or in part) of the change of control, there is either: (i) a reduction in or withdrawal of the investment grade credit rating of the notes during the change of control period specified in the final terms; or (ii) to the extent that the notes are not rated at the time of the change of control, the issuer fails to obtain an investment grade credit rating of the notes within the change of control period as a result (in whole or in part) of the change of control. Imperial Tobacco Finance PLC issued on 15 September ,000, per cent guaranteed notes due 2014 under the 10,000,000,000 Debt Issuance Programme. The Company acted as guarantor. The change of control provisions in the applicable final terms of this series of notes are the same as those mentioned in the above paragraph in respect of the 600,000, per cent guaranteed notes due Board of Directors Mr B F Bich joined the Board on 25 April 2008 as a Non-Executive Director. Mr B Setrakian joined the Board on 25 June 2008 as a Non-Executive Director and Mr J-D Comolli joined the Board on 15 July 2008 as a Non-Executive Director and Deputy Chairman. Mr Comolli also provides certain consultancy services to the Group. The Directors of the Company for the year to 30 September 2008 are shown on pages 38 and 39. Messrs G L Blashill and P H Jungels retire at the Annual General Meeting and being eligible, offer themselves for re-election. As part of the Board Evaluation Process the contributions to the Board of Messrs G L Blashill and P H Jungels were assessed and the Board confirms that they continue to be effective Directors. Messrs J-D Comolli, B F Bich and B Setrakian, having been appointed during the year, retire at the Annual General Meeting and offer themselves for election. Messrs D Cresswell and A G L Alexander retired from the Board on 31 December 2007 and 29 January 2008 respectively. The Company has entered into qualifying third party indemnity arrangements for the benefit of all its Directors in a form and scope which comply with the requirements of the Companies Act 2006 and the transitional arrangements in respect of the Companies Act Employees The Group s employment policies are designed to attract, retain, train and motivate the very best people, recognising that this can be achieved only through offering equal opportunities and fair consideration to applications for employment, career development and promotion regardless of gender, race, religion, age or disability. These policies also cover the continuation of employment and appropriate training for employees who become disabled during their period of employment. To ensure employees can share in our success, the Group offers competitive pay and benefit packages and, wherever possible, links rewards to individual and team performance. Employees are encouraged to build a stake in the Company through ownership of Imperial Tobacco Group PLC shares. A further opportunity to join the Sharesave Plan was offered during the year and 32 per cent of eligible employees around the world now participate. The Group is committed to providing an environment that encourages the continuous development of all its employees through skills enhancement and training programmes. Using their own consultative and communication methods each of the Group s businesses is encouraged to keep its employees informed on Group and individual business developments and to make its employees aware of the financial and economic factors affecting the performance of their employing company. To progress this aim further, employee representatives are briefed on pan-european issues through a European Employee Forum and through CEEGA, the Altadis European Works Council. The Group s financial results and important initiatives are communicated through a number of mechanisms including company magazines, electronic updates, presentations, face to face briefings and the Group s Intranet. Information concerning employees and their remuneration is given in note 4 to the accounts and in the Directors Remuneration Report. 42 Imperial Tobacco Group PLC 2008

47 Charitable and Political Donations During the year the Group made charitable donations of 3.0 million of which 0.2 million was in respect of the UK (2007: 2.0 million, of which 0.2 million was in respect of the UK), much of which was distributed through the Charities Aid Foundation in accordance with the Group s charities policy. As in the previous financial year, no political donations were made by the Imperial Tobacco Group to EU political parties, organisations or candidates. Since its acquisition by Imperial Tobacco in April 2007 and in line with its long-standing practice, Commonwealth Brands has made corporate donations totalling in aggregate US$ 97,000 to candidates and political parties in the USA States of Florida, Texas and Mississippi. Commonwealth Brands has not made any corporate donations at a federal level. Since 1 October 2008, Commonwealth Brands has adopted Imperial Tobacco Group s long-standing policy of not making contributions to any political party, organisation or candidates. Since its acquisition by Imperial Tobacco in January 2008, neither Altadis USA nor its subsidiaries have made, and will not make, any corporate donations to political candidates or parties at either a state or federal level. Creditor Payment Policy The Company s current policy concerning the payment of the majority of its trade creditors is to follow the CBI s Prompt Payers Code (copies are available from the CBI, Centre Point, 103 New Oxford Street, London WC1A 1DU). For other suppliers, the Company s policy is to: > agree the terms of payment with those suppliers when agreeing the terms of each transaction; > ensure that those suppliers are made aware of the terms of payment by inclusion of the relevant terms in contracts; and > pay in accordance with its contractual and other legal obligations. The payment policy applies to all payments to creditors for revenue and capital supplies of goods and services without exception. Wherever possible UK subsidiaries follow the same policy and international subsidiaries are encouraged to adopt similar policies, by applying local best practices. The amount of trade creditors outstanding as at 30 September 2008 was equivalent to 46 days (2007: 30 days) of trade purchases. Research and Development The Group recognises the importance of investing in research and development, which brings innovative improvements to the Group, both in the products supplied to the consumer and in production and marketing techniques. Auditors and Disclosure of Information to Auditors Each of the Directors in office as of the date of approval of this report confirms that: > so far as they are aware, there is no relevant audit information (that is, information needed by the Company s Auditors in connection with preparing their report) of which the Company s Auditors are unaware; and > they have each taken all the steps that he/she ought to have taken as a Director in order to make himself/herself aware of any relevant audit information and to establish that the Company s Auditors are aware of that information. A resolution to reappoint PricewaterhouseCoopers LLP as Auditors to the Company will be proposed at the Annual General Meeting. Annual General Meeting Full details of the Annual General Meeting to be held on 3 February 2009, together with explanations of the resolutions to be proposed at the meeting, appear in the notice of meeting accompanying this report. By order of the Board Matthew R Phillips Company Secretary 26 November

48 DIRECTORS REPORT: GOVERNANCE Corporate Governance Report The Board of Directors (the Board) remains committed to maintaining high standards of corporate governance, which it sees as a cornerstone in managing the business affairs of the Group and a fundamental part of discharging its stewardship responsibilities. Applicable Corporate Governance Provisions and Compliance Throughout the year under review and up to the date of approval of the Annual Report, the Group has complied with the governance rules and best practice provisions applying to UK listed companies as contained in section 1 of the Combined Code on Corporate Governance (the Code) which was introduced in 1998 and further revised during The Code is publicly available on the Financial Reporting Council s website During the financial year Imperial Tobacco Group PLC also had securities registered with the US Securities and Exchange Commission (the SEC) and complied with the appropriate provisions of the Sarbanes-Oxley Act of 2002 (SOXA) until delisting on 12 September The Board recognises that it is accountable to shareholders for the Group s standard of governance and this report, together with the Directors Remuneration Report, seeks to demonstrate how the principles of good governance, advocated by the Code, have been and continue to be applied in practice within the Group. During the course of the financial year the Board and its Audit Committee have continued to keep under review the Group s entire system of internal control, encompassing both financial and operational controls, as well as compliance and risk management. Based on these reviews the Board is satisfied that an appropriate internal control framework is in place across the Group. Throughout the Group, formal procedures, including well established and embedded internal controls, have been and continue to be maintained. Such procedures, together with continued regular formal reporting to the Audit Committee, have ensured the maintenance of a strong procedural framework for the ongoing identification, evaluation and management of the significant areas of risk to achievement of the Group s strategic objectives. Any weaknesses identified have a plan of remedial action, progress against which is regularly reported to the Audit Committee. A Risk Co-ordination Committee was established during the year in order to further enhance the Group s top down risk management activities. During the course of the year business reviews of the Group s operations have been performed as part of the Group Compliance function s programme of activity. This has highlighted a small number of controls requiring minor remediation work which is currently being completed. From reports to the Group Compliance function by the business operations of any potential instances of fraud or accounting irregularity that may have occurred during the financial year, the Audit Committee concluded that neither individually nor collectively did they have a material impact on the results or performance of the Group for the financial year. Consequences of Delisting from the NYSE and De-registration from the SEC Subsequent to the delisting of the Group s American Depositary Shares (ADSs) from the NYSE on 12 September 2008 it had retained a level 1 American Depositary Receipt (ADR) program. Imperial Tobacco Group s ADSs are now listed on the International Premier Tier of OTCQX under the ticker symbol ITYBY. While registered under the US Securities Exchange Act 1934, Imperial Tobacco was subject to the provisions of SOXA and management was responsible for establishing and maintaining an adequate system of internal control over financial reporting. Management used the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework to evaluate the effectiveness of that system. Following deregistration, Imperial Tobacco is no longer required to comply with SOXA, however, management recognises the benefit of the system of financial controls introduced to meet its requirements and has therefore decided to maintain the key elements of the system. Update on Ongoing Enquiries German Investigations Certain investigations were initiated by German authorities in January 2003 into alleged foreign trading and related violations by a number of people, including Reemtsma employees, during a period prior to its acquisition by Imperial Tobacco Group in May In the course of 2005, parts of the investigations into certain of the individuals were terminated on terms agreed by the individuals with the authorities and settlement was made of any duty payable as a result of certain of the activities being investigated at no cost to the Imperial Tobacco Group. In 2006 and 2007, investigations against some of the other individuals were terminated for lack of evidence. In September 2006, charges relating to smuggling were brought in connection with one of the investigations against 18 individuals, one of whom is a former Reemtsma employee. In November 2006, in connection with a separate investigation, charges relating to violations of the German foreign trade act were brought against four other former Reemtsma employees. In October 2008, the German court agreed to open the trial in relation to the charges of smuggling, but no hearing date has been set. In connection with the charges relating to violations of the German foreign trade act, the authorities have applied for financial penalties to be imposed on Reemtsma. Such penalties could be imposed if the former employees who have been charged are ultimately found to have committed offences. In those circumstances, the Imperial Tobacco Group would seek recovery of any losses under arrangements made on the acquisition of the business. A Board Committee established in 2003 remains in place to monitor the progress of the investigations and the Group s responses on behalf of the Board. The German authorities investigations are based on alleged activities prior to the Group s acquisition of Reemtsma and the Committee remains satisfied that, since the acquisition, the Group has not been involved in any activities of a nature similar to those alleged by the German authorities. Office of Fair Trading As previously reported, information was supplied by Imperial Tobacco Group and a number of other companies to the UK Office of Fair Trading (OFT) in October 2003 in relation to an OFT investigation into the operation of the UK tobacco supply chain. Further information was supplied in April On 24 April 2008 the OFT issued a Statement of Objections (SO) alleging that certain tobacco manufacturers and retailers had engaged in unlawful practices in relation to retail prices for tobacco products in the UK. The SO sets out the OFT s allegations against tobacco manufacturers, Imperial Tobacco Group and Gallaher, and 44 Imperial Tobacco Group PLC 2008

49 11 retailers Asda, the Co-operative Group, First Quench, Morrisons, Safeway, Sainsbury, Shell, Somerfield, T&S Stores, Tesco and TM Retail. The OFT alleges that these tobacco manufacturers and retailers variously engaged in one or more unlawful practices in relation to retail prices for some or all of a number of tobacco products in breach of Chapter I of the Competition Act 1998 (which prohibits anti-competitive agreements and concerted practices that have the object or effect of preventing, restricting or distorting competition in the UK or a part of it and which may affect trade in the UK or a part of it). The alleged practices comprised: a) arrangements between each manufacturer and each retailer that restricted the ability of each of these retailers to determine its selling prices independently, by linking the retail price of a manufacturer s brand to the retail price of a competing brand of another manufacturer. The alleged infringements span different periods for different parties between 2000 and 2003; and b) in the case of Imperial Tobacco Group, Gallaher, Asda, Sainsbury, Shell, Somerfield and Tesco, the indirect exchange of proposed future retail prices between competitors. The alleged infringements span different periods for different parties between 2001 and Following the issue of the SO, the OFT invited recipients of the SO to enter into without prejudice settlement discussions to reach early resolution agreements with the OFT in which they were invited to admit liability for the conduct set out in the SO in return for a reduction in the level of fine that the OFT indicated it would otherwise impose. On 11 July 2008 the OFT announced that six of the parties subject to the SO had reached early resolution agreements with the OFT, in which they admitted liability in respect of all of the infringements alleged against them in the SO and agreed to pay individual penalties which amounted to a combined maximum of million before discounts ( million if all leniency and early resolution discounts are given). Those companies are Asda, First Quench, Gallaher, One Stop Stores (formerly named T&S Stores), Somerfield and TM Retail. The parties which have not settled, and are therefore contesting the OFT s allegations other than Imperial Tobacco Group, are the Co-operative Group, Morrisons (including Safeway), Shell and Tesco. According to the OFT s press release of 11 July 2008, Sainsbury has been granted leniency and will, therefore, receive complete immunity from financial penalty if it continues to co-operate fully with the OFT. Imperial Tobacco Group s detailed written response to the SO was submitted to the OFT on 15 August An oral hearing has been scheduled for 3 December 2008 for Imperial Tobacco s representatives to make submissions to the OFT in defence of the allegations. No timetable for the remainder of the OFT s enquiry has been published. In light of the responses it receives to the SO, the OFT may decide to close the investigation, present additional evidence by issuing a supplemental SO, or proceed to an infringement decision. If the OFT proceeds to an infringement decision, it may impose a fine. The amount of the fine is calculated by reference to the turnover of the infringing company. The rules regarding the maximum amount of such a penalty changed on 1 May Before that date, the maximum amount of a fine was 10 per cent of a company s UK turnover for up to three years. In the three years to 30 September 2003 Imperial Tobacco Group s aggregate net UK turnover was 2,215 million. The applicable turnover on which the amount of a fine is based expressly excludes VAT and other taxes directly related to turnover, which Imperial Tobacco Group has been advised would also exclude duty. In addition, if the OFT were to make an infringement finding, it could issue orders prohibiting that activity in the future, whilst the infringing company might face the prospect of damages actions from third parties. If the OFT were to make an infringement decision, Imperial Tobacco Group would be able to appeal the OFT s decision to the Competition Appeal Tribunal, and ultimately, on a point of law to the Court of Appeal. Board and Board Committee Board Structure The Board of Directors, which met nine times during the year (with two of the meetings having a duration of two days), currently comprises a Non-Executive Chairman, eight independent Non-Executive Directors, one Non-Executive Director not classified as independent for the purposes of the Code when determining the composition of the Board or its Committees, and four Executive Directors. There is a clear separation of the roles of the Chairman, Mr I J G Napier, and the Chief Executive, Mr G Davis, to ensure an appropriate balance of power and authority. The Chairman is responsible for the leadership of the whole Board, with the Chief Executive, in conjunction with the Chief Executive s Committee, responsible for managing the Group and implementing the strategy and policies which have been set by the Board. Mr J-D Comolli is Deputy Chairman and Dr P H Jungels is the recognised senior independent Non-Executive Director to whom the Company would encourage shareholders to raise any concerns they may have. Following the annual Board evaluation and consideration of all other relevant factors contained in the Code and the New York Stock Exchange (NYSE) Corporate Governance rules, the Board concluded at its meeting in September 2008 that all Non-Executive Directors continue to contribute effectively and constructively to Board debate, to challenge and question management objectively and robustly and at all times to have the best interests of the Group in mind and that, taking account of these factors, together with the other relevant factors contained in the Code and the NYSE Corporate Governance rules, with the exception of Mr J-D Comolli, the other nine Non- Executive Directors (including the Chairman) remain independent for the purposes of the NYSE Corporate Governance rules and the other eight Non-Executive Directors (excluding the Chairman as required by the Code) remain independent for the purposes of the Code. The Board does not classify Mr J-D Comolli, for the purposes of the Combined Code and the NYSE Corporate Governance rules, as an independent director, due to his ongoing Chairmanships of certain subsidiaries within the Group and his provision of consultancy services to the Group. The Board has satisfied itself that there is no compromise to the independence of those Directors who have appointments on boards of, or relationships with, companies outside the Group. The Board requires Directors to declare all appointments and other situations which could result in any possible conflict of interest and has adopted appropriate processes to manage and if appropriate approve any such conflicts. In this regard, and to underpin his independence, the Company has entered into an agreement with Mr B Setrakian, a former Non-Executive Director of and legal adviser to Altadis, to minimise the risk of any conflict of interest between, inter alia, the law firm Dewey & LeBoeuf LLP, of which he is a partner, and the Company. 45

50 DIRECTORS REPORT: GOVERNANCE Corporate Governance Report continued The Directors biographies, appearing on pages 38 and 39, demonstrate a detailed knowledge of the tobacco industry and the wider Fast Moving Consumer Goods sector, together with a range of business and financial experience which is vital to the management of an expanding international company. The biographies also include details of any other major directorships. Board Changes During the year the Nominations Committee again reviewed the composition and balance of the Board. This review took into account not only the overall balance of skills, knowledge and experience of Board members but also of the wider provisions of the Code and the results of the annual evaluation of the performance of the Board, its Committees and individual Directors. As announced last year, Mr J-D Comolli was invited to become Non-Executive Deputy Chairman and to provide certain consultancy services to the Group. Following approval by the Board Mr J-D Comolli was appointed on 15 July In addition the Altadis board was requested to submit two of its non-executive directors to be invited to join the Board as non-executive directors. After due consideration of the appropriate candidates and the approval of the Nominations Committee and the Board, Messrs B F Bich and B Setrakian joined the Board as Non-Executive Directors on 25 April 2008 and 25 June 2008 respectively. As previously announced, Messrs D Cresswell and A G L Alexander retired on 31 December 2007 and 29 January 2008 respectively. In addition to extensive Investor Relations roadshows, Mr I J G Napier met with a number of key shareholders during the year. The opportunity also exists for major shareholders to meet with new and existing Directors. In addition, Directors made themselves available to meet shareholders after the formal business of the Annual General Meeting (AGM) had been completed. Structure of the Board and Board Committees Board Audit Committee Remuneration Committee Nominations Committee Executive Directors G Davis Member R Dyrbus Member G L Blashill Member A J Cooper Member Non-Executive Directors I J G Napier Chairman Member Chairman B F Bich Member Member K M Burnett Member Member J-D Comolli Deputy Chairman Member M H C Herlihy Member Member Member Member P H Jungels Senior Independent Director Member Member Chairman Member C F Knott Member Member Member Member S E Murray Member Member Member Member B Setrakian Member Member M D Williamson Member Chairman Member Member Performance Evaluation During the year, in accordance with the Code and with the assistance of an external consultant, the Board formally reviewed and evaluated its own performance together with the performance of its Committees and individual Directors. The reviews were conducted by way of detailed questionnaires, completed by the Directors, followed by one to one interviews between each Director and the external consultant. Feedback on individual Directors was discussed with the Chairman and this in turn was followed by private feedback meetings between the Chairman and each of the Directors. A report on the performance of the Board as a whole and of the Board Committees was made to the Board at its meetings in September and November Following a private feedback meeting with the external consultant, Dr P H Jungels, the senior independent Non- Executive Director, met with the Non-Executive Directors as a group, without the Chairman present, to consider the performance of the Chairman. After also taking account of the views of the Executive Directors and the results of the Chairman s formal performance evaluation, Dr P H Jungels held a private feedback meeting with the Chairman. The Chairman held meetings exclusively with the Non-Executive Directors to consider, amongst other things, succession issues and the performance of the Executive Directors in the discharge of their duties. Following these reviews the Board and its Committees are satisfied that they are operating and performing effectively. No fundamental issues or training needs were identified and the Board is also satisfied that each of the current Directors has sufficient time, knowledge and commitment to contribute effectively to the Board and its Committees. Accordingly, the Board recommends that Mr G L Blashill and Dr P H Jungels should stand for re-election and that Messrs B F Bich, J-D Comolli and B Setrakian should stand for election at the 2009 AGM. The key positive theme which emerged from this year s evaluation was that, notwithstanding the Altadis acquisition, the increased size of the Board and refreshment of Board membership, there remains a high degree of Board unity with all Board members working well together. 46 Imperial Tobacco Group PLC 2008

51 The key themes for development included the need to ensure a continued high degree of Board unity and effectiveness during the ongoing Board succession and refreshment process. Commencing with the Remuneration Committee s September 2008 meeting, a standing item has been added to the Committee s agenda allowing the members of the Committee to meet without the Company Chairman, any Executive Director or other manager being present. The Board plans to continue to conduct evaluations on an annual basis and may employ alternative formats and approaches in future years. Board Operations The Board is the principal decision making forum of the Group and manages overall control of the Group s affairs by the schedule of matters reserved for its decision contained in the Group s Corporate Manual. These include, inter-alia, responsibility for the Group s commercial strategy, the approval of financial statements and corporate plans, the overall corporate governance framework, acquisitions and disposals, treasury, tax and risk management policies and appointment and removal of Directors and the Company Secretary. The Company Secretary is responsible for advising the Board, through the Chairman, on all governance matters and for ensuring Board procedures are followed and applicable rules and regulations complied with. All Directors are equally accountable in law for the proper stewardship of the Group s affairs, with the Non-Executive Directors having a particular responsibility for ensuring that strategies proposed for the development of the business, resources and standards of conduct are critically reviewed using their independent judgement and experience. This ensures that the Board acts in the best long-term interests of the Company s members, takes account of the wider community of interests represented by employees, customers and suppliers, and that environmental, community, ethical and reputational issues are fully integrated into the Group s decision making and risk assessment processes. During the year matters considered by the Board included the acquisition of Altadis, together with the follow-on bid resulting in the subsequent acquisition of all Logista shares not already owned by Altadis, review of Group funding arrangements, including the one for two Rights Issue, the divestment of Aldeasa, the Board changes detailed above, review of the strategy and operating results of the business, approval of annual and mediumterm plans and brand divestments which were a condition of the European Commission s approval of the Group s acquisition of Altadis and the integration of Altadis. Actual results of the Group were reviewed at each Board meeting, with monthly reports, including detailed commentary and analysis, being provided in the intervening periods. This ensured that Board members were supplied with information on the progress of the business in a timely manner and that at Board meetings the Directors were properly briefed on issues arising. All Board members receive reports from the chairmen of all Board Committees and receive copies of each Committee s minutes. The Non-Executive Directors also play a leading role in corporate accountability and governance through their membership of the Remuneration Committee, the Nominations Committee and the Audit Committee. The membership and remit of each Committee are considered below, together with a record of each Director s attendance at Board and Board Committee meetings during the year. As part of the Group s policy of annual review, the terms of reference for each of these Committees were reviewed, and updated where necessary, during the year and are published on the Imperial Tobacco Group website, They are also available from the Company Secretary. The Group has procedures in place to allow Directors to seek both independent professional advice, at the Group s expense, and the advice and services of the Company Secretary in order to fulfil their duties. The Group maintains appropriate insurance cover in respect of Directors and Officers liabilities. The Company has entered into qualifying third party indemnity arrangements for the benefit of all its Directors in a form and scope which comply with the requirements of the Companies Act 2006 and the transitional arrangements in respect of the Companies Act Chief Executive s Committee Over the financial year, the Chief Executive s Committee, comprising the Executive Directors, the Manufacturing Director, the Chief Operating Officer Cigar, the Group Human Resources Director and the Company Secretary, met 11 times to ensure appropriate control and management of day-to-day business matters. Within the framework of the Chief Executive s Committee, the Board delegates day-to-day and business control matters to the Chief Executive and the Chief Executive s Committee, who are responsible for implementing Group policy and monitoring the detailed performance of all aspects of the business. They have full power to act, subject to the reserved powers and sanctioning limits laid down by the Board and the Group s policy guidelines. Mr G Aldridge joined the Chief Executive s Committee as Manufacturing Director with effect from 1 January Mr F Domínguez joined the Chief Executive s Committee as Chief Operating Officer Cigar Business Unit with effect from 11 June Between formal Board and Board Committee meetings, the Chairman and chairmen of the Board Committees communicate regularly with the Chief Executive and other members of the Chief Executive s Committee. 47

52 DIRECTORS REPORT: GOVERNANCE Corporate Governance Report continued Meetings of the Board, Board Committees and Shareholders Board Audit Remuneration Committee Committee Nominations Committee Annual General Meeting Total number of meetings in Number of meetings attended in 2008 Executive Directors Mr G Davis 9/9 1/1 Mr R Dyrbus 9/9 1/1 Mr G L Blashill 9/9 1/1 Mrs A J Cooper 9/9 1/1 Mr D Cresswell 1 1/1 Non-Executive Directors Mr I J G Napier 9/9 6/6 2/2 1/1 Mr A G L Alexander 2 4/4 1/1 Mr B F Bich 3 3/4 1/1 Dr K M Burnett 9/9 2/2 1/1 Mr J-D Comolli 3 1/1 Mr M H C Herlihy 9/9 4/4 6/6 2/2 1/1 Dr P H Jungels 9/9 3/4 6/6 1/2 1/1 Mr C F Knott 9/9 3/4 6/6 2/2 1/1 Ms S E Murray 9/9 3/4 6/6 2/2 1/1 Mr B Setrakian 3 2/2 Mr M D Williamson 9/9 4/4 5/6 2/2 1/1 1 Mr D Cresswell retired from the Board on 31 December Mr A G L Alexander retired from the Board on 29 January Messrs B F Bich, B Setrakian and J-D Comolli were appointed on 25 April 2008, 25 June 2008 and 15 July 2008 respectively. Prior to his appointment Mr Bich informed the Company that he would be unable to attend one Board meeting due to a prior engagement. The maximum number of meetings for each individual Director is the number which they were eligible to attend. Remuneration Committee The membership and responsibilities of the Remuneration Committee are contained in the Directors Remuneration Report which appears on page 55. The Committee s terms of reference are published on the Imperial Tobacco Group website, The Remuneration Report, which has been approved by the Remuneration Committee and the Board and signed by the Chairman of the Remuneration Committee, outlines remuneration strategy and policy, details the Committee s activities over the financial year and contains full details of Directors emoluments. The performance of the Committee was evaluated as part of the Board performance evaluation process described above. 48 Imperial Tobacco Group PLC 2008

53 Nominations Committee Report Members Mr I J G Napier (Chairman); Mr A G L Alexander (retired 29 January 2008); Mr B F Bich (appointed 25 April 2008); Dr K M Burnett; Mr J-D Comolli (appointed 15 July 2008); Mr M H C Herlihy; Dr P H Jungels; Mr C F Knott; Ms S E Murray; Mr B Setrakian (appointed 25 June 2008); Mr M D Williamson; and Mr M R Phillips, Company Secretary, acts as Secretary to the Committee. Responsibilities The responsibilities of the Committee include:- > the evaluation of the balance of skills, knowledge and experience on the Board; > the development of role specifications; > the formulation of succession plans; and > the making of recommendations to the Board with regard to the appointment of Directors. Induction and Training Detailed training and briefing is provided to all Directors on appointment to the Board, taking into account their individual qualifications and experience. Messrs B F Bich and J-D Comolli s induction programme included meetings with the Group s advisers and key Group personnel representing major functions, and site visits. These meetings also included briefings on relevant corporate responsibility and corporate affairs issues, legal matters, product stewardship, environmental management, social impact, scientific and regulatory affairs and commercial risk management. Mr B Setrakian completed a similar induction process subsequent to the end of the financial year. Ongoing training is made available to all Directors to meet their individual needs. Regular briefings are also provided to Directors on relevant issues such as legislation and regulation changes and corporate governance developments. During the year the Group s external lawyers briefed the Board on topical items of interest, including the implications of the Companies Act The Audit and Remuneration Committees also received briefings from PricewaterhouseCoopers and Hewitts Limited respectively to ensure they remain up to date with current regulations and developments. Membership The Nominations Committee comprises all the Non-Executive Directors and meets on an as required basis. During the year the Committee met twice. Overview The Committee s terms of reference are published on the Imperial Tobacco Group website, In the financial year the Committee met its responsibilities by the identification of suitable candidates, who met the relevant skill profile, from the Non-Executive Board Members of Altadis, in fulfilment of a commitment given on acquisition. The Committee also made a number of recommendations to the Board resulting in the appointments as detailed in the Board Changes section above, consideration of succession plans and the annual review of the Committee s terms of reference. Following recommendation by the Nominations Committee, Directors are appointed by the Board. They must, however, submit themselves for election by shareholders at the AGM following their appointment. Thereafter all Directors, in accordance with the Code, are subject to re-election at least every three years. Furthermore, it is the Company s practice that any Non-Executive Director, including the Chairman, having been in post for nine years or more is subject to annual re-election. The performance of each Director is considered before recommending such election or re-election. In order to facilitate succession planning, during the year there were a number of opportunities for Board members to interact with senior management, for example during strategy days, Board meetings and Board dinners. Succession planning was also discussed at Non-Executive Director dinners held during the year. The performance of the Committee was evaluated as part of the Board performance evaluation process described above. 49

54 DIRECTORS REPORT: GOVERNANCE Corporate Governance Report continued Audit Committee Report Members Mr M D Williamson (Chairman); Mr M H C Herlihy; Dr P H Jungels; Mr C F Knott; Ms S E Murray; and Mr M R Phillips, Company Secretary, acts as Secretary to the Committee. Responsibilities The responsibilities of the Committee include:- > review of internal control and risk assessment; > oversight of the Group Compliance function; > monitoring of external audit; > review of financial statements; and > oversight of other matters including the requirements of the UK listing authority and the Group s Public Interest Disclosure (Whistleblowing) Policy. Membership The Audit Committee, which has determined that all its members are independent Non-Executive Directors, met four times during the year and members attendance is set out in the table on page 48. Messrs M D Williamson and C F Knott are qualified accountants and, therefore, are appropriately qualified to discharge the responsibilities that Audit Committee membership entails and are regarded as financial experts for the purposes of both the Code and section 407 of the Sarbanes-Oxley Act (with which the Company had to comply until deregistration from the Securities & Exchange Commission on 12 September 2008). The remaining members of the Committee supply a supporting mix of skills and backgrounds. Mr M R Phillips, Company Secretary, acts as Secretary to the Committee. Overview The Committee s terms of reference cover the matters recommended by the Code and are published on the Imperial Tobacco Group website, During the year and up to the date of approval of the Annual Report, the Committee worked with a structured agenda of matters focused to coincide with key events of the annual financial reporting cycle, together with standing items that the Committee is required to consider at each meeting. During the year the Committee met its responsibilities by:- > monitoring internal control throughout the Group; > approving the Group s accounting policies, including changes to segmental reporting, impairment testing and provisions; > consideration of the accounting treatment of the ongoing enquiries detailed above on pages 44 and 45; > reviewing the interim and annual financial statements, together with the USA filing on Form 20-F in respect of the 2006/07 Financial Year, prior to submission to the Board; > reviewing the scope of the external audit plan and the internal Group Compliance work plan; > consideration of any related party matters; > review of Auditor performance and independence, including rotation of Senior Audit Partner; > consideration of and recommendations to the Board regarding the reappointment of the Auditors; > review of audit fees and of non-audit fees paid to the Auditors and other accountancy firms; > review of the Going Concern statement prior to consideration by the Board; > oversight and monitoring of the Group s Public Interest Disclosure (Whistleblowing) Policy; > the financial integration of acquired businesses; > review of Group Compliance s performance; and > review of the Group s control and corporate governance environments including risk management systems. The performance of the Committee was evaluated as part of the Board performance evaluation process described above. During the year the Head of Group Compliance provided the Committee with detailed reports to facilitate the regular monitoring and review of its activities and effectiveness including those in respect of the programmes of activity in place to enable the Group to meet the requirements of both the Code and section 404 of the Sarbanes-Oxley Act (up to 12 September 2008). The Committee undertook its annual review of the scope and content of the risk assessment and compliance programme implemented by the Group Compliance function and confirmed its approval. The Committee continually monitors and critically reviews the authority, effectiveness and level of resource allocated to the activity. During the year a Risk Co-ordination Committee was established in order to further enhance the Group s top down risk management activity. The Risk Co-ordination Committee will provide regular reports to the Audit Committee. The Finance Director, the Group Financial Controller, the Head of Group Compliance, the Deputy Company Secretary and other financial management were invited to attend each meeting of the Committee. A standing item on each agenda allowed for the Head of Group Compliance to meet formally with the Committee, without any Executive Director or other manager being present, in line with the Code s requirements. In addition, the Group s Auditors attended each meeting of the Committee during the year and, as a standing item on each agenda, had the opportunity to meet with the Committee members without the presence of any Executive Director or other manager, providing a direct line of communication between the Auditors and Non-Executive Directors. Auditor Independence Policy The Group regularly reviews its Auditor Independence Policy, which provides clear definitions of services that the external Auditors can and cannot provide such that their independence and objectivity are not impaired. The policy also establishes a formal authorisation process, including the tendering and pre-approval by the Audit Committee for allowable non-audit work that they may perform, establishes guidelines for the recruitment of employees or former employees of the external Auditors and for the recruitment of the Group s employees by the external Auditors. This policy is published on the Group s website, 50 Imperial Tobacco Group PLC 2008

55 The Audit Committee also carried out bi-annual reviews of the remuneration received by the Auditors for audit services, audit-related services and non-audit work with the aim of seeking to balance objectivity, value for money and compliance with this policy. The outcome of these reviews was not only that performance of the relevant non-audit work by the Auditors was the most cost-effective way of conducting the Group s business but also that no conflict of interest existed between such audit and non-audit work. The fees for such non-audit work within the financial year were principally related to acting as reporting accountant in connection with our offer for Altadis and the associated Rights Issue and tax advisory work. Such fees are shown on page 87. Following a review during the year by the Audit Committee of the scope, efficiency and effectiveness of the audits performed by the Auditors it was agreed that the Group continues to receive an efficient, effective and independent audit service. Internal Control The Board acknowledges responsibility for the Group s system of internal control and for reviewing its effectiveness. The Audit Committee, on behalf of the Board, reviewed the effectiveness of the system in accordance with the guidance set out in the Code from information and regular reports provided by management, the internally independent Group Compliance Function and external Auditors. However, given the size and complexity of the Group s operations, such a system can provide only reasonable and not absolute assurance of meeting internal control objectives by managing rather than eliminating risk and can only provide reasonable and not absolute assurance against material misstatement or loss. The Board, either directly or through the Audit Committee, regularly reviewed the effectiveness of the key procedures which have been established to provide internal control. It confirms that an ongoing process for identifying, evaluating and managing the Group s significant risks operated throughout the year and up to the date of the approval of the Annual Report. The Group has established control processes and procedures to ensure compliance with the best practice UK governance provisions as advocated by the Turnbull Guidance. The Group considers its approach, methodology and actions in support of maintaining high standards of corporate governance satisfy the requirements of the Turnbull Guidance. The following key features have operated to provide reassurance of both the reliability of information and the safeguarding of assets: Risk Assessment: > The Group has clearly set out its strategic objectives as part of its medium-term planning process. These objectives are incorporated as part of the annual planning cycle; > A detailed assessment of strategic risks was undertaken by the Executive Directors as part of the medium-term planning and annual and monthly forecasting reporting cycles; > All areas of the business undertook bottom-up, risk-profiling exercises to formally review their principal areas of risk so that all major risks were reviewed at all levels across the Group. This formal system is based on the annual submission of risk assessment summaries from each of the business operations identifying their major areas of business risk, together with the controls embedded in the business processes to mitigate such risks. This review is ongoing throughout all business operations of the Group to ensure that there continues to be clear and consistent procedures for monitoring, updating and implementing appropriate controls to minimise the risk exposure identified; > The Audit Committee has delegated responsibility for considering Group-wide operational, financial and compliance risks on a regular basis. The Group Compliance Function formally reported at each Audit Committee meeting the outcome of its ongoing activities, including its programme of compliance reviews and any, more general, business reviews. These reports have supported the Audit Committee and the Board in assessing the effectiveness of internal controls within the business operations. In this way, the Audit Committee satisfied itself that the Group s exposure to major business risks is minimised such that the levels of retained risk are acceptable to the Group; > A Risk Co-ordination Committee has also been established to supplement the bottom-up risk profiling exercises described above with a top-down approach; and > A summary of the principal risks facing the business is included on pages 22 to 24. Control Environment and Control Activities: > The Group is organised on a functional basis with manufacturing, cigar, logistics, sales and marketing and central support functions each having their own management and control structures which satisfy the Group s controls, accounting policies and regulatory responsibilities; > The Board continually reviews the Group s organisational structure to ensure that clearly defined lines of responsibility with appropriate delegation of authority and segregation of duties exist, with personnel of the necessary calibre in place to fulfil their roles. Such delegated authority ensures that decisions, significant either because of their value or impact on other parts of the Group, are taken at an appropriate level; > The Board has formally adopted, and annually reviews, the schedule of matters of a strategic, financial, operational or compliance nature, which are required to be brought to it for decision; > The Group has an established framework of policies and procedures laid down by the Board which personnel are expected to comply with. These cover key issues such as acceptable business practices, authorisation levels, segregation of duties, ethical compliance matters and legislation, physical and data security as well as regulatory, governance and health, safety and environmental issues. This framework of policies and procedures, which has been developed and issued, with consistent communication throughout the Group, is reviewed and updated on a periodic basis to ensure it continues to provide the requisite control guidance and remains pertinent to the Group s business activities; > A cross-functional project team has reviewed the Group s framework of policies and procedures with respect to their usefulness to the business and their relationship to each other. A new corporate documents intranet site has been created in order to provide improved clarity on the purpose of the documents, how they are connected, how they are maintained and how they are to be used by the business; > A major focus during the year has been the rollout of our control environment into Altadis. This included a briefing to senior management during the first week following acquisition, the rollout of interim control measures, business and budgetary reviews within the first month, establishment of Imperial Tobacco s reporting processes, changes to the boards of Altadis SA and its subsidiaries and post acquisition due diligence. Imperial Tobacco s corporate governance processes, including risk assessments and control certifications, have also been rolled out across the Altadis business; 51

56 DIRECTORS REPORT: GOVERNANCE Corporate Governance Report continued > A formal policy and arrangements for dealing in confidence with issues of genuine and significant concern raised by employees or others relating to perceived malpractice, improper business practices, management impropriety or other similar matters, whether financial or non-financial (commonly referred to as Whistleblowing arrangements) operates throughout the Group; > The Group has an established and consistent methodology for ranking the level of risk from each of its business operations and identifying significant risk issues associated therewith. Appropriate strategies have been implemented to deal with each significant risk that has been identified, including not only internal controls but also other external measures such as insurance and dual sourcing of supplies; > There are well-defined procedures for appraisal, approval, control and review of capital and strategic expenditure including acquisitions; > The Group s treasury function operates within a well-defined policy designed to control the Group s financing arrangements and to minimise its exposure to interest rate and foreign exchange risks through treasury instruments; and > The Board reviews annually the Group s Treasury and Tax policies and Occupational, Health, Safety and Environmental matters. Information and communication: > Each area of the business produced detailed financial plans, prior to the start of the financial year, which were reviewed for robustness and realism; and > A comprehensive system of controls, including regular periodic performance reviews for each area of the business, ensured that major variances against plan were promptly and thoroughly investigated. These reviews were conducted at a detailed level within each function and at a high level by the Chief Executive s Committee. The achievement of business objectives, both financial and non-financial, were assessed on a regular basis using a range of key performance indicators. These indicators are periodically reviewed to ensure that they remain relevant and reliable. Monitoring: > A range of procedures is used to review the risk profile and monitor the effective application of internal controls across the Group. These included independent reviews by the Group Compliance Function, together with self-assessment of risks and relevant controls. Furthermore both the senior operational and financial managers of each business and function annually certify that effective systems of internal control, in accordance with the Group s policies and covering all business activities (both financial and non-financial), have been maintained within their area of responsibility; > The Group Compliance Function s responsibilities include reporting to the Audit Committee on the effectiveness of internal control systems, focusing on those areas of greatest perceived risk to the Group. This is now a standing item on the Chief Executive s Committee s agenda; > Follow-up procedures ensure that there is an appropriate response to recommendations for any enhancement to risk controls as identified by the independent reviews of the Group Compliance Function; and > A Risk Co-ordination Committee chaired by the Company Secretary and comprising senior representatives of the Group s functions was established during the year. The remit of this Committee is to ensure relevant risks identified within the Group from a top-down perspective are efficiently co-ordinated and to track mitigation activities by operational management. The Audit Committee confirms it has reviewed and reported to the Board on the system of internal control for the financial year ended 30 September 2008, and up to the date of approval of the Annual Report, in accordance with the requirements of the Code and Turnbull Guidance. Through the procedural and reporting framework for monitoring business risks and controls, as set out above, and review of the Group s financial statements, the Board is satisfied there is sufficient information to enable it to review the effectiveness of the Group s system of internal control. Disclosure Committee: In line with recommendations issued by the US Securities and Exchange Commission and to meet corporate governance best practice in the UK, the Group has a Disclosure Committee comprising appropriate senior executives: > Company Secretary (Chairman); > Head of Group Compliance (Co-ordinator); > Head of Group Legal Affairs; and > Group Financial Controller. The Deputy Company Secretary acts as Secretary to the Committee. The External Auditors, together with other senior management, are invited to attend or to submit matters for the attention of the Committee. The Committee, in accordance with its terms of reference, considered the significance of relevant information identified after due enquiry by its members both prior to each meeting and on an ongoing basis. During the year the Disclosure Committee reviewed all the Group s major financial disclosures including Trading Updates, Interim Management Statements, Half Year Report, Report & Accounts, Form 20-F and documentation in respect of the European Medium Term Note Programme. The Committee reported on its evaluation of such information to the Chief Executive, Finance Director and, as appropriate, the Audit Committee to assist them in their evaluation of material issues for the purposes of any disclosure that may be required. The terms of reference of the Disclosure Committee were reviewed during the year. The Disclosure Committee will continue to operate following the Group s USA delisting and deregistration. Going Concern The Directors are satisfied that the Group and Company has adequate resources to meet its operational needs for the foreseeable future and, accordingly, they continue to adopt the going concern basis in preparing the financial statements. Pension Fund The Group s main pension fund, the Imperial Tobacco Pension Fund, is not controlled by the Board but by Trustees consisting of five nominees from the Company; one member of which is chosen by employees and two by current and deferred pensioners. The Trustees look after the assets of the pension fund, which are held separately from those of the Group and are managed by independent fund managers. The pension fund assets can only be used in accordance with the fund s Rules and for no other purpose. 52 Imperial Tobacco Group PLC 2008

57 Political Donations As in the previous year, no political donations were made to EU political parties, organisations or candidates. However, one acquired business made corporate donations to candidates and political parties in three USA states, as detailed on page 43. These donations were stopped with effect from 30 September New York Stock Exchange Corporate Governance Requirements On 12 September 2008 the Group s voluntary delisting from the New York Stock Exchange (NYSE) became effective. Until that date, as a listed non-usa issuer, the Group was required to comply with some of the NYSE s listing standards relating to the corporate governance practices of listed companies, but was exempt from others. This included an obligation to disclose any significant ways in which the Group s corporate governance practices differed from those followed by USA companies under the NYSE listing standards. During the period of its NYSE listing, the Group believes that it was in compliance in all material respects with the relevant NYSE listing standards. It is, however, the Board that develops, recommends and adopts the corporate governance principles to be applied throughout the Group. In addition, the role of an internal audit department is incorporated within the general remit of the internally independent Group Compliance Function. The Group will continue to provide a high standard of corporate governance, information and disclosure in line with the current UK corporate governance code and regulatory requirements, and will use the progress it has made in achieving compliance with regulations under section 404 of the Sarbanes-Oxley Act as part of its ongoing approach to governance, internal control and reporting. Communication with Shareholders Communication with all shareholders is given a high priority and a number of methods are used to promote greater understanding and dialogue with investment audiences. The Chairman, Chief Executive and Finance Director, together with feedback from external advisers, ensured that the views expressed at meetings with major shareholders were communicated effectively to the Board as a whole such that any issues or concerns were fully understood. At the half year a Half Yearly Report was published, which together with this Annual Report, is available online through the Imperial Tobacco Group s website, together with all announcements, investor presentations and share price information. During the year shareholders were kept informed of the progress of the Group via Interim Management Statements, trading statements and of significant developments through other announcements. These were also made available on other news services and on the Group s website. There was regular dialogue with institutional shareholders and participation in sector conferences, which has been extended to ensure that major shareholders are given the opportunity to meet Non-Executive Directors on appointment and the senior independent Non- Executive Director will, if so requested, attend meetings with major investors. The Group regularly liaises with its major shareholders and their representative bodies on significant issues. The Group also met with Corporate Governance representatives of investors when requested. All shareholders are offered the choice of receiving shareholder documentation, including the Annual Report, and submitting proxy votes either electronically or in paper format, including the ability to abstain if desired. In addition, at the AGM in 2008 individual shareholders received presentations from the Chairman and Chief Executive on the Group s performance and current business activities and were given the opportunity to question the Chairman and the chairmen of the Audit, Remuneration and Nominations Committees and other Directors. In accordance with the Group s practice, the Annual Report and Accounts and Notice of the AGM were sent to shareholders more than 20 working days prior to the date of the meeting. Separate resolutions are proposed on each discrete subject, with all resolutions put to a poll. The Company indicates the level of proxy votes lodged in respect of each resolution proposed during its AGMs, together with the number of votes for, against and withheld for each such resolution. In 2008, voting levels at the AGM represented approximately 77 per cent of the Company s then issued share capital (excluding shares held in Treasury). After the conclusion of the meeting the final results are published through a Regulatory Information Service and on the Company s website. Statement of Directors Responsibilities The Directors are responsible for preparing the Annual Report, the Directors Remuneration Report and the Group and the parent Company financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the Group financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union, and the parent Company financial statements and the Directors Remuneration Report in accordance with applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice). The Group and parent Company financial statements are required by law to give a true and fair view of the state of affairs of the Company and the Group and of the profit or loss of the Group for that period. In preparing those financial statements, the Directors are required to:- > select suitable accounting policies and then apply them consistently; > make judgements and estimates that are reasonable and prudent; > state that the Group financial statements comply with IFRSs as adopted by the European Union, and with regard to the parent Company financial statements that applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and > prepare the Group and parent Company financial statements on the going concern basis unless it is inappropriate to presume that the Group will continue in business, in which case there should be supporting assumptions or qualifications as necessary. The Directors confirm that they have complied with the above requirements in preparing the financial statements. 53

58 DIRECTORS REPORT: GOVERNANCE Corporate Governance Report continued The Directors are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the Company and the Group and to enable them to ensure that the Group financial statements comply with the Companies Act 1985 and Article 4 of the IAS Regulation and the parent Company financial statements and the Directors Remuneration Report comply with the Companies Act They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. The Directors are responsible for the maintenance and integrity of the Company s website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. Disclosure and Transparency Rules The Directors confirm that to the best of their knowledge:- > the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and > the management report includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face. Statement of Auditors Responsibilities Imperial Tobacco Group PLC s registered Auditors, PricewaterhouseCoopers LLP, are responsible for forming an independent opinion on the financial statements of the Group and on the financial statements of the Company as presented by the Directors, on other elements of the Annual Report and Accounts as required by legislation or regulation, and for reporting their opinion to members. Their report is set out on page Imperial Tobacco Group PLC 2008

59 DIRECTORS REPORT: GOVERNANCE Directors Remuneration Report Remuneration Committee Report Members Dr P H Jungels (Chairman); Mr M H C Herlihy; Mr C F Knott; Ms S E Murray; Mr I J G Napier; Mr M D Williamson; and Mr M R Phillips, Company Secretary, acts as Secretary to the Committee. Responsibilities The responsibilities of the Committee include:- > determination of the Remuneration Policy for Executive Directors and members of the Chief Executive s Committee; > recommendations to the Board in respect of Chairman s remuneration; > determination of targets for performance-related pay elements; > policy for Directors pensions and contracts; > oversight of the overall policy for senior management remuneration; > oversight of disclosures in the Remuneration Report; and > oversight of the Group s share incentive plans. This Report has been prepared by the Remuneration Committee in accordance with schedule 7A to the Companies Act 1985 and to meet the relevant requirements of the Listing Rules of the UK Listing Authority. In particular, it describes how the Board has applied the principles of good governance relating to Directors remuneration set out in the Code. The Companies Act 1985 requires the Auditors to report to the Company s shareholders on the audited information within this Report and to state whether, in their opinion; those parts of the Report have been prepared in accordance with the Companies Act The Auditors opinion is set out on page 72 and those aspects of this Report which have been subject to audit have been clearly marked. The Remuneration Committee, which met six times during the year and operates under clear written terms of reference (available on the Company s website confirms formally that throughout the year it has been in compliance with the governance rules and best practice provisions relating to remuneration as set out in section 1 of the Code. Following the Remuneration Committee s recommendation, commencing with the Committee s September 2008 meeting, a standing item has been added to the Committee s agenda allowing the members of the Committee to meet without the Company Chairman, any Executive Director or other manager being present. Membership The Remuneration Committee comprises five independent Non-Executive Directors together with the Company Chairman, Mr I J G Napier (who is excluded from any matter concerning his own remuneration and/or conditions of service), who have no personal financial interest, other than as shareholders, in the matters to be decided. Mr G Davis (Chief Executive) and Mr R Dyrbus (Finance Director) are invited to attend to respond to questions raised by the Committee. Mr M R Phillips (Company Secretary) also attends meetings as secretary to the Committee. They are, however, all specifically excluded from any matter concerning the details of their own remuneration. Advisers to the Remuneration Committee The Committee sets the remuneration package for each Executive Director and member of the Chief Executive s Committee after taking advice principally from external sources, including remuneration consultants Hewitts Limited and Towers Perrin, both of whom are engaged by the Committee as required. Hewitts Limited also reviews the Group s remuneration principles and practices against corporate governance best practice. Neither provides any other services for the Group. Executive remuneration data provided by Towers Perrin and Boardex have also been used to assist in benchmarking processes ensuring the consistent application of the executive remuneration policy. Mrs K A Turner (Group Human Resources Director) and the Group Compensation and Benefits Manager also provide internal support and advice to the Committee. Solicitors Allen & Overy LLP have been retained by the Company to provide legal advice in respect of the Group s share plans and to provide services to the Committee as and when required. The firm also provides other legal services to the Group as a whole. The Company has appointed Alithos Limited to undertake Total Shareholder Return (TSR) calculations and provide advice on all TSR related matters, including advice in respect of the bespoke comparator group. Alithos Limited provides no other services for the Group. PricewaterhouseCoopers LLP, the Group s Auditors, perform agreed upon procedures on Earnings Per Share (EPS) calculations used in the Group s share plans prior to awards vesting. Overview The Board is ultimately responsible for the framework and cost of executive remuneration but has delegated to the Remuneration Committee, within its terms of reference, responsibility for certain activities. In discharging its responsibilities the most significant issues addressed by the Committee during the year were: > annual review of Executive Directors and Chief Executive s Committee members remuneration; > review of the standard Chief Executive s Committee service contract; > review of the executive bonus arrangements including determination of bonus performance criteria, and review of performance against the selected criteria prior to bonus payment, while ensuring the criteria remain appropriate following the Altadis acquisition; > approving adjustment to outstanding share plan awards to reflect the Rights Issue; > approval of minor amendments to share plan rules; > extension of share plans to acquired companies; > annual review of the operation, performance conditions, vesting schedules, comparator groups and grant levels of awards under the Group s share plans, to ensure that they remain appropriate in light of the Group s current performance and prospects and aligned with the strategy and objectives of the Group and the Group s overall remuneration strategy; and > annual review of the Committee Terms of Reference. 55

60 DIRECTORS REPORT: GOVERNANCE Directors Remuneration Report continued The Committee s approach is fully consistent with the Group s overall remuneration strategy and philosophy that all employees should be competitively rewarded to attract and retain their valued skills in the business, as well as supporting corporate strategy, by directly aligning executive management reward with the Group s strategic business goals. Remuneration Strategy Imperial Tobacco Group PLC operates in a highly competitive, international environment. For the Group to continue to compete successfully it is essential that the level of remuneration and benefits offered achieves the objectives of attracting, developing, retaining and motivating the necessary high quality pool of talented employees at all levels across the Group while ensuring that there is a clear link between reward and performance. The Group, therefore, sets out to provide competitive remuneration to all its employees, appropriate to the business environment in the countries in which it operates. The Remuneration Committee oversees the remuneration policy for all employees. The Group s remuneration arrangements not only align with the Group s fundamental values of fairness, competitiveness and equity but also support the Group s corporate strategy. The Group continues to relocate employees internationally to facilitate their development, and thus enhance the Company s pool of talent, and to achieve the optimum balance of experience within the Group. A cohesive reward structure across the Group is critical in ensuring that all employees can associate with, and strive for, the Group s strategic goals. During the year this structure was consistently applied and communicated to ensure each element of the package is understood and the links to corporate performance recognised. To assist in this communication senior employees were issued with total reward statements. The Group strives to align the interests of shareholders and employees at all levels by giving employees the opportunity to build a shareholding in Imperial Tobacco Group PLC. The majority of employees of the Company and its subsidiaries have been offered participation in one or more equity-based plans, with in excess of 32 per cent of eligible employees participating in one or more of those plans. To ensure the interests of management are aligned with those of shareholders, Executive Directors and senior management are required to meet minimum shareholding guidelines. Executive Remuneration Policy The Remuneration Committee determines the remuneration package for Executive Directors and members of the Chief Executive s Committee. The package is designed to attract and retain high quality executives, induce loyalty and motivate them to achieve a high level of corporate performance in line with the best interests of shareholders, while not being excessive. Notwithstanding the Company s continued outperformance of the FTSE 100 as shown in the graph on page 64 the executive remuneration policy continues to be set to provide base salary at around the median level of the comparator group, as set out below, while providing the Executive Directors and Chief Executive s Committee members with the capacity to earn upper quartile total compensation on achievement of superior business performance. The executive remuneration policy combines short-term and longterm rewards focusing on, and significantly weighted towards, performance-related elements that take into account individual, functional and corporate performance. The main components are base salary, annual cash bonus, share matching scheme (SMS), long term incentive plan (LTIP) and pension benefits. The Remuneration Committee has the discretion to consider corporate performance of environmental, social and governance issues when setting remuneration for the Executive Directors. 56 Imperial Tobacco Group PLC 2008

61 Percentage of Total Remuneration for the financial year to 30 September 2008 Mr G Davis Mr R Dyrbus Mr G L Blashill Salary Bonus Pension Salary Supplement Benefits SMS LTIP Mrs A J Cooper From the financial year ended September 2004, following a comprehensive remuneration review carried out during that year, more stringent performance criteria have been and continue to be applied to the performance-related elements, as detailed in the annual cash bonus and LTIP sections below and on pages 58 and 61 to 64, both of which form part of this policy statement. In September 2008, the Remuneration Committee reviewed the executive remuneration policy including award policies, performance criteria, relevant comparator groups and vesting schedules. Following the review of the bonus scheme detailed below the Committee is satisfied that these remain appropriate and support the strategy and objectives of the Group, including the creation of shareholder value. It was, however, agreed that the constituents of the bespoke comparator group for the third element of the LTIP described below should be reviewed following the demerger of Altria and the acquisition of Scottish & Newcastle PLC by Heineken N.V. Executive Directors Remuneration Package Element Objective Award level Performance criteria Base salary Attract and retain high performing Median of FTSE 50 excluding N/A individuals reflecting market value companies in the Financial and of role and executive s skills Pharmaceutical sectors with and experience. reference to the FTSE 30 excluding companies in the Financial and Pharmaceutical sectors. Annual bonus Share matching scheme Long term incentive plan Incentivise delivery of Group objectives. Incentivise delivery of improved Group adjusted EPS and align with interests of shareholders. Incentivise long term delivery of TSR and EPS (adjusted for certain items) and align with interests of shareholders. Maximum percentage of base salary: Chief Executive and Finance Director 125%, other Executive Directors 100%. May elect to invest some or all of gross cash element of the annual bonus in shares. These can be matched on a 1:1 basis. Percentage of base salary: Chief Executive 200%, Finance Director 150%, other Executive Directors 100%. Financial Targets (100% base salary Chief Executive and Finance Director, 75% other Executive Directors). Strategic Targets (25% base salary for all Executive Directors). Adjusted EPS growth. Performance period N/A 1 year 3 years 3 elements 3 years 50% adjusted EPS growth 25% TSR vs. FTSE % TSR vs. comparator group. 57

62 DIRECTORS REPORT: GOVERNANCE Directors Remuneration Report continued Base Salary Base salary is reviewed annually and is determined by the Remuneration Committee following detailed consideration of a number of factors including individual responsibilities, performance and external market data. It is set within a range around the market median of the comparator group to reflect the experience, responsibility, effectiveness and market value of the relevant executive. The comparator group of companies chosen remains the FTSE 50 excluding companies in the Financial and Pharmaceutical sectors with reference to the FTSE 30 excluding companies in the Financial and Pharmaceutical sectors. Base salary is the only element of the package used to determine pensionable earnings. Annual Bonus For the financial year ended 30 September 2008 the potential maximum bonus was 125 per cent of base salary for the Chief Executive and Finance Director and 100 per cent for other Executive Directors. The targets for the year were related to adjusted EPS growth and stringent, quantifiable strategic elements including volume growth and integration-related criteria, however, they are not disclosed as they are considered to be commercially confidential. During the year the Company achieved adjusted EPS of pence. In addition the strategic targets were met in part resulting in bonuses, as detailed in the table on page 60, being awarded to the Executive Directors. These payments represented per cent of base salary in respect of the Chief Executive and Finance Director and 90.1 per cent in respect of the other Executive Directors. Cash bonuses were also earned by other senior management for achieving relevant performance targets for the financial year to 30 September For the financial year ending 30 September 2009 the Remuneration Committee has determined that the potential maximum bonus will remain unchanged. The performance criteria continue to be based on financial targets in respect of 100 per cent of base salary for the Chief Executive and Finance Director and 75 per cent for other Executive Directors. The performance criteria for 25 per cent of base salary will be based on stringent, quantifiable strategic targets which are set each year and are subject to the achievement of the minimum threshold in respect of the financial targets. Any bonus earned up to 100 per cent of base salary for the Chief Executive and Finance Director and 75 per cent for other Executive Directors is paid in cash and is eligible for investment into the Share Matching Scheme as detailed on page 65. Any bonus payable in excess of this level is paid in shares which the Director is required to retain for a minimum of three years. These shares are not eligible for investment in the Share Matching Scheme. In support of the Group s key performance indicators, as set out on page 17, the Remuneration Committee has determined that the financial performance criteria for the financial year ended 30 September 2009 will be based on a matrix comprising Adjusted EPS and Group debt and that the strategic targets will be based on measures including volume growth and delivery of synergies from the Altadis integration. No element of the bonus is guaranteed. 58 Imperial Tobacco Group PLC 2008

63 Directors Emoluments for the Year Ended 30 September 2008 (Audited) Executive Directors Base Salary 2,460 2,515 Benefits Pension Salary Supplement Bonus 2,560 2,140 LTIP annual vesting 1 2,576 2,866 SMS vesting 2 1,877 2,092 9,788 9,945 Non-Executive Directors Fees Benefits 1 3 Subsidiary Board Fees 32 Consultancy fees Former Executive Directors Salary of former Executive Director Bonus of former Executive Director 68 Pension Salary Supplement of former Executive Director Consultancy fees to former Executive Director Subsidiary Board Fees LTIP vesting SMS vesting Benefits , Fees of former Non-Executive Directors Subsidiary Board Fees Total remuneration 12,889 10,945 Chief Executive s Committee Salary Benefits Pension Salary Supplement Bonus LTIP annual vesting SMS annual vesting ,047 2,150 1 Value of LTIP shares vesting in the year based on the prevailing closing share price on the day of exercise. 2 Value of SMS shares vesting on maturity based on the prevailing closing share price on the day of vesting. Key Management Compensation for the Year Ended 30 September 2008 (Audited) Short term employee benefits 7,609 6,648 Post-employment benefits Other long term benefits Termination benefits Share-based payment 3,265 2,669 11,238 9,

64 DIRECTORS REPORT: GOVERNANCE Directors Remuneration Report continued Emoluments by Individual Director (Audited) Base salary 000 Fees 000 Subsidiary Board fees 000 Consultancy fees 000 Bonus 000 Pension salary supplement Benefits in kind 2 Sub total LTIP SMS Total Base Salary/ Total Fees from /10/ Executive Directors Mr G Davis, Chief Executive 939 1, ,023 1, ,899 3,494 1,033 Mr R Dyrbus, Finance Director , ,642 2, Mr G L Blashill, Group Sales and Marketing Director ,239 1, Mrs A J Cooper, Corporate Development Director , Mr D Cresswell 4, Manufacturing Director ,435 Dr F A Rogerson 5, Corporate Affairs Director 1,315 2,460 2, ,335 2,576 1,877 9,788 9,945 2,581 Non-Executive Directors Mr I J G Napier, Chairman Mr J-D Comolli 6, Deputy Chairman Mr A G L Alexander 7, Vice Chairman Mr D C Bonham 8 76 Mr B F Bich Dr K M Burnett Mr C R Day 8 23 Mr M H C Herlihy Dr P H Jungels Mr C F Knott Ms S E Murray Mr B Setrakian Mr M D Williamson ,101 Former Directors Mr S Huismans Mr S T Painter Dr F A Rogerson , , Further details are contained in the Executive Directors pension section on page Benefits in kind principally include the provision of a company car and health insurance. 3 LTIP and SMS represent the value of awards vesting and LTIP options exercised in the year. 4 Mr D Cresswell retired from the Board on 31 December Dr F A Rogerson resigned from the Board on 27 June Dr F A Rogerson completed a handover period and his employment terminated on 27 June Mr J-D Comolli was appointed on 15 July 2008 and in addition to his Director s fees receives consultancy fees for services provided to the Group. 7 Mr A G L Alexander retired from the Board on 29 January Messrs D C Bonham and C R Day retired from the Board on 2 January 2007 and resigned from the Board on 16 February 2007 respectively. 9 Messrs B F Bich and B Setrakian were appointed on 25 April 2008 and 25 June 2008 respectively. 10 Includes payment in respect of chairmanship of Board Committees at an annual rate of 10, Mr S Huismans retired from the Board on 31 January However, Mr S Huismans received fees in connection with his Non-Executive Director appointments to Subsidiary Boards within the Reemtsma and Altadis Groups. 12 Mr S T Painter retired from the Board on 31 May 2000 but received fees on a consultancy basis and in connection with his Non-Executive Director appointments to Subsidiary Boards within the Reemtsma and Altadis Groups. 13 No sums were paid to any Director by way of taxable expenses allowances and no Directors waived their fees. 60 Imperial Tobacco Group PLC 2008

65 Directors Interests in Shares (Beneficial, Family and any Connected Persons Interests) (Audited) Contingent Rights to Ordinary Shares Ordinary Shares Sharesave Options (LTIP and SMS Shares) Total Interests 1/10/ /9/ /11/08 3 1/10/ /9/ /10/ /9/ /10/ /9/ /11/08 3 Executive Directors Mr G Davis 367, , ,300 1, , , ,464 1,011,214 1,011,214 Mr R Dyrbus 237, , , , , , , ,866 Mr G L Blashill 91, , , ,465 80, , , , ,511 Mrs A J Cooper 57, , , ,256 82, , , ,633 Mr D Cresswell 4 102, , , ,173 79, , , ,490 Non-Executive Directors Mr I J G Napier 5,600 10,281 10,281 5,600 10,281 10,281 Mr J-D Comolli 5 Mr A G L Alexander 6 132, , , , , ,710 Mr B F Bich Dr K M Burnett Mr M H C Herlihy 343 2,173 2, ,173 2,173 Dr P H Jungels 2,993 4,866 4,866 2,993 4,866 4,866 Mr C F Knott Ms S E Murray 993 1,802 1, ,802 1,802 Mr B Setrakian Mr M D Williamson 81 1,934 1, ,934 1,934 1 Or date of appointment if later. 2 Or date of retirement if earlier. 3 All Directors took up their rights in respect of the Rights Issue and the Contingent Rights have been adjusted to reflect the bonus element of the Rights Issue. 4 Mr D Cresswell retired from the Board on 31 December Messrs B F Bich, B Setrakian and J-D Comolli were appointed on 25 April 2008, 25 June 2008 and 15 July 2008 respectively. 6 Mr A G L Alexander retired from the Board on 29 January Includes 377 ordinary shares and 209 American Depositary Shares (ADSs), each ADS representing two ordinary shares. There have been no changes in these holdings since 30 September 2008, other than the share purchases by Mr B Bich pursuant to an irrevocable mandate given by Mr Bich to his brokers under which they purchase American Depositary Shares each month equivalent in value to his net Director s fees. Executive Share Retention To ensure the interests of management are aligned with those of shareholders, Executive Directors and senior management are required to meet minimum shareholding guidelines. Over a period of five years from appointment they are required to build a holding in the Group s shares to a current minimum value broadly equivalent to three times base salary for the Chief Executive and Finance Director and twice base salary in respect of the other Executive Directors. Other senior management are expected to invest at a level equivalent to between once and twice base salary, dependent upon grade. Failure to meet the minimum shareholding is taken into account when determining eligibility for future LTIP awards. All Executive Directors currently exceed their required shareholding. Effects of the Rights Issue To take account of the effects of the Rights Issue completed in June 2008, adjustments were made to awards under the Group s share plans. In respect of the Share Matching Scheme, the Trustee sold sufficient rights nil paid to enable the balance of the rights to be taken up, using the proceeds of the sale. The newly acquired shares were allocated pro-rata to the relevant participants and will be released on the same basis as the awards to which they relate. In the case of the savings-related Sharesave Plan and the LTIP, the Remuneration Committee adjusted the number of shares under option, or subject to awards, and in the case of the savings-related Sharesave Plan, the price at which the shares may be acquired was also adjusted. These adjustments were made in accordance with the scheme or plan rules. The Group s Auditors performed their agreed upon procedures on the adjustments as required by those rules. Where appropriate the adjustments were approved by the relevant tax authorities. Long Term Incentive Plan (LTIP) Annual awards are made under the LTIP to Executive Directors and other senior management. These awards vest three years after grant, subject to the satisfaction of performance criteria over the relevant three year performance period. All grants are at the discretion of the Remuneration Committee and no employee has a right to receive any such grant. Awards granted prior to November 2005 were equivalent to 75 per cent of base salary for all Executive Directors and at a lower level for other senior management. Following a comprehensive remuneration review in 2004, and subsequent shareholder approval at the 2005 AGM, awards made in November 2005, November 2006 and October 2007 were equivalent to 200 per cent of base salary for the Chief Executive, 150 per cent for the Finance Director and 100 per cent for the other Executive Directors with awards at a lower level for other senior management. 61

66 DIRECTORS REPORT: GOVERNANCE Directors Remuneration Report continued Current Structure From November 2005 the performance criteria for all awards were split into three elements as follows: First Element Fifty per cent of the award with a performance criterion based on average growth in adjusted Earnings Per Share based on an agreed protocol (EPS), after adjusting for inflation over the period of the award. At the Remuneration Committee s request the Auditors performed agreed upon procedures on the calculations per cent of this element (i.e per cent of the total award) vests if average annual EPS growth, after adjusting for UK inflation (Real Annual EPS Growth), equals 3 per cent and 100 per cent of this element (i.e. 50 per cent of the total award) vests if Real Annual EPS Growth equals or exceeds 10 per cent. Between these two points this element vests on a straight-line basis. Second Element Twenty five per cent of the award with a performance criterion based on Total Shareholder Return (TSR) relative to the FTSE 100 Index as described below. The performance criterion for this element is based on a sliding scale depending on TSR achieved over the relevant period. No vesting of this element occurs unless the Company s TSR ranks it in the top 50 of the companies constituting the FTSE 100 Index. At this performance threshold 30 per cent of this element (i.e. 7.5 per cent of the total award) vests. If the return ranks the Company in the top 25 of the Index, this element (i.e. 25 per cent of the total award) vests in full. Between these thresholds this element vests on a straight-line basis. Third Element Twenty five per cent of the award with a performance criterion based on TSR relative to a bespoke comparator group as described below. The performance criterion for this element is also based on a sliding scale depending on TSR achieved over the relevant period. No vesting of this element occurs unless the Company s TSR exceeds that of the bottom six companies constituting the comparator group comprising 12 tobacco and alcohol companies as detailed below. At this performance threshold, 30 per cent of this element (i.e. 7.5 per cent of the total award) vests. If the return ranks the Company in the top three of the comparator group, this element (i.e. 25 per cent of the total award) vests in full. Between these thresholds this element vests on a straight-line basis. The proposed comparator group for the November 2008 award is: Altria Group Inc. British American Tobacco PLC Carlsberg A/S Diageo PLC Heineken N.V. Imperial Tobacco Group PLC Interbrew S.A. Japan Tobacco Inc. Philip Morris International Inc Pernod Ricard S.A. Reynolds American Inc. SABMiller PLC If one of the comparator group companies is acquired prior to the granting of an award a suitable replacement will be made. For any corporate actions affecting a comparator group company during an award period the intention would be to mirror the actions of a passive investor, e.g. for an equity bid the new shares offered in exchange for the original company would be held for the remainder of the award period. The TSR calculations use share prices averaged over a period of three months to determine the initial and closing prices rather than those ruling on a single day. It is assumed that the cash flow of dividend payments is recognised on the date the shares are declared ex-dividend. This method is considered to give a fairer and less volatile result as improved performance has to be sustained for several weeks before it effectively impacts on the TSR calculations. All share prices and dividend flows are converted to sterling on the applicable date to ensure that the calculations reflect the return achievable by a UK based investor. The TSR calculations themselves are performed independently by Alithos Limited. Each element operates independently and is capable of vesting regardless of the Company s performance in respect of the other elements. During the year the Remuneration Committee reviewed the performance criteria, award policy, comparator groups and vesting schedules for LTIP awards and decided that, notwithstanding the current conditions in financial markets, the three elements remain the most important measures that drive and measure sustainable improvement in shareholder value. The TSR criteria reflect comparative performance against the appropriate FTSE sector and the bespoke comparator group of companies. The EPS criterion reflects a key part of the Group s strategy to create sustainable shareholder value. Awards Under the Historical Structure For awards granted between December 2000 and November 2004, EPS growth was the sole performance criterion. This was seen as focusing on the financial performance of the business, over which Directors and senior management could exercise influence. These awards vested on a sliding scale depending on average growth in basic EPS adjusted under the terms of the relevant protocol. The EPS calculations were confirmed by the Auditors. For awards granted between 2000 and 2002 no vesting occurred unless the Company s Real Annual EPS Growth was positive. For awards granted in 2003 and 2004 no vesting occurred unless the Company s Real Annual EPS Growth exceeded 3 per cent. Full vesting occurred if Real Annual EPS Growth was equal to or exceeded 10 per cent. Between these two points the award vested on a straight-line basis. 62 Imperial Tobacco Group PLC 2008

67 Vesting of Awards On vesting a participant is granted an option to acquire the relevant number of shares. The option may be exercised at any time up to the seventh anniversary of its date of grant. Within this framework, for senior managers based outside the UK, the vesting process may be amended to conform to local tax and securities legislation. There is no opportunity to re-test if any of the performance criteria are not achieved. The Remuneration Committee has absolute discretion to vary, but not increase, the extent to which any awards vest. This ensures that they only vest, and vest at an appropriate level, if there has been an improvement in the underlying financial performance of the Company, including the maintenance of long-term return on capital employed. Under the LTIP Rules, in the event that Imperial Tobacco Group PLC is acquired the relevant performance period would come to an end on the date of acquisition. Any outstanding awards would vest on a time pro-rata basis, subject to the achievement of the applicable performance criteria. Award Summary Award Years Award as Percentage of Base Salary Performance Criteria for all Executive Directors 100 per cent on TSR for all Executive Directors 100 per cent on EPS 2005 onwards 200 for Chief Executive 150 for Finance Director 100 for other Executive Directors 50 per cent on EPS 25 per cent on TSR against FTSE per cent on TSR against comparator group Executive Directors Conditional Share Awards under the Long Term Incentive Plan (Audited) Market price at date of Vested Rights Market price at date of Market price at date of Amount Lapsed realised on Balance at Granted grant during year issue vesting exercise during exercise 1/10/2007 during year Date of grant (9/11/2007) adjustment year 000 Performance period November November Mr G Davis 42,513 09/11/ (39,014) (3,499) 1, ,594 02/11/ , , ,929 01/11/ , , ,730 31/10/ ,578 88, ,036 76,730 (39,014) 39,724 (3,499) 302,977 Mr R Dyrbus 26,974 09/11/ (24,754) (2,220) ,975 02/11/ ,937 52, ,810 01/11/ ,460 49, ,247 31/10/ ,318 40, ,759 35,247 (24,754) 18,715 (2,220) 142,747 Mr G L Blashill 8,600 09/11/ (7,892) (708) ,981 02/11/ ,316 25, ,001 01/11/ ,169 24, ,163 31/10/ ,589 19, ,582 17,163 (7,892) 9,074 (708) 69,219 Mrs A J Cooper 9,773 09/11/ (8,968) (805) ,003 02/11/ ,962 14, ,731 01/11/ ,072 15, ,368 31/10/ ,620 19, ,507 17,368 (8,968) 6,654 (805) 50,756 Mr D Cresswell 2 19,351 09/11/ (17,758) (1,593) ,981 02/11/ , ,463 01/11/ , ,795 (17,758) (1,593) 42,444 1 Or date of retirement if earlier. 2 Mr D Cresswell retired from the Board on 31 December Balance at 30/9/ There have been no changes in any Directors awards since 30 September 2008, other than the vesting of the November 2005 November 2008 award detailed below. 63

68 DIRECTORS REPORT: GOVERNANCE Directors Remuneration Report continued During the year, the November 2004 November 2007 award vested partially. Real Annual EPS Growth over the period averaged 9.42 per cent, resulting in partial vesting of the award. The remaining shares under award therefore lapsed. In respect of the November 2005 November 2008 award, the first to be granted under the current structure described above, based on EPS and TSR performance to the end of the financial year, partial vesting of 93.9 per cent of the first element, 77.6 per cent of the second element and none of the third element vested on 25 November For illustrative purposes only, the share price on 24 November 2008, being the latest practicable date prior to publication, was valuing the awards as follows: Award lapsing No. of shares Award vesting No. of shares over which option granted Award vesting Illustrative value 000 Mr G Davis 37,436 73,734 1,163 Mr R Dyrbus 17,818 35, Mr G L Blashill 8,519 16, Mrs A J Cooper 5,039 9, The value of any options exercised could vary significantly from that shown due to share price movements. The Remuneration Committee regards the November 2006 November 2009 and the November 2007 November 2010 awards to be too distant from maturity to be included in the value projected above. However, in respect of the award, based upon interim measurement calculations prepared as at 30 September 2008 full vesting of the first element, partial vesting of 72.0 per cent of the second element and none of the third element would occur if this performance were maintained over the relevant performance period. In respect of the award based upon interim measurement calculations prepared as at 30 September 2008 partial vesting of 97.0 per cent of the first element, 63.6 per cent of the second element and 53.3 per cent of the third element would occur if this performance were maintained over the relevant performance period. The illustrative values based on the above share price and performance criteria are as follows; Potential awards vesting November 2009 November 2010 Illustrative value Illustrative value No. of shares 000 No. of shares 000 Mr G Davis 70,380 1,110 68,631 1,082 Mr R Dyrbus 33, , Mr G L Blashill 16, , Mrs A J Cooper 10, , Evidence of the Group s sustained performance on a TSR basis when compared with the FTSE 100 Index is set out below. Total Return Indices Imperial Tobacco and FTSE Imperial Tobacco FTSE Sep 03 Sep 04 Sep 05 Sep 06 Sep 07 Sep 08 The FTSE 100 Index is seen to provide the most appropriate and widely recognised index for benchmarking the corporate performance of the Company, which is a constituent of that index and reflects the benchmark index used as an LTIP performance criterion. 64 Imperial Tobacco Group PLC 2008

69 Share Matching Schemes (SMS) Under the SMS the Remuneration Committee at its absolute discretion invites Executive Directors and the majority of the Group s management to invest any proportion of their gross bonus (capped at 100 per cent of base salary for the Chief Executive and Finance Director and 75 per cent for other Executive Directors) in Imperial Tobacco Group PLC ordinary shares to be held by a nominee managed by the Employee Benefit Trust. Provided that the shares lodged are left with the nominee for three years and the participant remains an employee in the Group, they will be matched on a one for one basis. Employees can vote shares held in the nominee by giving written instructions to the nominee. In respect of investments made by Executive Directors under the SMS a performance criterion is applied to the matched shares such that matching only occurs if the Group has achieved Real Average EPS Growth in excess of 3 per cent after adjusting for UK inflation over the three year retention period, being an indicator of sustained ongoing profit delivery. Achievement measurement is based on the same protocol as that applying to the LTIP. There is no opportunity to re-test if this performance criterion is not met. In setting the performance criterion for SMS awards, the Remuneration Committee decided that EPS reflects a key part of the Group s strategy to create sustainable shareholder value. Under the SMS Rules, should Imperial Tobacco Group PLC be acquired, the performance period would come to an end on the date of acquisition. Any outstanding awards would vest on a time pro-rata basis, subject to the achievement of the applicable performance criteria. The Executive Directors contingent rights to shares arising under the SMS are set out below: Executive Directors Contingent Rights to Shares under the Share Matching Schemes (Audited) Balance at 1/10/2007 Contingent rights arising Market price at date of grant 15/2/2008 Vested during year Rights issue adjustment Market price at date of vesting 29/01/2008 Amount realised on vesting 000 Balance at 30/9/ Actual/expected vesting date Mr G Davis 36,059 (36,059) January ,698 4,187 35,885 February ,601 2,722 23,323 February , ,418 37,859 February ,358 33,441 (36,059) 11, ,067 Mr R Dyrbus 22,947 (22,947) January ,111 2,657 22,768 February ,073 1,727 14,800 February , ,804 24,030 February ,131 21,226 (22,947) 7, ,598 Mr G L Blashill 9,211 (9,211) January ,701 1,413 12,114 February ,360 1,237 10,597 February , ,548 13,262 February ,272 11,714 (9,211) 4, ,973 Mrs A J Cooper 10,984 (10,984) January ,988 1,320 11,308 February ,777 1,027 8,804 February , ,326 11,366 February ,749 10,040 (10,984) 3, ,478 Mr D Cresswell 2 14,893 14,893 January ,109 13,109 February ,376 9,376 February ,378 37,378 1 Or date of retirement if earlier. 2 Mr D Cresswell retired from the Board on 31 December There have been no changes in any Directors contingent rights since 30 September During January 2008, annual bonuses earned in the financial year to 30 September 2004 and lodged under the SMS for a three year period matured, providing matched shares for participants on a one for one basis. In respect of annual bonuses earned in the financial year to 30 September 2007 and paid in December 2007, the Executive Directors elected, in February 2008, to invest their entire bonus in the form of Imperial Tobacco Group PLC ordinary shares under the SMS. These will be matched on a one for one basis provided they are left in the SMS for three years, the participant remains an employee in the Group and the Company has achieved in excess of 3 per cent Real Annual EPS Growth over the retention period. This performance criterion and the award policy and vesting schedules were reviewed by the Committee during the year and deemed to remain appropriate. These matching shares are shown within contingent rights arising above. 65

70 DIRECTORS REPORT: GOVERNANCE Directors Remuneration Report continued It is anticipated that, in February 2009, the Executive Directors will again invest their entire Financial Targets element of annual cash bonus earned in the financial year to 30 September 2008 in the form of Imperial Tobacco Group PLC ordinary shares under the SMS. Share Options The Company does not operate an executive share option scheme. However, Executive Directors are eligible (along with all employees of the Company and participating subsidiaries of the Group, where possible) to participate in Imperial Tobacco Group PLC s savings-related Sharesave Plan. Under this Plan options are granted, at a discount of up to 20 per cent to the closing mid-market price of an Imperial Tobacco Group PLC ordinary share on the London Stock Exchange on the day prior to invitation, to participants who have contracted to save up to 250 per month over a period of three or five years. Executive Directors Share Options (Audited) Balance at 1/10/2007 Granted during the year Rights issue adjustment Exercised during the year Market price at date of exercise 19/08/2008 Balance at 30/9/ Exercise price (rebased where appropriate) Range of exercisable dates of options held at 30/9/ Gains on exercise 3 During the year 000 Mr G Davis (890) /08/08 31/01/ /08/12 31/01/ /08/11 31/01/12 1, (890) Mr R Dyrbus /08/09 31/01/ /08/10 31/01/ Mr G L Blashill /08/08 31/01/ /08/11 31/01/ ,465 Mrs A J Cooper /08/09 31/01/ Mr D Cresswell /08/10 31/01/ Or date of retirement, if earlier. 2 Any option not exercised by the end of the range of exercisable dates will expire. 3 Gains made on exercise, calculated as the difference between the exercise price and the market price on the date of exercise. Aggregate gains during the year were 10,226 (2007: 47,557). 4 Mr D Cresswell retired from the Board on 31 December There have been no changes in any Directors share options since 30 September The Company s middle market share price at the close of business on 30 September 2008, being the last trading day of the financial year, was and the range of the middle market price during the year was to ( unadjusted for the rights issue). Full details of the Directors share interests are available for inspection in the Register of Directors Interests at the Company s registered office. Award Dates It is the Group s policy to grant awards under all its employee share plans on predetermined dates based on an annual cycle Imperial Tobacco Group PLC 2008

71 Employee Benefit Trusts The Imperial Tobacco Group Employee and Executive Benefit Trust (the Executive Trust) and the Imperial Tobacco Group PLC 2001 Employee Benefit Trust (the 2001 Trust) have been established to acquire ordinary shares and American Depositary Shares in the Company, by subscription or purchase, from funds provided by the Group to satisfy rights to shares and American Depositary Shares arising on the exercise of share options and on the vesting of the SMS and LTIP awards. Details of the shareholdings by the Employee Benefit Trusts are as follows: Balance at 1/10/2007 Purchased during year Distributed during year Balance at 30/9/2008 Shares under Award at 30/9/2008 Surplus/ (Shortfall) Executive Trust 994, , ,080 1,101, , , Trust 3,761,126 1,245,014 1,201,443 3,804,697 4,523,942 (719,245) As at 30 September 2008, the Company also held 51,717,000 shares in Treasury which may be used to satisfy options and awards under its share plans. Options and awards may also be satisfied by the issue of new shares directly from the Company. Share Plan Flow Rates The Company s policy has always been to satisfy all awards under its share plans from market purchased shares through the Trusts. The Trust Deeds and the Rules of all plans contain provisions limiting awards to 5 per cent in five years and 10 per cent in ten years for all employee share plans with an additional restriction to 5 per cent in ten years for executive plans. Currently an aggregate total of only 0.51 per cent of the Company s issued share capital is subject to awards under all the Group s executive and all employee share plans. In future the Trusts may also be provided with shares held by the Company in Treasury in order to satisfy vesting awards. Since demerger in 1996 the cumulative awards under all of the Company s share plans total 2.4 per cent of its issued share capital. Following initial grants on demerger, subsequent annual grants have averaged 0.3 per cent of issued share capital. Summary of Awards Granted Limit on awards Cumulative Awards granted as a percentage of issued share capital Awards granted during the year as a percentage of issued share capital 10% in 10 years % in 5 years % in 10 years (executive schemes) Executive Directors Pensions Post 6 April 2006 ( A day) the Group s UK pension policy, which applies to all current Executive Directors, provides the option to maintain membership of or join (new employees) the UK Imperial Tobacco Pension Fund or receive a salary supplement in lieu of membership of the Fund. The Executive Directors are all members of the Imperial Tobacco Pension Fund, the principal defined benefit scheme operated by the Group. For members who joined prior to 1 April 2002 the fund is largely non-contributory with a normal retirement age of 60. The fund allows members to achieve the maximum pension of two-thirds of their salary at normal retirement age usually after 32 years service. Pension commutation to enable participants to receive a lump sum on retirement is permitted. For death before retirement a capital sum equal to four times salary is payable together with a spouse s pension of two-thirds of the member s expected pension at retirement. For death in retirement, a spouse s pension of two-thirds of the member s pre-commutation pension is payable. Dependent children will also receive allowances. Pensions increase annually by the lesser of 10 per cent and the increase in the Retail Prices Index, together with an option under the rules to surrender part of a pension in order for the annual increase to be in line with the increase in the Retail Prices Index to 15 per cent. From 6 April 2006 a new tax regime was introduced by HM Revenue & Customs (HMRC) which abolished most of the detailed limits previously imposed on pension schemes and replaced them with a more simplified approach. Each member now has a Lifetime Allowance (LTA), 1.65 million for retirements in the tax year 2008/2009 and a tax, called the lifetime allowance charge, is levied at retirement if the value of their pension benefit from all sources exceeds this amount. For any member whose total benefit value on 6 April 2006 exceeded the LTA, transitional arrangements allowed them to register the higher value so that they would not be subject to a large retrospective lifetime allowance charge. To qualify for this enhanced protection the member was required to opt out of fund membership as regards future service accrual in order to retain a final salary linked pension entitlement in respect of past service. All Executive Directors earn benefits on the standard scale with a normal retirement age of 60. Other than Mrs A J Cooper, each of the current Executive Directors has opted out of fund membership as regards future service accrual as a result of registering for enhanced protection with HMRC. The detailed HMRC rules governing enhanced protection mean that it may not be permissible in some rare circumstances for the full final salary linked pension based on service up to 6 April 2006 to be paid from the fund. In this event an additional pension will be paid by the Company through an unfunded unapproved retirement benefit scheme (UURBS) so that the full accrued benefit may be provided. 67

72 DIRECTORS REPORT: GOVERNANCE Directors Remuneration Report continued Mr R Dyrbus is in receipt of a salary supplement of 35 per cent of salary, which is in lieu of future pensionable service accrual and arises because his accrued pension on 6 April 2006 was well below the maximum pension of two-thirds of salary. Mrs A J Cooper is also in receipt of a salary supplement. Prior to 6 April 2006 her pension benefits were limited by the effect of HMRC s earnings cap. Although this cap was removed as from 6 April 2006, the Imperial Tobacco Pension Fund did not disapply it in respect of past pensionable service but maintained its own earnings cap going forward. For service from 6 April 2006 onwards and for pensionable salary in excess of the Fund s earnings cap, the standard Fund benefit is a pension at the lower accrual rate of 1/60ths with a 50 per cent spouse s pension and member contributions of 5 per cent of this top slice of salary are payable. As an alternative to extra pension accrual on this top slice of salary through the UURBS, Mrs Cooper receives a salary supplement of 12 per cent of this amount. In each case these salary supplements have been calculated by the independent actuaries to reflect the value of the benefits of which they are in lieu and are discounted for early payment and for employers National Insurance contributions. The supplements are non-compensatory and non-pensionable. The following table provides the information required by both the Listing Rules and schedule 7A to the Companies Act 1985 and gives details for each Director of: > the annual accrued pension payable on retirement calculated as if he had left service at the year end (any potential UURBS entitlement is included); > the increase in accrued pension during the year, excluding any increases for inflation in respect of the disclosure required under the Listing Rules; and > the transfer value of the increase in accrued pension calculated in accordance with the actuarial guidance note GN11. None of the Directors has made additional voluntary contributions. Executive Directors Pension Disclosures (Audited) Disclosures required under Directors Remuneration Report Regulations 2002 Listing Rules Accrued pension 000 Transfer value of accrued pension 000 Increase in accrued Age at 30/9/2008 Pensionable service at 30/9/2008 At Increase during the At At Increase/ (decrease) during the year net of Directors Director s At pension (net of inflation) during the year Transfer value of increase (net of inflation) Years Years 1/10/2007 year 30/9/2008 1/10/2007 contributions contribution 30/9/ Mr G Davis ,061 (467) 9, Mr R Dyrbus ,185 (213) 3, Mrs A J Cooper Mr G L Blashill ,206 (401) 4, Former Director Mr D Cresswell ,799 (650) 4, Mr Cresswell retired from the Board on 31 December Mr Cresswell and Mr Blashill drew pension during the course of the year, as is permitted under the fund rules. Mr Cresswell left employment on 31 December 2007, and Mr Blashill was still in employment as at 30 September The transfer value figures in the table above incorporate allowance for the benefits paid out in order to provide a relevant comparison with the start of the year figures and have been calculated consistently with those disclosed at 30 September As at 30 September 2007, a slightly different methodology was used to calculate transfer values for pensioner members and this gave transfer values at 30 September 2007 of 5,161,000 for Mr Cresswell and 5,728,000 for Mr Blashill. The accrued pensions at 30 September 2008 represent the benefits accrued, assuming that they first started to draw pension from that date (31 December 2007 for Mr Cresswell). This is consistent with those figures disclosed at 30 September The transfer values disclosed at 30 September 2008 have been calculated using the amended transfer value basis introduced in July 2008 following a review by the Scheme Actuary. The combined effect of changing market conditions over the course of the year and the revised basis has been to reduce transfer values, leading to some negative changes under the Directors' Remuneration Report Regulations 2002 despite the increase in accrued pensions. Other than including an allowance for the benefits drawn by Mr Cresswell and Mr Blashill during the year, the transfer values disclosed above do not represent the value of a potential liability of the pension scheme. Benefits The principal taxable benefits for Executive Directors are the provision of company cars and health insurance. Remuneration from other Non-Executive Directorships The Company recognises that external non-executive directorships are beneficial for both the Executive Director concerned and the Company. At the discretion of the Board, Executive Directors are permitted to retain fees received in respect of any such non-executive directorship. Each serving Executive Director is restricted to one external non-executive directorship and may not serve as chairman of a FTSE 100 company. Mr G Davis serves on the Board of Wolseley plc and received fees of 70, Imperial Tobacco Group PLC 2008

73 Executive Directors Service Agreements The service agreements for Mr G Davis and Mr R Dyrbus were entered into at the time of the demerger of the Company from Hanson Group and the provisions dealing with compensation on termination following a change of control in their service agreements reflect that. The service agreements for the other Executive Directors reflect the Company s established policy that Executive Directors have service agreements which are terminable on no more than one year s notice and that there is no entitlement to the payment of a predetermined amount on termination of employment in any circumstances. There are no liquidated damages provisions for compensation on termination within Executive Directors service agreements, save as set out in the table below. The Executive Directors service agreements do contain payment in lieu of notice provisions but these are at the Company s sole discretion. The Group is unequivocally against rewards for failure and, save in the limited respects referred to above, the circumstances of the termination and an individual s duty and opportunity to mitigate loss are taken into account in every case. The Group s policy is to stop or reduce compensatory payments to former Directors to the extent that they receive remuneration from other employment during the compensation period and that any such payments should be paid monthly in arrears. Under the Rules of the LTIP and SMS outstanding awards vest on termination for certain reasons, such as death, retirement, redundancy, the business or company in which the participant is employed ceasing to be part of the Group or on a change of control, on a time-related pro-rata basis and subject to satisfaction of the relevant performance criteria. If, however, the termination of employment is for a reason other than one of those specified in the Rules an individual s full award lapses. Executive Directors Service Agreements Executive Directors Date of contract Expiry date Compensation on termination following a change of control Mr G Davis 21 August 1996 Terminable on 52 weeks notice Payment of a liquidated sum calculated by reference to benefits receivable during the notice period Mr R Dyrbus 21 August 1996 Terminable on 52 weeks notice Payment of a liquidated sum calculated by reference to benefits receivable during the notice period Mr G L Blashill 28 October 2005 Terminable on 52 weeks notice No provisions Mrs A J Cooper 1 July 2007 Terminable on 52 weeks notice No provisions Remuneration Policy for Non-Executive Directors Fees for Non-Executive Directors are determined by the Board as a whole with regard to market practice and within the restrictions contained in the Company s Articles of Association. The remuneration of the Chairman is determined by the Board following recommendation from the Remuneration Committee. The Non-Executive Directors and the Chairman do not take part in discussions relating to their own remuneration. They receive no other material pay or benefits (with the exception of reimbursement of expenses incurred in connection with their directorship of the Company and provision of administrative support including the use of Company offices by the Vice Chairman Mr A G L Alexander (until his retirement on 29 January 2008)), do not participate in the Company s share plans, bonus schemes or incentive plans and are not eligible for pension scheme membership. To align further the interests of the Non-Executive Directors with those of shareholders, it was agreed that a proportion of their fees be applied, after statutory deductions, to purchase shares in Imperial Tobacco Group PLC. These shares are to be held by a nominee during the term of each Non-Executive Directorship. Exceptionally, in respect of Mr A G L Alexander (up to the date of his retirement), this requirement was waived due to his continued level of investment, as detailed above. Following his retirement from the Board in January 2006, Mr S Huismans remains a member of Supervisory Boards within the Reemtsma group. He was also appointed as a non-executive director of Altadis, S.A. upon its acquisition by the Group in January 2008 until 5 November Mr S Huismans receives additional remuneration for fulfilling such non-executive roles. Non-Executive Directors Letters of Appointment The Non-Executive Directors do not have service agreements with the Company. The terms of their appointments are reviewed annually. These terms were reviewed for all Non-Executive Directors and confirmed on 29 January The letters of appointment are available for viewing at the Company s registered office during normal business hours, and prior to and at the AGM. Under the terms of the Articles of Association of the Company, Non-Executive Directors stand for election at the first AGM following appointment and are subject to triennial re-election by shareholders. There are no provisions regarding notice periods in their letters of appointment which state that the Non-Executive Director will only receive payment until the date their appointment ends and, therefore, no compensation is payable on termination. The letters of appointment detail the time commitment expected of each Non-Executive Director. 69

74 DIRECTORS REPORT: GOVERNANCE Directors Remuneration Report continued Although currently there is no maximum term of appointment for Non-Executive Directors, the Board is supportive of the best practice provisions contained in the Code. However, where the Board considers a Non-Executive Director is making a particularly valuable contribution, they may be invited to remain on the Board in excess of nine years. In such instances the length of tenure of the Non-Executive Director would be relevant to the Company s deliberations as to the independence of the Non-Executive Director and he/she would also be subject to annual re-election at the AGM. Consultancy Agreement with Non-Executive Director Mr J-D Comolli In addition to his appointment as Non-Executive Deputy Chairman Mr Comolli has entered into an agreement with Imperial Tobacco Limited, the Group s principal operating company. Under this agreement he provides consultancy services to the Group and receives fees up to a maximum of 850,000 per annum. The agreement terminates on 31 January 2009 but may be renewed by mutual consent for further one year periods. In the event that Mr Comolli ceases to be Deputy Chairman, the agreement terminates with immediate effect but Mr Comolli would receive fees for the remainder of the relevant one year period. Remuneration Arrangements for Former Executive Directors Dr F A Rogerson Dr F A Rogerson resigned as a director on 27 June 2007 for personal and private reasons. Under his contract of employment, Dr Rogerson was required to give 12 months notice to terminate his employment. Dr Rogerson completed a handover period and was on compassionate leave until 27 June 2008, when his employment terminated. Dr Rogerson was excluded from the 2007/2008 bonus scheme and did not receive any bonus payment in respect of that bonus year. He was also excluded from any invitations to the LTIP and SMS from his Board resignation date. The Remuneration Committee agreed that the awards granted to Dr Rogerson under the LTIP and the shares awarded to him under the SMS would vest, to the extent that the applicable performance conditions were satisfied, pro rata for the period up to 31 December No compensation has been paid to Dr Rogerson in connection with the termination of his employment. Dr Rogerson opted out of pension fund membership as regards future service accrual as a result of registering for enhanced protection with HMRC from 6 April Dr Rogerson was in receipt of a salary supplement in lieu of future pension service accrual of 16.4 per cent of salary. This amount was a non-pensionable payment. It was agreed with Dr Rogerson that this salary supplement ceased to be paid on 30 December 2007 and that no salary supplement would be paid for the remainder of his notice period. Mr S T Painter Following his retirement in May 2000, Mr S T Painter entered into a consultancy agreement with Imperial Tobacco Limited, the Group s principal operating company. The agreement, as amended in October 2001 and May 2004, ran until March Under the terms of the agreement he provided consultancy services as required and received fees at a day rate of 1,000 with a minimum fee based on 100 days service for each 12 month period ending on 30 June, and 67 days for the period 1 July 2006 to 6 March Mr S T Painter is still providing consultancy services as required and receives fees at a day rate of 1,000. However, there is now no minimum fee. He is entitled to reimbursement for the use of his car. Mr S T Painter is also a member of Supervisory Boards within the Reemtsma and, between January and October 2008, Altadis groups for which he receives additional remuneration for fulfilling such non-executive roles. Mr M A Häussler Mr M A Häussler is currently in receipt of a retirement pension that has been reduced because it has been taken before he reached his normal retirement age. His service agreement with the Group provided that he would receive similar overall pension benefits to those that he would have received had he remained in the Reemtsma Cigarettenfabriken GmbH pension arrangement. This was a pension for life equivalent to 42 per cent of his fixed annual salary at age 63. For death in retirement, a spouse s pension for life of 60 per cent of that amount would be payable. The pension is made up of two parts: one part payable from the unfunded pension arrangement of Reemtsma Cigarettenfabriken GmbH, the other part payable from the separately funded Imperial Tobacco Pension Fund. The pension payable under the Reemtsma arrangement and from the Imperial Tobacco Pension Fund may be increased annually in accordance with the Rules of those arrangements, or as required by law. For the Board P H Jungels Chairman of the Remuneration Committee 26 November Imperial Tobacco Group PLC 2008

75 In this section: Independent Auditors Report to the Members of Imperial Tobacco Group PLC 72 Consolidated Income Statement 74 Consolidated Balance Sheet 75 Consolidated Statement of Recognised Income and Expense 76 Consolidated Cash Flow Statement 76 Accounting Policies 77 Critical Accounting Estimates and Judgements 83 Notes to the Financial Statements 85 Independent Auditors Report to the Members of Imperial Tobacco Group PLC 127 Imperial Tobacco Group PLC Balance Sheet 128 Notes to the Imperial Tobacco Group PLC Balance Sheet 129 Financial Statements